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Edited Transcript of WSC earnings conference call or presentation 15-Mar-19 2:00pm GMT

Q4 2018 WillScot Corp Earnings Call

LOS ANGELES Jun 13, 2019 (Thomson StreetEvents) -- Edited Transcript of WillScot Corp earnings conference call or presentation Friday, March 15, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bradley Lee Soultz

WillScot Corporation - President, CEO & Director

* Matthew Jacobsen

Williams Scotsman International, Inc. - VP of Finance

* Timothy D. Boswell

WillScot Corporation - CFO

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Conference Call Participants

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* Ashish Sabadra

Deutsche Bank AG, Research Division - Research Analyst

* Kevin Damien McVeigh

Crédit Suisse AG, Research Division - MD

* Manav Shiv Patnaik

Barclays Bank PLC, Research Division - Director & Lead Research Analyst

* Philip H. Ng

Jefferies LLC, Research Division - Equity Analyst

* Scott Andrew Schneeberger

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Sean-M Wondrack

Deutsche Bank AG, Research Division - VP & Senior Credit Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the WillScot Fourth Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to introduce your host for today's conference, Matt Jacobsen, Vice President of Finance. Sir, please begin.

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Matthew Jacobsen, Williams Scotsman International, Inc. - VP of Finance [2]

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Thank you, and good morning. Before we begin, I'd like to remind you we will discuss forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those forward-looking statements as a result of various factors, including those discussed in our press release and the risk factors identified in our Form 10-K filed with the SEC later today.

While we may update forward-looking statements in the future, we disclaim any obligation to do so. You should not place undue reliance on these forward-looking statements, all of which speak only as of today.

We'd like to remind you that some of the statements and responses to your questions in this conference call may include forward-looking statements. As such, they are subject to future events and uncertainties that could cause our actual results to differ materially from these statements. WillScot assumes no obligation and does not intend to update any such forward-looking statements.

The press release we issued last night, and the presentation for today's call, are posted on the Investor Relations section of our website. A copy of the release has also been included in an 8-K that we submitted to the SEC. We will make a replay of this conference call available via webcast on the company website.

For financial information that has been expressed on a non-GAAP basis, we have included reconciliations to the comparable GAAP information. Please refer to the tables and the slide presentation accompanying today's earnings release.

Lastly, this morning, we are filing our 10-K with the SEC for the 2018 fiscal year. The 10-K will be available through the SEC or on the Investor Relations section of our website.

Now with me today I have Brad Soultz, our President and CEO; and Tim Boswell, our CFO. Brad will kick off today's call with a brief overview of WillScot's strategy, summarize our fourth quarter and full year results and provide an update on our progress related to integration activities among other things. Tim will then provide additional detail on the financial results for the quarter and for the full year 2018 and discuss what we're seeing for 2019 before we open up the call for questions.

With that, I'll turn the call over to Brad.

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [3]

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Thanks, Matt, and welcome, everyone, to WillScot's Fourth Quarter and Full Year 2018 Conference Call.

First, turn to Slide 3. I'd like to provide a brief overview of the company, given that we have new investors and analysts joining us today. As a specialty rental service market leader, our mission is to provide innovative modular space and portable storage solutions. We focus on providing these solutions Ready to Work, so that our customers can forget about this space, focus on what they do best, working their project, being productive and meeting their goals.

We now provide these solutions to more than 50,000 customers with a fleet of over 150,000 units, which represent over 75 million square feet of temporary space through an unparalleled branch network of over 120 locations across the U.S., Canada and Mexico.

When we deliver an immediately functional space, productivity is all our customers see. This value proposition is unique in the industry. Our customers, including those new to us through recent acquisitions, are embracing it and it's driving our growth.

If you'll turn to Slide 4, our strategy has been to accelerate our already strong organic growth with accretive M&A. Just over a year ago we committed to doubling the company without overpaying or overleveraging. I'm pleased to report that we've delivered on that commitment, as evident in our fourth quarter 2018 revenue and adjusted EBITDA, which were up 114% and 104%, respectively, year-over-year.

In summary, we delivered on our commitments last year, and we expect to continue to do the same into the future.

We delivered $216 million of adjusted EBITDA in the full year 2018, which is slightly above the midpoint of our increased 2018 guidance, which we issued in October of 2018 and reaffirmed in January.

Looking forward, we believe we have a simple recipe to deliver the $345 million to $365 million of adjusted EBITDA organically in 2019, all the while delevering the business.

Importantly, we believe this outlook is largely within management's control due to the substantial cost synergies and organic earnings growth potential embedded in this portfolio.

I'd like to now point out 5 attributes underpinning this unique and fast-growing specialty rental services platform. First, we have significant revenue visibility given the trajectory at which we exited 2018, the 30-month average lease durations and the embedded growth from pricing and VAPS initiatives.

In the fourth quarter of 2018, our average monthly modular rental rates in our U.S. segment were 12.6% up on a year-over-year basis. This result is the same as the preliminary result included in our January Investor Update Call. This represents the fifth consecutive quarter of double-digit rate growth, and we expect this momentum to continue as we look ahead.

On the Ready to Work side, this value proposition continues to increase in penetration. If we simply continue to deliver new units at the current level of VAPS penetration, we will realize a greater than $140 million revenue opportunity over the next 3 years, as units which are currently on rent return are reequipped and redeployed. This represents a $15 million increase over the preliminary results communicated in our January Investor Update Call.

Our VAPS penetration levels are continuing to increase towards our longer-term stated goals, which we believe could provide additional upside over this time horizon. We'll share additional context on this important new development a bit later in the call.

Second, the ModSpace system integration is complete. We've now fully transitioned to realization of the $70 million of cost synergies attributed to the prior acquisitions. I'll remind, 80% of these cost synergies are expected to be included in our fourth quarter 2019 run rate, and we expect 90% of the associated cost to realize these synergies to be expensed in the first half of 19 with the related cash payments completed by Q4.

Third, from an accelerating adjusted EBITDA growth and margin expansion, we expect to achieve an adjusted EBITDA run rate of approximately $400 million, with EBITDA margins expanding to 35% as we exit 2019.

Fourth, the substantial cash flow generation due to the discretionary nature of our capital expenditures. At the midpoint of our 2019 guidance, we expect free cash flow to be a $140 million before growth CapEx and one-time cost associated with realizing these cost synergies. As previously noticed -- noted, we expect 90% of these cash payments to be completed by Q4 of '19.

