聯合設備租賃 (URI) 2015 Q3 法說會逐字稿

Good morning and welcome to the United Rentals third-quarter 2015 investor conference call. Please be advised that this call is being recorded.

Before we begin, note that the Company's press release, comments made on today's call and responses to your questions contain forward-looking statements. The Company's business and operations are subject to a variety of risks and uncertainties, many of which are beyond its control, and consequently actual results may differ materially from those projected. A summary of these uncertainties is included in the safe harbor statement contained in the Company's earnings release.

For a more complete description of these and other possible risks please refer to the Company's annual report on form 10-K for the year ended December 31, 2014, as well as to subsequent filings with the SEC. You can access these filings on the Company's website at www.unitedrentals.com. Please note that United Rentals has no obligation and makes no commitment to update or publicly release any revisions to forward-looking statements in order to reflect new information or subsequent events, circumstances or changes in expectations.

You should also note that the Company's earnings release, investor presentation and today's call include references to free cash flow, adjusted EPS, EBITDA and adjusted EBITDA, each of which is a non-GAAP term. Speaking today for United Rentals is Michael Kneeland, Chief Executive Officer; William Plummer, Chief Financial Officer; and Matt Flannery, Chief Operating Officer. I will now turn the call over to Mr. Kneeland. Mr. Kneeland, you may begin.

Good morning, everyone, and welcome. I want to thank everybody for joining us on today's call. I am going to use some of the time today to share how we're thinking about the opportunities in 2016. But first let's start with the results that we reported last night.

As you saw from our press release there are some mixed dynamics in the quarter as well as strong positives. Our revenue was up just slightly year over year but we made the most of every dollar and delivered substantial profitability. In fact, it was a record quarter for us with adjusted EPS of $2.57 per diluted share and an adjusted EBITDA margin of over 50%. This is a Company record not only for the third quarter but for every quarter in our history.

In addition, our trench safety and power & HVAC businesses had stellar results. And our nine-month free cash flow stands at a robust $508 million.

So there is a lot to like about the quarter, and as you saw last night we reaffirmed our outlook for 2015. But we also dealt with some ongoing challenges to our top line, most notably upstream oil and gas and a weak Canadian economy with a negative impact on FX. In addition, there is still an oversupply of fleet in our industry and these three dynamics taken together have put pressure on rates and utilization.

This all unfolded pretty much as we expected and we are running the Business with great cost discipline in this environment. As the numbers show, we stayed true to our strategy by taking a balanced approach in a competitive market environment. That is where our focus is today and that's where it will be as we continue to be in 2016.

We'll issue our outlook in January as usual but I think it's valuable to start that dialogue now. So before Bill goes through the quarter, I'd like to give you insights into the current market conditions and our perspective on the coming year. First, our industry grew steadily through 2015. The demand for equipment rental in North America is far from hitting its peak.

In the third quarter we once again increased our volume of equipment on rent. And while time utilization eased year over year, it was still a healthy 70%.

About half hour regions had year-over-year rental revenue growth in the third quarter. Our mid Atlantic region was particularly strong with double-digit growth. Activity in this region is anchored by large manufacturing plants under construction in South Carolina and Tennessee, as well as data center work and solar farms.

Industrial activity remains strong with year-over-year growth in an attractive pipeline of projects. Our utilization for industrial has been in the mid-70%s for the past four to five weeks.

Looking at our specialty businesses, our two largest lines, trench safety and power & HVAC, both had an exceptional quarter. Trench generated year-over-year revenue growth of more than 16% and power & HVAC delivered 20% growth. These increases were primarily driven by same-store growth which is another indicator of demand.

All of our specialty businesses benefited from greenfield expansion this year. To date in 2015 we have opened a total of 15 new specialty branches in trench, power, pump and tools and another three are under construction.

In our pump network we are pursuing a penetration strategy with new and existing verticals. Many of our pump cold starts in 2016 will be co-located with existing branches where customer relationships can leverage for cross selling. We have had good success in developing a customer base for pump in verticals that de-risk the exposure of upstream oil and gas. The business has now shifted to less than 50% of upstream and is growing in other areas.

Another positive indicator of demand is the performance of our national accounts, which showed a year-over-year revenue increase in the quarter. We've had good success in selling to high-growth verticals such as chemical processing, power and multi-family residential construction. National and strategic accounts are driving some of this business, but these verticals are also benefiting from a broader customer base. So those are some of our observations from the quarter and we expect the remaining months of the year to play out with a typical seasonality.

Looking forward, our industry is in a very good place. Forecasters such as Global insight, Dodge and others see multiple years of up cycle ahead. A number of factors are working in our favor. For example, a fair amount of US construction growth is driven by large multi-year projects with price tags of $50 million or higher. This is an area where our scale really works to our advantage.

In the US, spending on plant maintenance projects is ticking upward which adds to industrial demand. And industrial spend in Canada is forecast to begin a modest but steady recovery starting in 2016.

This is all very positive but the disconnect between demand and revenue of course is supply. As I mentioned earlier, we believe that our industry has continued to fleet up slightly ahead of demand in anticipation of a long cycle ahead.

For our part, we can control which is quite a lot. We can adjust our CapEx up or down real time. We can manage our use equipment sales together with CapEx for optimal fleet size. We can adjust the timing of our spend and we can move idle fleet to areas of higher demand.

In addition, we can continue to drive cross-sell and invest in our sales force. And we will be even more stringent on cost controls and take any number of other actions.

We'll be making these decisions against an industry backdrop that continues to look very positive. We expect to benefit from the growth in demand for at least the next several years, driven by construction and industrial activity and a secular shift towards rental.

And as far as withstanding any headwinds, we're looking at 2016 as a clean slate with every option on the table including the timing and the amount of capital spend. We already know that we will spend significantly less CapEx in the first quarter of 2016 than in Q1 of this year.

We will be watching demand very closely and we will make sure we continue to meet our customer needs as the year unfolds. In our opinion the best way to grow the business is to go into the year with a strong understanding of the market but with no preconceived notions as operators.

Our goal is and always has been to drive higher returns and we have tremendous flexibility in the path we take to make that goal. With that, I'll ask Bill to go with the financial results and then we will take your questions. So over to you, Bill.

Thanks, Mike, and good morning to everyone. As has been our custom, I will try to add some color to the information that was released last night and to Mike's comments, and also leave plenty of time for questions if we don't get to something you are interested in.

Starting with rental revenue, within rental revenue rental revenue grew overall 0.8% year over year. That's about $11 million of increase versus last year. Within that we had rerenting ancillary items this year essentially flat to last year, so no contribution to growth from rerenting ancillary combined or individually.

It was all about OER growth and that was driven by the rental rate experience that we posted last night, rates being down 0.1% year over year. That cost us about $1.5 million of year-over-year rental revenue.

Our volume growth was still a solid 2.4% volume growth; that's growth in OEC on rent. That translates into about $29 million worth of year-over-year revenue increase.

Replacement CapEx inflation was about a 1.7 percentage point headwind, good for just under $20 million of year-over-year revenue decline as an offset to the volume increase. And then everything else we're calling mix and other was an increase of about 0.3% or about $3.1 million year over year, and that includes the mix of our business as well us a little bit of FX. Most of FX shows up in the volume measure in this way of breaking things down, but a little bit drops down into that mix and other line.

Speaking of FX, we continue to have headwinds from the Canadian currency being down materially. It was down about 17% in the quarter compared to last year. And that was worth about $26 million of revenue decline year over year sprinkled among the other components that I already mentioned. If you took out CapEx for the quarter, our rental revenue growth would have been 2.8% and certainly more in line with what we have seen in terms of fleet growth and the other components.

So those are the comments that I'd offer regarding rental revenue. Just to touch a little bit more on some of the operating measures, time utilization in the quarter finished at 70%. As I said, that reflected fleet on rent growth of about 2.4% year over year. $6.27 billion was our average fleet on rent during the quarter.

That 70% utilization was down 150 basis points versus last year, comparable to the decline that we saw back in the second quarter, maybe a touch more. That's clearly an area of focus for us as we go through the fourth quarter and into next year, and certainly you will hear us talk more about focusing on driving that utilization improvement wherever we can.