Assuming we achieve our objective of $400 million adjusted EBITDA run rate, our discretionary free cash flow generation will be approaching $200 million annualized rate as we exit 2019.

And fifth, our net income and free cash flow generation in the second half of 2019 accelerates our deleveraging into 2020. These accelerating earnings and inherent cash flow characteristics of our platform provide confidence that by the second quarter of 2020, we expect to be at or below the 4x net debt to adjusted EBITDA, which is in line with our target net leverage range of 3 to 4x.

In summary, we remain committed to our goal of creating long-term shareholder value and are extremely excited about our future. We are confident in this outlook and believe achieving the run rate of $400 million adjusted EBITDA exiting 2019 is well within management's control, all while delevering the business.

Now if I turn to Slide 5, there's no other company that has the scope, scale, turnkey capability and service commitment to deliver like we do. For the combined business on a pro forma basis, our 2018 revenues were just over $1 billion, and our adjusted EBITDA would have been to $285 million. This is inclusive of our 3 acquisitions, Acton, Tyson and ModSpace, as if we own them for the entire period.

Approximately 90% of our revenues are generated in the U.S., serving a very diverse group of end markets, and over 90% of our adjusted gross profit is derived from our recurring leasing business.

Beyond our substantial scale advantage, there are 3 key attributes that really differentiate Williams Scotsman. First, Ready to Work. We've repositioned the business strategically with this unique value proposition through the expansion of our offering of value-added products and services or VAPS. Our customers value it and is driving our growth with highly accretive returns.

Second, we have a differentiated and scalable operating platform. Over the past several years we've invested in our people, processes and technology and created a highly scalable and differentiated operating platform, capable of asserting market leadership.

This operating platform includes sophisticated price management, capital allocation characteristics. We've leveraged this platform to swiftly and efficiently integrate acquired companies.

Third, we have very attractive unit economics, which provide a high degree of visibility into future performance. You'll recall, over 90% of our adjusted gross profit is derived from our recurring leasing business, which is underpinned by long-lived assets, typically 20-plus years, coupled with average lease durations of 30 months.

Now I'll direct you to Slide 6. In a little over 1 year, we've doubled the size of the company by leveraging the unique WillScot operating platform to further accelerate the already strong organic growth with highly accretive M&A.

As depicted in the boxes process above the arrow, our EBITDA has continued to accelerate since late November of last year where we recapitalized the company and returned to the public markets.

The full year 2018 adjusted EBITDA of $216 million is up 74% on a year-over basis and is just above the midpoint of our revised 2018 guidance issued last October.

Our fourth quarter 2018 revenues of $257 million and adjusted EBITDA of $74 million, which are up 114% and 104% respectively year-over-year better reflect the underlying business as this was the first full quarter that we owned ModSpace.

During the same period across the bottom, we joined the Russell 2000 all while making and integrating 3 acquisitions. Our execution in the ModSpace commercial, operational and systems integration on budget and earlier than scheduled enables us to begin to realize the $70 million of annualized cost synergies and over $140 million of annualized VAPS-related revenue growth potential.

As a part of this journey, we've combined forces with 3 outstanding peer companies and hundreds of talented people that are committed to bring our customers an expanded fleet of Ready to Work solutions. Tremendous effort has gone into safely and efficiently integrating these companies, and I'm extremely proud of the team and their accomplishments.

Now as we turn to Slide 7, I'd like to highlight the 2019 adjusted EBITDA guidance that we reaffirmed via press release last night. While Tim will take you through the full 2019 financial guidance in more detail, I'd like to highlight our adjusted EBITDA expectations.

We have a very simple recipe to deliver the $345 million to $365 million adjusted EBITDA organically in 2019 while delevering the business. First, ingredient one is already in place, given we've completed the ModSpace systems integration.

The second ingredient is to deliver the $70 million of associated cost synergies. The third agreement is to harmonize and further optimize rate, utilization and VAPS.

We're excited about the full year 2019 outlook and in particular the resulting adjusted EBITDA run rate of approximately $400 million, with EBITDA margins of 35% generating substantial discretionary free cash flow as we exit 2019.

Importantly, we believe this outlook is largely within our control. We delivered on our commitments last year and we expect to do the same going forward.

Turning to Slide 8, I'd like to just expand upon the aforementioned cost synergies related to the acquisitions. With the ModSpace systems integration complete, we've transitioned to cost synergy realization. These integrations required no changes to the WillScot operating platform, consistent with prior acquisitions and a further testament to the scalability of the platform.

There are over $70 million of annualized cost synergies associated with the acquisitions, over 80% of these cost synergies are expected to be included in our fourth quarter run rate, as mentioned before, the balance executed in 2020. And approximately 60% of these cost synergies are related to redundant headcount, with the balance split between branch, real estate consolidation and other nonpeople-related SG&A. It's a simple equation to deliver $70 million of annualized cost synergies.

In order to realize these cost synergies, we expect an additional $15 million to $20 million of integration and restructuring cost to be expensed. We anticipate more than 90% of these costs will be expensed in the first half of 2019, with the respective cash payments disbursed by the end of 2019.

We've made significant progress now evaluating the collective-owned real estate portfolio, which now totals $87 million of net book value, $29 million of which is associated with 19 surplus properties, which are now either listed for sale or soon will be. The remaining $58 million of net book value is associated with owned properties, which we are continuing to utilize.

Based upon this progress, we remain confident in our ability to realize $30 million of proceeds from selling surplus real estate throughout 2019 and 2020 with potential upside as we evaluate financing alternatives for the $58 million net book value associated with the owned properties we expect to continue to utilize on a go forward basis.

I would also note that there are other potential cost and fleet synergies, which are not yet quantified or otherwise included in the initial $70 million. A few examples of these incremental opportunities yet to be evaluated include branch scale efficiency, logistics optimization, sourcing and procurement and further fleet optimization.

Now as we turn to Slide 9, in addition to this $70 million of cost synergies, there's a $140 million of annualized revenue growth opportunity achievable over the next 3 years attributed to VAPS.

Focusing on the top-left set of bar charts, I'm delighted to confirm that we achieved an average rate of $250 of VAPS value per month across all office units delivered in 2018. This rate is up 26% over the LTM levels achieved the prior year and up 7% from the LTM levels the prior sequential quarter.

I'm particularly pleased with this result as the period includes deliveries to many new customers of the acquired customers.