For used equipment, a solid quarter for used equipment sales in the quarter. $142 million in the quarter, that's basically flat with third quarter of last year. And an adjusted gross margin up 44%, that's down about 3 percentage points from last year.

The primary driver of that decline is the mix of channels that we used. We sold about 52% of our used equipment in the resale channel and we did a little bit more in auctions we have been doing historically and certainly more than we did last year in selling used equipment in the quarter. That combination was the primary driver for the margin decline year-over-year.

The auction increase I wouldn't go too far with that. We used about 12% of our sales through auction in the quarter. That compares to something like 4% or 5% last year and it's consistent with our focus on making sure that we dispose of the fleet that we need to dispose of during the course of 2015.

Moving on to profitability. Adjusted EBITDA was $780 million in the quarter and very importantly, as Mike said, 50% margin, 50.3% margin to be precise. That represents about $19 million of improvement over last year and a margin improvement of 100 basis points.

To break down that year-over-year increase of $19 million, we saw rental rates as a headwind in its contribution to EBITDA of about $1 million. That volume revenue drive drove about $20 million worth of volume impact at EBITDA. The fleet inflation headwind there was $14 million against that. And the margin decline that I called out earlier in used sales cost us about $4 million year over year.

The impact of our merit increases, we've been calling that out, is about $6 million per quarter. It's again $6 million in this quarter. And the two big positives in the quarter this year were the incentive compensation adjustment that we've made in the third quarter of this year. As incentive programs have come down, our accrual for incentive programs have come down, reflecting the weaker performance than what we had in our original plan. That was worth about $13 million of year-over-year improvement.

We also had a mix and other improvement of about $11 million. That came from a variety of cost-save items that Mike referred to. In our cost of rentals we had nice performance in delivery cost during the quarter. Some wage and benefit saves during the quarter and some puts and takes elsewhere that overall resulted in a very nice cost of rentals performance. On top of that we also had a nice SG&A performance in the quarter, with SG&A lines like T&E expense, professional fees, a little bit of improvement in bad debt expense all adding up to a nice contribution there.

All and all it was a pretty good quarter on the cost front. And when you add those two benefits of incentive comp decline and mix and other, it adds up to the overall $19 million of EBITDA improvement that we saw versus third quarter last year.

Currency is sprinkled throughout those different lines of the EBITDA bridge as well. Currency had an unfavorable impact of about $8 million when you're talking about EBITDA in the quarter. So it continues to be a material headwind.

Flow-through in the quarter, it's hard to even say some of these numbers sometimes but flow through was very high 317% for the quarter. Obviously it's a very sensitive calculation, driven by the fact we had a very small denominator in the year-over-year change in total revenue. So that 317% was heavily benefited by the incentive compensation accrual adjustment. If you take that out in the quarter flow-through would've been 86%. Still pretty robust and therefore reflecting some of the other cost saves that we had.

But as we've said all along, you shouldn't look at flow-through in a one-quarter lens, you should think about it longer term. If you look at our year-to-date flow-through the total number, including the incentive comp adjustments that we've made, is 84%. Still pretty high. If you take out the adjustment to incentive comp, year-to-date flow-through would be about 62%, and that's very much in line with the roughly 60% that we have been guiding to. So a good flow-through story for the quarter.

Just real quickly on EPS. As Mike mentioned, $2.57 adjusted EPS for the quarter was a Company record. That's up 17% over EPS in the comparable quarter. That, I'll remind you, includes the effect of the currency headwind. Currency cost us about $0.05 per share in this $2.57 EPS quarter. Continued to deliver a nice result at EPS even with the various impacts that we're talking about.

Moving on to free cash flow. Year to date we've generated $511 million of free cash flow, once you exclude the $3 million impact of merger-related payments which is the way we talk about it. That compares to $328 million on the same basis in the first nine months of last year. We continue to feel very comfortable with our free cash flow view for the full year.

The primary drivers of the free cash flow result this quarter were the better EBITDA performance, a little bit less CapEx than the year-to-date period last year and a little bit better cash interest expense in the year-to-date period as well.

Gross rental CapEx, just to mention that, for the third quarter was $409 million. That brings the full year-to-date period of CapEx spend to $1.4 billion. Actually the actual number was $1.425 billion. Net rental CapEx for the third quarter was $268 million and that brought the full year-to-date net rental CapEx number to $1 billion.

Moving on quickly to our capital structure and a little bit on liquidity, at the end of the quarter we had liquidity of just over $800 million. That included ABL capacity of about $620 million and roughly $170 million of cash on the balance sheet. So we feel we are well positioned with regard to liquidity.

A real quick update on the CR repurchase program. We continue to execute purchases under the $750 million authorization. In the quarter we bought back $167 million and that brings the total against this program at quarter end to $740 million, leaving $10 million to complete during the course of the fourth quarter.

We do believe we will finish that in the fourth quarter and as we have said before, the new billion-dollar authorization that we have from the Board we will commence buying on right after we complete the existing $750 million program. Our thinking now is that the $1billion program we will execute on a fairly steady basis. And as we've called out before, we expect to complete that program over 18 months once we start it.

Last quarter I did mention to you all that we need to be mindful of limitations on the amount of share repurchases that we can do under our debt covenants. Just to update you there, as we said at the end of the quarter, we had roughly $500 million of available capacity for repurchasing shares or other restricted transactions. That includes the restricted payments baskets in our debt facilities as well as the cash capacity that we have up at the holding company level of URI.

Just real briefly on ROIC for the quarter, 8.9% in the third quarter. That's a trailing 12-month number as you all know. And that's up 50 basis points compared to the same period last year and flat with where we were at the second quarter of this year.

Not going to spend much time on the outlook because we didn't change anything in the outlook. Certainly the numbers remain operative there. Certainly if you have any questions about the outlook we can address them in Q& A.

I will stop there with my comments and again welcome any questions on things that I didn't touch on or more detail on things that I did. But just want to echo the commentary that you heard from Michael in that the results in the quarter we feel very good about. Certainly the profitability, certainly the margin, and we feel like we're on the right track in dealing with the environment that we are in. We certainly are thinking very much about how do we finish out the year strong and get good momentum going into 2016. With that, I will ask the operator to open up the call for questions and answers. Operator?

(Operator Instructions)

Ted Grace, Susquehanna.

Good morning, guys, this is Tim Robinson on the line for Ted. Thanks for taking my question. First of all, I was hoping you could help me understand how your replacement CapEx needs of $1.1 billion square up with your larger suppliers' comments about lower replacement demand next year. I was just wondering if there was an opportunity for CapEx to be adjusted down in 2016 without impacting your strategic growth.

And secondly I was hoping to get your thoughts on the pros and cons of aging your fleet next year as a strategy to maintain discipline on CapEx while still supporting growth. Thanks.

Maybe I'll start and you guys can chime in. I won't offer any commentary on the OEMs' view of what next year's order pattern will look like. The $1.1 billion of replacement CapEx for us is the calculation of what it would take in order to just replace the units that we would be selling as used. And so it's a pretty straightforward mathematical calculation.

We make a separate decision every year about how much we will actually replace, and that is driven by where the fleet stands versus what we calculate its rental useful life as well as how the used sales strategy fits in with our overall fleet management strategy. Those are the things that are going to drive how much we actually sell as used. What that means to the OEMs I'll let them comment on.

The one thing I will point out that we do -- obviously we feel the impact of prior-years' purchasing patterns on any given year's rental useful life. So we'll certainly be monitoring that dynamic as we go forward. But again, I will let the OEMs commentary stand as their own commentary.

Yes, this is Mike by the way, as I stated, we have no preconceived notions. We have and open thought on how we look at next year and the years beyond. I think what you pointed out is that there is flexibility and we will exercise our flexibility as we go forward.

Right now we are in the midst of our budget process where it's the ground up and that process is underway. Then we'll have that discussion with our Board and come forward in January. But you laid out a scenario, or various scenarios, but it really points out to the flexibility we have.

Okay, thanks, guys. Best of luck next quarter.

Seth Weber, RBC Capital Markets.