You may recall, we began offering this solution to acting customers in the second quarter and to ModSpace customers early in the fourth quarter of 2018.

Our VAPS penetration levels are continuing to increase towards our long-term stated goals. And as noted before, we believe this could provide additional upside over this time horizon.

Now the math behind the $140 million of annualized revenue growth is simple. It's simply $123, which is the difference between the $250 of the average for the units delivered last year and $127, which is the average value for all units currently on rent times 12 months times approximately 95.5000 units, which are on rent, which equals $141 million. Many of these units on rent were delivered by acquired companies, which did not offer a Ready to Work solution.

Timing of the realization of this opportunity is simply paced by the time it takes for the units, which are currently on long-term leases, to return from their current lease and be reequipped and redeployed.

Increasing VAPS penetration will remain a key focus for the business. Aside from M&A, the expansion of the Ready to Work value proposition represents the fastest growing aspect of our business, with returns of greater than 40% unlevered IRRs.

This value proposition provides a turnkey solution to our customers, affording them the ability to focus on immediately getting on with their work. We expect demand for this value proposition to continue to increase over the next several years as we both expand our offering and increase penetration to legacy customers as well as new customers of the acquired businesses.

Turning to Slide 10, I'd like to provide a snapshot of the key U.S. leasing KPIs realized in the fourth quarter of 2018 since they are the primary foundation for the run rate, which we enter in 2019.

I'll first note that this slide is consistent with the preliminary data we shared during the January Update Call. I'm also representing the results on a pro forma basis, as this best reflects the underlying trajectory of the business.

First, on the top-left chart, Modular Space AMR of $563 was up 12.6% year-over-year in the Q4, representing the fifth consecutive quarter of solid double-digit rate increases. The increase is driven both by expanding VAPS penetration and WillScot price optimization tools.

In the left-middle chart, U.S. Modular Space utilization was up 290 basis points year-over-year to 75.3%, given our continued focus on rate optimization, VAPS expansion and capital allocation as we rebalanced the acquired idle fleet.

And in the lower-left chart, U.S. Modular Space units on rent were down a modest 1% in the fourth quarter as the company began executing major integration in fleet rebalancing activities across the branch network.

As previously mentioned, we expect unit on rent to remain down on a year-over-year basis through the first half of 2019, transitioning to a 1% year-over-year growth by the end of 2019.

Our primary focus throughout the integration in these subsequent periods of optimization was and remains: first, the safety of our colleagues; second, rate harmonization and optimization; third, VAPS penetration; and fourth, asset utilization.

As we look forward to 2019, we continue to see sustained double-digit year-over-year revenue growth on average rental rate as we drive pricing and value-added products across the combined portfolio.

Before turning it over to Tim, I'd ask you to turn your attention to Slide 11 in order to expand a bit upon our diverse end markets and our robust demand outlook. First, I'd like to direct you to the piechart in the bottom left of this slide, which depicts a further disaggregation of our customer profile. Our customer database is highly fragmented, with no individual customer representing more than 3% of our 2018 revenue and the top-50 customers representing less than 15% of the revenues.

Previously, we'd presented this customer data aggregated into 6 end market groups. We've now further disaggregated the construction, which are the dark green slices and the commercial and industrial groups, which are the black slices, in order to highlight the significant diversification underlying the portfolio. This data includes the WillScot legacy customers by SIC Code as well as those that have joined us through the recent acquisitions.

A few highlights at the end market level are, first, while construction and commercial industrial end markets collectively represent about 80% of our revenues, they're actually comprised of 11 discrete end markets providing for an overall very diverse end market mix. Second, no end market represents more than 17% of our revenues. Nonresidential general contractors, which is its largest group, is actually quite diverse in itself as these customers' construction projects are typically serving one of our other discrete end markets.

And finally, energy and natural resource end markets represent only 8% of our revenue and has remained stable over last several quarters.

The majority of the revenues from the customers in this end market segment associated with mid- and downstream energy, mining and other major utilities, which will continue to remain stable, as they have, for several years. Less than half of these revenues are associated with upstream oil and gas. These upstream markets bottomed several quarters ago, following the late 2014 decline in oil prices.

Our 2019 outlook simply assumes these upstream markets remains stable, although in the medium to longer term, an increase in oil prices would potentially be a catalyst for increased demand.

Overall, our demand outlook remains quite positive as we continue to see strength across the diverse end markets.

I'd also like to highlight a few relevant external forecast and indicators. First, the American Rental Association is forecasting a 5% annual revenue growth through 2020. Second, the AIA Consensus forecast is generally aligned with 3% to 5% growth over the same period. The ABI, which is Architectural Billing index, which has been a great leading indicator for nonres construction activity looking forward 9 to 18 months is -- was a strong 55.3 in January and has been positive for over 24 months.

Non-res construction starts on a square foot basis continues to remain supportive, with current levels just near long-term average. And finally, U.S. and Canada 2019 GDP forecast are for growth above 2%.

While largely not included in our outlook, we would expect any substantial U.S. infrastructure spending bills once approved and implemented to further underpin and strengthen many of our diverse end markets.

Based upon this demand outlook, we expect our net CapEx growth-related investments to be in the range of $30 million to $60 million in 2019. These investments are highly discretionary and assume continued end market strength and VAPS growth as we're currently expected.

We will be vigilant in maintaining our flexible capital strategy, investing to support growth as markets allow and balancing growth with long-term returns.

As a reminder, one of the key strengths of our business model is the discretion which we have over capital spending in the short term coupled with over 30-month average lease duration and long-lived assets, which together allow us to reduce capital spending and drive free cash flow to the extent markets don't support growth.

We have a disciplined quarterly process through which we control, reassess and allocate our capital.

With that, I'll hand it over to Tim, who will provide additional context.

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Timothy D. Boswell, WillScot Corporation - CFO [4]

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Thank you, Brad. And please turn to Slide 13. Q4 was an historic period for our company, marking the first full quarter of financial results delivered by the combined WillScot and ModSpace organizations.

While we did not realize any material cost synergies related to ModSpace in Q4, you can begin to see the organic growth and operating leverage in the combined business, which we expect will continue to build each quarter in 2019.

In the top charts, we show our year-over-year revenue and EBITDA growth as they are reporting our financial statements. Revenues were up 113.6% and, adjusted EBITDA was up 103.6% versus prior year.

Obviously in Q4 2017 we did not own Tyson or ModSpace, and we only owned Acton for the last 11 days of the quarter, so the bulk of the growth is coming from the full contribution of those acquisitions in Q4 2018.