Hey, good morning, guys. First, a clarification. Bill, is it possible to frame how much the incentive comp will help for the whole year this year? And then does that become a headwind next year? And if so, are you still targeting a 60% pull through margin next year? Is that still the right way to think about it, given the rate set up into next year? That's just a clarification to start. Thanks.

Sure. The incentive comp impact, $13 million in the third quarter. Somebody's going to have to get me what we called out, was it $12 million in the second quarter? That's really where the adjustment started. Year to date it's $25 million. As a modeling starting point, you probably wouldn't be far off to say that we'd get something like the $13 million in the fourth quarter as well. Those are the impacts.

Your question about whether it reverses next year, it certainly will reverse out, at least we hope it will reverse out next year, as we perform closer to what we ultimately plan for next year. It won't be a full-year reversal though, because remember last year we accrued to a very high payout level for our program, almost maxed out. This year we are accruing to a below-target payout level.

So to normalize next year back to something like target, which is how we would model and plan around next year, the snap back won't be quite as dramatic as the benefit year over year that we have seen so far this year. So I think those are the thoughts that I would offer. Was there another part of your question that I --

Just as a tack-on to that clarification, is a 60% pull-through margin given the rate dynamics and some of these puts and takes, is 60% still the right pull-through margin to think about for next year?

Yes, that's the way we're thinking about it, Seth, right here and now. Certainly if there is a significant impact from the snap back of the incentive comp, we would call out what that impact was next year just as we did just now. But as you think about the rest of the business, 60% we feel is a good way to think about flow-through next year.

Okay, thanks. Then my real question is on trying to get my arms around the oil and gas discussion. Where do you think we are in anniversarying that impact? I think last quarter you had talked about you had repositioned something like $125 million of the $200 million of fleet. What's the update to that number?

Then as I look at your dollar utilization numbers like product category, the trench and other, the comparable, got less bad this quarter relative to the second quarter. So I'm wondering are we past the worst of that as far as a negative headwind on dollar utilization? Because the implication for your rate guide for the year suggests that rates are going to step down here in the fourth quarter. I'm trying to understand where we are in the spectrum on the oil and gas market. Thanks.

Seth, this is Matt, I'll take the oil and gas question. We've increased our movements as we had forecasted. We have moved year to date $170 million out from that $124 number that you had previously stated.

Other than seasonal items, like heat and light towers, we feel that we are mostly done there. You could look at one of the charts in the investor deck and it will show you on slide 6 that we feel that the oil and gas demand is pretty much flattened, bottomed out. If it goes a little bit lower it's not going to be by a lot and we are not terribly positioned from a fleet perspective. We feel we have that mostly captured and finish it up through the winter season. As far as your other question was --

So your dollar utilization for like the trench and other category got less negative in the third quarter relative to the second quarter. Are we past the worst of the comps there? How do we reconcile that type of move with the pretty severe rate decline that's implied in your maintained guidance for the year?

I'll take the dollar utilization and maybe Bill or Matt will take over the rate as you try to build out your model. If you recall that we had a tremendous amount of cold starts in the specialty arena, as a result of that you bring fleet in. And as it goes forward it's going to be putting it out on rent. That should improve as we go forward. I think that's the biggest delta around the trench and other. Again, building it out and now putting what we put in place now monetizing that and putting the stuff out on rent.

I'm struggling with how to respond to what that might mean for our rate expectation going forward. I think it's very clear that the fourth quarter year-over-year rate that we expect as implied by our guidance, is down materially more than it was in the third quarter. Honestly, Seth, I'm struggling what more to say about that. If you've got more detailed question maybe you can take it off-line and we'll see if we can address it better for you.

Okay, thank you very much, guys.

Justin Jordan, Jefferies.

Well done on the great quarter. Following on from Seth, I'm trying to get a handle on how we should be thinking about 2016. When we think about time utilization which was down 150 bps year on year in both Q2 and Q3, just to give us comfort on returning back to, let's say, year-on-year positive rates in 2016 and give us comfort on how you think 2016 will be a growth year for URI, I'm trying to understand is that going to be you need to see time utilization at least being flat year on year before we can think about rate going positive year on year? Or what are the building blocks to getting rate moving positive again year on year and moving to the dollar utilization normalizing again, as Seth was touching on?