And the net result was $73.5 million of adjusted EBITDA, which, as Brad said, is slightly above the midpoint of the Q4 range, implied by the annual guidance that we increased in October incorporating ModSpace.

While straightforward, the top charts reinforce 2 important points. First, we've more than doubled the size of the business in the last 12 months and are entering 2019 on a substantially higher earnings trajectory after seamlessly executing 3 acquisitions.

Secondly, the operating leverage is not immediately obvious because prior to any cost synergy realization, both Acton and ModSpace initially were dilutive to margins, with contribution to adjusted EBITDA of less than 25%. Margins actually declined 140 basis points on an as-reported basis from 30% in Q4 2017 to 28.6% in Q4 2018 due to this dilution from ModSpace relative to where our legacy WillScot business was operating. I'll talk about this a bit more when we go into the U.S. segment results.

The bottom charts look at revenue and adjusted EBITDA on a pro forma basis, and they paint a clear picture of what's going on. First, overall, pro forma revenue growth of 3% appears modest, but masks a significant and intentional shift in revenue mix away from equipment sales to reoccurring leasing revenues in our U.S. segment.

Modular leasing revenues are up 18% year-over-year on a pro forma basis, more than offsetting an 18% decline in equipment sales. And sales represented only 11% of total revenue in Q4, with the remainder coming from our leasing operations. This resulted in a $7 million net increase in revenue, a $5.3 million increase in adjusted EBITDA and 140 basis points of adjusted EBITDA margin expansion on a pro forma basis. Again, that's with no material cost savings yet coming out of ModSpace.

This pro forma view is quite helpful because it demonstrates both the net impact of the revenue mix shift as well as the operating leverage that we expect will become more pronounced as we operate the fully integrated business.

Continuing that point on Slide 14, we expect that this mixed shift towards higher-quality leasing revenue to continue, and our organic adjusted EBITDA growth to accelerate in 2019.

At the midpoint of our guidance ranges, we expect total revenues will be up 3.3%, with leasing revenues offsetting a $30 million to $50 million decline in sale revenue, and adjusted EBITDA will increase 24.6% on a pro forma basis at the midpoint.

You'll recall that ModSpace executed a hurricane relief project in Q3 2018, which generated $30 million of revenue. So that accounts for the majority of the expected decline in pro forma sale revenues in 2019. And if I adjust for that, the pro forma revenue growth exceeds 6% and adjusted EBITDA would be up over 28% organically, again, at the midpoints.

I'll again highlight the substantial margin expansion we expect to deliver in 2019 and carry into 2020. While Acton and ModSpace were dilutive to EBITDA margins initially relative to our legacy WillScot business, those deals give us the scale that allows us to expand margins rapidly beyond where any of the companies could have achieved independently.

We expect adjusted EBITDA margins to expand over 500 basis points in 2019 on a pro forma basis at the midpoint of our ranges. And our target margin of approximately 35% in Q4 2019 would be up approximately 640 basis points versus our Q4 2018 result.

Relative to the Q4 starting point of 28.6%, again, that's our adjusted EBITDA margin in the quarter, I'd expect some modest expansion quarter-to-quarter in Q1 as cost synergies offset what is typically a softer quarter from a margin standpoint. And then over 100 basis points of expansion each quarter thereafter with the larger quarter-to-quarter and year-over-year increases coming in Q3 and Q4.

As we said on our January call, as we execute this plan, our financial profile shifts significantly, with consistent net income generation, accelerating free cash flow generation and adjusted EBITDA run rate of approximately $400 million and margins of 35% heading into 2020.

Sitting here in March with another eventful quarter behind us, our original plan since the announcement of the ModSpace transaction 9 months ago are on track.

On Slide 15, we have our usual reconciliation of net loss to adjusted EBITDA. While we believe adjusted EBITDA is the best indicator of our operating performance, we remain bottom line focused and expect to improve that bottom line steadily throughout 2019.

While net loss did improve by over $96 million in 2018 versus prior year, it was obviously a transitional year, to say the least, with over $86 million of transaction, integration and restructuring costs incurred related to our acquisition and refinancing activity.

That said, as Brad mentioned, those costs are largely behind us, with only $15 million to $20 million of integration and restructuring charges remaining related to ModSpace.

And if we look at the right-hand column of the reconciliation, it's easy to bridge how the business will transition to consistent net profitability after isolating the $30 million of transaction-related items in the Q4 and prior to the realization of any ModSpace cost synergies or future growth.

On Slide 16, Brad already highlighted the fundamental leasing KPIs in the U.S. segment. In the top-left chart, our U.S. office fleet on rent increased 129% versus prior year to over 86,000 units, primarily due to acquisitions. The right-hand chart show our results on a pro forma basis, as if we had owned Acton, Tyson and ModSpace in 2017.

In the top right, utilization is up 290 basis points year-over-year, while average units on rent were basically flat organically through the course of 2018 and down 1% year-over-year in Q4 as we enter January.

In the bottom right, as we've highlighted for some time, average rental rates inclusive of value-added products were up 12.6% in Q4, representing our fifth consecutive quarter of double-digit year-over-year increases in the U.S. segment.

As significant as those increases have been, we believe that we have multiple levers at our disposal that will allow us to continue this rate growth trend through 2019 while we rationalize our fleet and branch network.

Slide 17 goes into a bit more detail on the U.S. segment revenue and adjusted EBITDA performance, which is frankly driving the trends that I already discussed at the consolidated level. In the top-left chart, you see Q4 revenue growth was up 4.4% versus prior year on a pro forma basis, so growing faster organically than the overall consolidated result.

And in the bottom left chart, you see adjusted EBITDA on an as-reported basis ramping due to our acquisitions, organic growth and synergy realization related to Acton.

I'll note, you see 2 consecutive quarters of margin contraction, from Q2 to Q3 to Q4. That is entirely expected and due to the inclusion of ModSpace, whose revenues contributed approximately 24% to our adjusted EBITDA.

As I said earlier, we expect that trend will reverse in 2019 and head to 35% by Q4 2019 as we execute our plans.

Those that were with us last year will recall the exact same phenomenon in Q1 of 2018, which you can see in the bottom-left chart. When margins dipped in the first full quarter after the Acton acquisition and then rebounded in Q2 before the inclusion of ModSpace revenue in Q3 and Q4. So all you are seeing Q4 is the revenue weighted average margin of 2 recently combined businesses prior to synergy realization. Now with the integration complete, we expect those margins will climb to 35% by Q4 2019.

Moving to Slide 18, we'll look at our Other North America segment, which includes operations in Canada, Alaska and Mexico. We are, again, showing pro forma metrics for this segment denoted by the white boxes, since ModSpace roughly doubled our presence in Canada.

As we talked about last quarter, the Other North America segment bottomed in 2018 on a pro forma basis due to the long run off of upstream oil and gas projects primarily in Alberta and Alaska resulting from our 3-year average lease durations and some specific ModSpace projects that completed in the first half of 2018.

Average rental rates in the top-right chart have essentially been range bound on a pro forma basis for 3 years. And average units on rent in the bottom-right chart have been flat for 4 consecutive quarters, with utilization up 80 basis points year-over-year.

So we believe these markets have found their supply/demand equilibrium, and we are seeing modest improvements in Canada, Alaska and Mexico as we head into 2019.

Slide 19 reiterates our expectations for free cash flow in 2019 and is useful to illustrate how the sources and uses of cash change as we head into 2020, with an adjusted EBITDA run rate of approximately $400 million.

In 2019, with our current debt structure and maintenance Capex requirements, we see $130 million to $150 million of free cash flow prior to growth investments. That's in the green bar in the middle of the page. And that number pushes towards $200 million based on the expected 2020 run rate.

Based on current market conditions, new order activity and tremendous traction on value-added products, we expect to invest at least $30 million of the discretionary growth CapEx on value-added products and we'll evaluate the remaining growth investments as we get deeper into Q2.

As we shared in January, we expect the integration and restructuring cost to be front loaded in 2019, such that we are cash generative in the second half of the year, with an accelerating run rate heading into 2020.

This is all consistent with what we discussed in January, although we have the benefit of our final Q4 results and 2 additional months of performance here in 2019.

Moving to Slide 20. These are the December 31 debt balances that we provided to you in January. We remain very comfortable with the flexibility we have to manage the debt structure, particularly in light of the cash flow dynamics I just discussed. Approximately 70% of the debt structure is fixed rate after taking into account the interest rate swap we put in place in November, so we see limited interest rate exposure, with some clear opportunities to reduce our weighted average cost of debt, which is currently approximately 6.6%.

We have no debt maturities prior to 2022, yet we do have flexibility to repay debt at every level in the debt structure, so we have good optionality around how we delever the business in time.

We drew approximately $23 million on the ABL in the quarter to fund $42 million of net CapEx as well as cash restructuring interest costs. And we had $533 million of liquidity in the ABL revolver as of December 31, and we report 4.6x leverage to our bank group in Q4 based on the definitions in our credit agreement. Our target leverage range remains 3 to 4x. As we said in January, we expect to achieve the high end of that range organically by Q2 2020, assuming current market conditions and a full capital expenditure plan. And this is perfectly comfortable, given the visibility we have into the earnings growth in the business and the speed with which we can adjust capital spending, if we so choose to accelerate the deleveraging.

The combination of 30-month average lease durations underpinning our lease revenue and a 90-day capital planning cycle create this flexibility in managing our discretionary free cash flow.

We have some new material for you on Slide 21. Our business model has always been very efficient from a cash tax standpoint, and you'll see approximately $2.6 million of cash taxes paid in 2018 in our 10-K.

Aside from that, we reported $38.6 million GAAP tax benefit, which is noncash and approximately $20.7 million of that was due to our final adjustments related to the 2017 Tax Act. There's a detailed reconciliation of our effective tax rate in the 10-K. However, barring any changes in tax policy or major transaction activity, we expect our effective tax rate to be in the 24% to 27% range for GAAP purposes.

In June 2018, when we announced the ModSpace transaction, we noted approximately $50 million of net present value from expected tax benefits. I'm pleased to report that we've completed our initial Section 382 analysis, and we have $936 million of gross U.S. federal NOLs as of December 31, 2018. In addition, we have gross deferred tax assets of $557 million related to section 163(j) interest deductions and $50 million from prior capital losses, with which we can shield future taxable income and gains in the U.S. These assets offer a valuable optionality, and we expect will shield any meaningful U.S. federal income taxes for approximately 5 to 7 years.

The cash taxes that you see in our cash flow statement are largely state and local in nature, and we've been in a net refund position in Canada in recent years.

My last comment on this page before turning it back to Brad, the pace and complexity of transaction activity over the past 18 months has been quite high. And you'll recall, we had identified a material internal control weakness in 2017 specifically related to accounting for income taxes in the context of reverse acquisitions. Those transactions don't happen every day. And while we did take on some additional complex transactions in 2018, I'm pleased to affirm that we had no such weaknesses or deficiencies in 2018.

This is a testament to some relentless efforts behind the scenes by our team, a belt-and-suspenders remediation plan that we executed throughout the year as well as our preparation for large accelerated filer status in 2019. These are critical milestones as we build the best-in-class specialty rental services platform in North America.

With that, I'll hand it back to Brad on Slide 23 for his closing comments and Q&A.

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [5]

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Thanks, Tim. In closing, we delivered on our commitments last year, and we expect to do the same into the future. We have a simple 3-ingredient recipe to deliver the $345 million to $365 million adjusted EBITDA organically in 2019 while deleveraging this business. Ingredient one is already in place, given we've completed the ModSpace integration. Ingredient 2 is to deliver the $70 million of associated cost synergies. And ingredient 3 is to harmonize and further optimize rate, utilization and VAPS.

We're extremely proud of all that we accomplished in 2018, which provides the foundation for a great future. We're very confident in our 2019 outlook and in achieving the resulting adjusted EBITDA run rate of approximately $400 million, with EBITDA margins expanding to 35%, all while being -- generating substantial discretionary free cash flow as we exit 2019. These accelerating earnings and the inherent cash flow characteristics of our platform provide confidence that by the second quarter of 2020, we expect to be at or below the 4x net debt-to-EBITDA level, in line with our target levels.

We appreciate now that you've taken the time to join us today and for your interest in our company. We look forward to speaking with many of you very soon. That concludes our prepared remarks, and we now would be happy to take your questions. Operator, please open the line.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Manav Patnaik of Barclays.