Hey, Justin, maybe I'll start on this as well. We start from thinking about what is the macro backdrop expected to look like in 2016. All of the forecast that we see suggests that there is still going to be a solid macro backdrop. That is a good starting point and it gives us the opportunity to continue to absorb whatever is left of the oil and gas dislocation, absorb any excess fleet that might have been built up in the early part of 2015. That's starting point number one that is that we think the backdrop will be positive.

Point number two is that we are very focused on the utilization performance of the Company as we think about next year. That's going to be a very important guide for us in thinking about what we're doing, where we're doing it, how much we're investing in the fleet to get it done. So we will be, I think, in a better position to be able to manage rate if we're absorbing our existing fleet through utilization more effectively. That's going to be another, I think, positive for us in how we approach delivering improved rate next year.

Obviously that will come along with a very intense cost focus. It won't directly impact rate but certainly will help us examine everything that we are doing and seeing if there's a way to be more effective inside the Company and therefore be more effective in the marketplace. So those are the key things that I'd point to. Guys, what did I miss?

I would say that it's always -- you try and say what is the backbone. I think it's everyone's strategy and for us it is about driving profitable growth and it's a balance between utilization and rate. That's our strategy and that's what we are going to be focused on.

One other thing that I'd throw out is if you look at where we expect to exit 2015, and we talked last quarter about it being somewhere in that one-quarter to one-third of a point of carryover, negative carryover, next year. That's not a huge deficit to make up, is one point I would make in terms of getting rate back to breakeven or positive rate next year.

That gives us some encouragement that it's not an impossible game to get rate back to being positive next year. If we're doing the right things in managing our fleet and the rest of our business and the macro is there with us, that's a reasonable way to think about next year.

Thank you. Just one quick follow-on on fleet. You talked about bonus accrual, but can I get a better sense on what you're doing in SG&A? You called out on the slide deck a $22 million run rate of lean cost savings which is impressive. Just give us some color on what else you're doing on SG&A to really help on the EBITDA margins which are up 100 basis point year on year, which is a very strong performance.

Sure. I did talk about focusing on T&E and professional fees and getting some benefit there year over year. We will continue to look for opportunities to maintain on that front. We are being very conscious about all the other lines within SG&A as well.

We did have a little bit of a benefit in bad debt expense. We will continue to look for opportunities there and focusing on managing the age of our receivables, which drives that measure. We hope to continue to improve there.

And then just general cost focus. It's ramped up in the Company over the last several months and I think that will be the case going into 2016 as well. Stay tuned and we will call out more as we actually deliver.

Great, thank you very much.

Jerry Revich, Goldman Sachs.

Good morning, this is Brandon Jaffe on behalf of Jerry. In your slide deck you disclose branches with significant oil and gas exposure as having about 400 basis point lower utilization than your other locations. Do you expect that gap to narrow over the next few quarters? Or are you simply looking to reduce the amount of equipment in those oil and gas-heavy regions?

We certainly expect it to reduce whether that's the numerator or denominator. I'd rather it be that we put more fleet on rent, but we're going to react appropriately to the demand that's in the oil and gas. So if we can't move the numerator we will pull more fleet out of there.

It does look like it's bottomed out. The headwinds on a year-over-year comp will be there probably through the end of January, February which is when we sought this year a lot of the rates come off and then the fleet come off shortly thereafter. We feel comfortable that we'll manage that gap even tighter this year.

Okay, thanks. The second question, you reduced CapEx guidance by about $100 million this year in response to about a 250 basis point cut in rate guidance. Can you comment on what level of pricing you would need to see for you to significantly cut CapEx further?

I don't know that we would think about it as X amount of rate yields, Y amount of CapEx. I do think that we try to look at the overall position of the Company and the environment that we are in to make that decision around CapEx.

I mentioned earlier, for example, that we're going to have a very bright light shining on our utilization of existing fleet in 2016. That's going to be an important driver alongside whatever rate we expect to yield. I wouldn't think about it as being that tightly linked to rate as long as we've got other opportunities to drive improvement in our business, like with utilization.