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Manav Shiv Patnaik, Barclays Bank PLC, Research Division - Director & Lead Research Analyst [2]

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I guess we've been through a lot of the financial stuff and so the main question I had for you guys was just around the macro update. So you had that 1 deck where you had those, I guess, the AIA Consensus forecast, and I guess it shows it's almost halving in 2020. And so I guess I was just wondering how do you plan today, if you do follow this forecast, how do you plan today for the slowdowns in all the different moving pieces? If you could just maybe help us understand that better it would be helpful.

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Timothy D. Boswell, WillScot Corporation - CFO [3]

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You want to start maybe the current macro outlook, and I can talk about our response plan.

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [4]

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Yes. So first of all, the macro level -- this is Brad, our outlook remains quite robust. I mean, if we look at our quoting activity, which we monitor on a weekly basis, which is a great indication of inquiries combined with these external forecast, all are supportive of continued growth. I think just as a reminder, I referenced our quarterly capital allocation process whereby we look at this demand on a frequent basis and adjust capital accordingly. And I'll ask Tim to expand a bit upon that.

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Timothy D. Boswell, WillScot Corporation - CFO [5]

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Yes, Manav, I think -- when I think about this, I use kind of Slide 19, the free cash flow bridge as a framework with which to think about this. And sitting here today, as we think about the outlook for 2019, it's hard to see a macro event kind of disrupting the run rate and the trajectory that the business is on. So we're kind of looking a bit further into the future. And as Brad said, the ABI being a great indicator of 9 to 12 months out of future, nonres construction starts on a square footage, which in turn correspond to our delivery volumes. We don't see immediate red flag from a volume perspective, barring the disruption that we've incurred related to the integrations. So looking into 2020, what's the plan? As we monitor all of our leading indicators, quoting activity on the ground being the primary indicator Brad mentioned, you'll recall, we're on a quarterly capital planning cycle. And you can see where the capital investments in the business are going in 2019, and that's probably not a bad guidepost to use for 2016 and going forward. So I think in any macro environment, Manav, we continue to invest in the value-added products and services program. We believe that opportunity is really just based on the penetration of our assets, not on macro factors. So I'd expect we continue to fund that growth irrespective of market environment, and that will frankly insulate a part of the business along with our 3-year lease durations from any change in macro conditions.

That gives you a lot of time then to respond with other fleet investments. So you can quite easily pull back on the additional $30 million of growth investments in the fleet. And a substantial portion of, what we call, the maintenance CapEx can be reduced as well in a declining volume environment. We define maintenance CapEx as the investment level required in a volume-neutral market environment. So if market support grow, like we think they will in 2019, we'd invested above that level. And if markets are contracting, we can cut that CapEx and dramatically increase the free cash flow coming out of the business. This is a unique dynamic that's fairly unique to our business model and gets us very comfortable with both the capital structure and the outlook.

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Manav Shiv Patnaik, Barclays Bank PLC, Research Division - Director & Lead Research Analyst [6]

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Go it. And just a quick follow up and then I'll hop off. It's -- internally, do you see any leading indicators or is it just more of the macro stuff that we all will end up seeing that causes you to start acting differently?

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [7]

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No. I think it's -- they're -- obviously, there's been some disruptions in the capital and equity markets and kind of global concerns. But as far as demand at the end market level, it remains robust. I mean, as Tim mentioned, it's our job to watch it like a hawk, and we do. If we see things softening, if you were to see that, we swiftly pull back capital and shift the platform such that we're increasing the free cash flow. But circling back to your point, I'm not seeing anything now that cause me concern in the end markets. We have worked through substantial fleet rebalancing and branch consolidation. And as I noted before, our priority is keep book safe and drive rates, right, and increased utilization and as volume opportunities are presented, we're very selective about the ones we take.

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Operator [8]

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Our next question comes from Kevin McVeigh of Crédit Suisse.

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Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [9]

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Just help us understand what gave you the confidence to boost the VAPS? I think it was around $125 million, you're going up to $140 million. And is there any way to think about what the acceptance rate embedded in that $140 million is?

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [10]

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Yes. The difference, if you'll remember, Kevin, the last time we published that was a quarter ago, that LTM rate was, I want to say, $234 million from memory, right? So it simply continued increased penetration that we realized through the fourth quarter. And we put our preliminary results out right, we were still consolidating 2 ModSpace and WillScot systems. So we were maybe a little more cautious, but if you can't tell, I'm quite bullish on this. I'm extremely proud of the fact that we expanded that LTM delivered rate through 3 acquisitions. So I think that's great testament, not only to platform but the team that's driving it.

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Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [11]

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Great. And then, Tim, just if you wanted to kind of by that 4x leverage kind of Q2 2020, what could you get it to -- if you kind of drive it to in a tougher scenario, if you wanted to by the end of 2020? Like, not even macro, just if you were to kind of focus on deleveraging as opposed to anything else, where do you think you get that leverage to?

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Timothy D. Boswell, WillScot Corporation - CFO [12]

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Yes, they're too many potential scenarios to give you a specific target, Kevin. So suffice to say, it could be lower, and I would use the capital spending in the business as the primary lever that we would pull between now and Q2 of 2020 to influence that number level -- lower. Like I said, in response to the previous question, I don't see as much risk around the run rate from an EBITDA standpoint just based on the lease durations in the portfolio. So CapEx would be the primary variable. And by sensitizing CapEx, you could sensitize leverage in Q2 of 2020.

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Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [13]

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Got it. And just quickly, is there any kind of meaningful difference between the average lease cap -- lease duration for ModSpace versus WillScot in the core business?

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Timothy D. Boswell, WillScot Corporation - CFO [14]

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Yes, it did pull us down slightly. I'd say, some of this is how we measure of our data. So I don't think there's a fundamental difference in the 2 portfolios. We reported a 30-month average lease duration most recently. And a year ago, we would have been talking about 35-month average lease duration across the portfolio. We see no real change in terms of -- if you compare like-for-like contracts or transactions rather in terms of the ultimate lease durations. So we'll keep an eye on it as the portfolios harmonize.

If you recall, the biggest difference between the ModSpace fleet and the WillScot fleet is that ModSpace had a slightly higher mix of complexes. These are the buildings that we coupled together to make larger square footage installations. And those actually tend to have longer lease durations than the smaller single-wide units, for example, that we acquired from Acton.

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Operator [15]

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Our next question comes from Sean Wondrack of Deutsche Bank.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [16]

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Congratulations on completing the integration. So just to touch on a couple of things in the end markets. It's great to hear the robust outlook. There are couple of things that I've sort of heard. I had a company reduce guidance this morning based on wetter weather that sort of impacted construction. Also, we had the government shutdown. Can you comment on a --both of them? And has that really impacted your business? Or has there been anything sort of holding you back and -- that you can think about in Q1?

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [17]

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Yes. I would say there has been a bit of weather anomaly this year. It's not something that concerns me because 5 years in the business it's not unusual. I would say, it's been more broad spread throughout both Canada and the U.S. And as mentioned, I mean what it typically means is, maybe a delay of a month or 2 of projects starting. Our inquiries or quotes remain very robust, frankly above our targets for the combined portfolio.

So yes, it is factual. I think there's been a bit of an impact on new activations as associated with that. But I think we're talking about weeks and months here, not something that gives me concern. We left the first -- we left the fourth quarter down a modest 1%. If you think about that fourth quarter, 1/2 to 2/3 of it was pretty significantly impacted by these ModSpace branch consolidation and fleet reallocation. Do you remember that started in November. And then that activity kind of continued heavily into the first quarter. So I think as commented before, we expect to be down unit on rent through the first half and then slowly bringing that back to up a modest 1% at the end of the year.

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Timothy D. Boswell, WillScot Corporation - CFO [18]

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It's also safe to say, we are reiterating our guidance today. So whatever softness you see on the volume side, we see opportunity on pricing to value-added products.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [19]

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Great. Fair enough. And with government being roughly 3% of your overall demand, did you see any impact from the shutdown? And then you also mentioned some of these discrete end market opportunities. Obviously, the immigration issue has been a very politically charged issue. But if you can kind of comment on what you're seeing with your boots on the ground there would be helpful?

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [20]

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Yes, we didn't really see anything on the government side at all good or bad, I guess, if you will. And these kind of discrete end market opportunities, first, I'd characterize this is a very broad portfolio across Mexico, U.S. and Canada. So at any one time there's usually 1 or 2 of those going on somewhere, right? And typically as those events occur, we'll see a surge in demand, and certainly a surge in sustained pricing. One of the more recent national issues, the wildfires in California, I think the infrastructure plans are just finalized that, that business has just been awarded for the rebuild and we expect to experience some benefits of that. But then just, again, keep in mind that's one little small piece of a very broad portfolio here, so kind of ebbs and flows over time, if you will.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [21]

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Great. I'll ask one more and I'll get back in the queue. Just regarding our current capital structure, you outlined your goals, you've been basically hitting all of the goals that you've outlined. Some of your debt is shorter term, do you foresee there being a global refi in the next few years as you move onto the next stage of your growth?

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Timothy D. Boswell, WillScot Corporation - CFO [22]

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Well, we'll undertake all of that the opportunistically, Sean. It's hard to sit here today and say, yes, we're absolutely going to refi everything. So what I like about the debt structure specifically is, in the meantime, setting aside any global refinancing, you've got a handful of tactical things you could do, flexibility to pay down at every tranche in the debt structure. And given our free cash profile is shifting dramatically in the second half of this year and heading into 2020, I think we'll definitely start with those tactical opportunities and be opportunistic as it relates to everything else.

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Operator [23]

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Our next question comes from Ashish Sabadra with Deutsche Bank.

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Ashish Sabadra, Deutsche Bank AG, Research Division - Research Analyst [24]

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A quick question about the VAPS monthly rate $250 on an LTM basis. Can you -- do you provide what the penetration rate for VAPS was there? And maybe any color on what the average VAPS monthly rate is right now ongoing?

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [25]

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Yes. So we do not provide specific penetration guidance. I think the $250 is -- if you think about dollars per unit, it's the best reflection of penetration. We have characterized that $200 to $250 level represents about a 40% furniture penetration, meaning of 100 units we shipped in the period, 40 were fully equipped with furniture and 60 weren't. And that increase in penetration over time, so what's really driving that increase in value. We've stated that our internal target is to drive that penetration to 80% over the next several years. And as noted, I'm pretty encouraged about the progress through these acquisitions in the early adoption of the new customers.

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Timothy D. Boswell, WillScot Corporation - CFO [26]

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Ashish, this is Tim. In response to the second part of your question, which is the overall average, if you look at Slide 9 in the top-left chart, our delivered rate on contracts in the last 12 months is $250 of recurring monthly revenue per unit per month. And the overall portfolio average is the $127 that you see next to it. So what's interesting here is, the $127 is actually down slightly. And that is due to the dilution from Acton and ModSpace, because they did not have as robust of a value-added products program, so you actually have the overall portfolio average that is contracted slightly due to acquisition dilution. We've continued to push the delivered rates, therefore the spread between delivered rates in the overall portfolio widened, resulting in the higher revenue potential number that Brad articulated.

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Ashish Sabadra, Deutsche Bank AG, Research Division - Research Analyst [27]

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That's extremely helpful. And am I -- yes, so I guess, as you continue to improve penetration, what I was wondering was there could be potential upside to even that $250 number on a monthly run rate as the penetration continues to improve. But maybe my next question was around margins, Tim. And you laid out the 35% margins in the fourth quarter of 2019. As we think about going forward, there are still opportunities, like, for further cost synergies as well as the pricing and VAPS, those are higher margin businesses. So the right way to think about it is, is there further upside to that 35% margins in the out years?

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Timothy D. Boswell, WillScot Corporation - CFO [28]

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Yes. So we believe there's opportunity on the cost synergy slide that Brad talked about. In the bottom left-hand corner, there is a list of very logical projects that we are undertaking that could certainly contribute to future margin expansion. If we rewind a year and a half ago, when we were first marketing Williams Scotsman to the [SPA], we did present a -- an EBITDA margin bridge that went up to 38% based on -- it was illustrative. But yes, we have from the outset of this journey, headline aside, see higher margins.

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Operator [29]

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And our next question comes from Phil Ng of Jefferies.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [30]

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You've seen really strong momentum on AMR. Do you expect that double-digit run rate to be sustainable in '19? Just based on the updated VAPS opportunity alone, it that kind of implies about mid-single-digit lift annually. So just curious, how you think about for like-for-like pricing? And any other mix dynamics we should be appreciative of?

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Timothy D. Boswell, WillScot Corporation - CFO [31]

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Yes, that's exactly what we expect. It's consistent with the January update we gave. And you're right, value-added products will continue to be a -- driving at least half of that year-over-year improvement. As you think about what other levers we have to manage pricing just on the modules themselves, we -- obviously you've got the upfront rental rates, which have been supportive. You'll recall that an average contract that we sign lasts for about 11 months, but ends up staying on rent 30 months on average. So you've got flexibility to manage rates during that intervening period. And we've been rolling out the price optimization platform across the combined volume of the WillScot, Acton and ModSpace portfolio. So you've got really 4 different levers right now that we're managing in order to drive absolute rate improvement.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [32]

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Got it, that's really helpful. And just on that note, how has the new sales force for ModSpace transitioned away from maybe how they approached pricing or rate optimization? And then the up-selling piece for VAPS, have you kind of provided any new training for the new sales force? And has that resonated well? Just curious, this new customer base that you have via acquired assets, has VAPS resonated in a similar fashion for them as well?

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [33]

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Yes, Phil, this is Brad. I would say that was a pleasant find once we were under the hood with ModSpace. So first of all, where there were redundant or overlapping sales rep between Williams Scotsman and ModSpace, we obviously focused on the best talent. And generally, it was about a 50-50 selection. The ModSpace team had began to implement the same rate optimization tools that Scotsman was deploying and had began to offer furniture through a third-party lease release. So I would say, it was already well within their behaviors and their mindset. We did have an all sales and operations joint session back in October of last year where we really focused everyone on the Williams Scotsman operating platform and then significant training on our tools and processes, and we continue to follow that. So long and short of it is, they've been great adopters and adapters. They were already started on the journey, very pleased with the progress, and I'm sure that's contributing to the increase in VAPS that we spoke about earlier.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [34]

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Got it. And just one last one for me. Tim, appreciated you provided some of that color on the free cash flow run rate exiting 2020 of $200 million. Actually the -- which is a nice acceleration. The other piece I just want to make sure you could help us frame up is the discretionary spend associated with that, whether it's CapEx? And what's left on the restructuring front we should be mindful of?

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Timothy D. Boswell, WillScot Corporation - CFO [35]

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Yes. So on the free cash flow bridge, the assumptions I'm making that get to a $200 million -- this is directional -- discretionary free cash flow number. Some improvement on our overall cost of debt combined with a -- the $400 million EBITDA run rate. And then the CapEx assumption for 2020, so here today I'd say, use the 2019 guidance as directional guidance for the foreseeable future in this market environment. So does that answer your question, Phil?

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [36]

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With the discretionary piece, was there anything that we need to be mindful of? Because you gave maintenance CapEx and I guess the growth CapEx piece, I guess we could kind of flush out whatever you guided for '19. Is there anything else that we should be thoughtful of in terms of, like, restructuring spend that (inaudible).

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Timothy D. Boswell, WillScot Corporation - CFO [37]

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No. As you get into 2020, we expect that all the restructuring costs on a cash basis to be incurred. In this view, you do -- if you just think about our cash flow statement, you have the gross profit associated with our rental unit sales. So just make sure you're capturing that piece if you're starting with EBITDA as the starting point for bridge. But other than that, no, we expect the integration restructuring to have been completed from a cash standpoint, barring any other transaction activity.

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Operator [38]

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(Operator Instructions) Our next question comes from Scott Schneeberger of Oppenheimer.

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [39]

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First question from me, could you please discuss the drivers of the 12.6% rental rate growth in the fourth quarter in terms of core rate repricing acquired assets and VAPS growth? And then, Tim, how might you think about the composition going forward?

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Timothy D. Boswell, WillScot Corporation - CFO [40]

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Yes, we talked about this a little bit in January, and rough numbers approximately 60% of the percentage growth in Q4 was coming from the base rates. And the remainder was coming from the value-added products opportunity. And like I think roughly 50:50 mix as you go through 2019 is a reasonable assumption, and we are managing those a bit independently. So if one taketh away, the other may give it a bit, so.

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [41]

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I understand. And then just -- could you discuss the expected cadence of adjusted EBITDA over the course of 2019 and perhaps elaborate on some seasonal dynamics. It was touched upon earlier, but obviously you have a bit of a sporadic history with acquisitions laden in there. So just a little bit of thought of the cadence this year will be great help.

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Timothy D. Boswell, WillScot Corporation - CFO [42]

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Yes, I mean, my comments earlier were around the pace of the margin expansion. Obviously, we haven't been giving quarterly guidance, but appreciate that there's been a fair amount of change in the portfolio, so it's a good question. As you go from Q4 and what we're at 28.6% at adjusted EBITDA margin in Q4, I'd expect some modest expansion going into Q1, which in prior years would be a little unusual, usually Q1 is a bit lower from a margin perspective. So what we have going on is the usual seasonal weakness from a margin standpoint as your variable costs start to ramp up heading into Q2. But it's offset by cost synergy realization that will be generated from really the -- all of the Acton synergies as well as the beginning of the ModSpace synergies. And then that margin percentage expansion should expand by, as I said, about 100 basis points quarter-to-quarter, with the larger improvements happening in Q3 and Q4.

So those margin percentages, and we saw this in Q4, Scott, for example, can be impacted pretty significantly by sale volume, so that's probably the primary variable that can change things quarter-to-quarter. But when you look at the kind of the core underlying leasing gross margin, which is where we have the bulk of our management time and attention focused, that doesn't surprise us as much.

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Operator [43]

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And our next question comes from Sean Wondrack of Deutsche Bank.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [44]

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Just one more quick one from me. Can you comment on the M&A environment, if you're seeing any other opportunities there? And kind of what you're seeing there?

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [45]

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I mean, we obviously can't comment about specifics, but I think I characterized on the last call with the ModSpace integration behind us, we have the capability and the capacity to make further acquisitions. We've also consistently said, we're not going to overpay, and we're not going to over lever. So coming back to our primary focus right now that the ModSpace system integrations are complete is harvest the $70 million in cost synergies, drive this VAPS growth potential and delever the platform back into the 4x range. So we've got the capability and capacity to do it. We're not compelled to do it and we're not going to overpay and we're not going to increase leverage.

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Operator [46]

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I'd like to turn the call back over to Mr. Brad Soultz for closing comments.

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Bradley Lee Soultz, WillScot Corporation - President, CEO & Director [47]

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Hey, thanks, everyone, for joining the call. I think as we said before, we're really proud of 2018 accomplishments beyond the financials as well, and extremely excited about the future for this pretty unique and fast growing specialty rental platform. So thanks, everyone. Have a great day.

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Operator [48]

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Ladies and gentlemen, thank you for your participation in today's conference. You may now disconnect. Everyone, have a wonderful day.