I think Bill said it well. It's about what rate and utilization do we need to have profitable growth. That's going to be our North Star, that's what we will manage to. And then some of the other metrics are usually directionally supported but it won't be as myopic as a direct tie that X rate brings Y capital growth.

Okay, thank you very much.

Scott Schneeberger, Oppenheimer.

Thanks, good morning, guys. It sounds like you're progressing nicely on the oil patch absorption. But it sounds like the overall industry fleeting is going to linger into next year. Could you give us a feel how long you expect that will persist, what you're seeing from the competition? Obviously a lot of questions about what you might do, but just the environment there and what you're seeing others with regard to price and how they are handling the fleet. Thanks.

I'll talk about what we're seeing. Obviously we, as well as others, have tempered their capital spending. And then I think most recently there was one of the OEMs yesterday said on their AWP they saw an increase in the smaller categories of rental companies. It's not unusual.

If you think about it for a moment that as a publicly-held company, have always had access to capital. The larger companies followed suit and then you would see the capital that comes into play on to a much smaller fragmented section. Not unusual. Not alarming to me but something we closely watch.

We will adjust to our strategy on driving profitable growth. I think I made it very clear that you will see a significant drop in capital spend in Q1 for us. As we come into January, Scott, we'll clearly communicate our thoughts going forward.

We watch it. We understand that the oil had a disruption. We also understand and experienced the fleeting up within the industry. The good thing is there's multiple years of expansion left and we will have to play it and we'll make our calls.

Thanks, Mike. Just following up on that. This is the time of year where you're negotiating with the OEMs for the out year. Anything unique you are seeing this year? Are they very disciplined on pricing? Might we see some increased inflation coming to you next year? Any thoughts or commentary on this year looking any different from the past.

Scott, we are in the middle of negotiations with our strategic suppliers right now but we certainly don't expect to see increases coming into next year for a lot of reasons. We'll be very diligent about making sure we are reacting and we're having our partners react to the current environment.

Thanks, I'll turn it over. Appreciate it, guys.

George Tong, Piper Jaffray.

Hi, thanks, good morning. Switching over to the demand side of the equation, can you talk about how trends you're seeing in rental demand have evolved for you over the past quarter or so with this commercial industrial infrastructure?

Hey, George, it's Bill. Ask that question again for me.

Trying to get a sense for how, aside from the rental supply issues you are seeing, how rental demand is evolving for you along your main verticals of commercial and industrial.

It continues to be a solid demand environment for us. You heard some of Mike's comments about some of the industrial demand that we're seeing and the drivers there. The commercial side of the house still has got a solid tone to it and that's supported by whether you use non-res construction or some other measures by economic data.

The demand environment is still pretty solid. It's indicated to us both by what we are actually putting on rent but also the commentary that we get from our customer base. It's still very much supportive of growth in the next near-term period. We expect that to continue to be the case into 2016.

The only thing I would add is the equipment we have is very universal applied to multiple verticals. To give you some industrial, manufacturing, automotive, some distribution, some fabricated metal products, heavy manufacturing, semiconductors and transportation systems and chemical procession continue to show some areas of growth and expansion.

LNG, we've had some numerous projects, particularly in the beginning of the year, on LNG starts. But again, the fleet that we have in general is universally applied to the verticals that we're talking about with the exception of maybe some of the pumps, and we've talked about pumps in the past.

Got it. And Bill, following up on your 60% EBITDA target flow-through for next year, what are they conditions loosely around rate growth and time utilization that you would need to see for you to be able to deliver on that?

George, I think it's fair to say that any reasonable range of rate growth and time utilization that we are thinking about gives us a real good shot at 60%. That's still very much within our thinking here about 2016.

Obviously if you don't get rate or times not as strong as you'd like then it puts more emphasis on the cost lever. But we feel like any reasonable combination that we're likely to see next year we can think about 60% as a flow-through. That's why we're communicating it.

Thank you.

Steven Fisher, UBS

Thanks, good morning. Just to follow up again on the oil and gas questions. Matt, it sounds like you're saying that you're expecting activity to be pretty flattish next year. Can you give us any color on what gives you that confidence? Because we are still hearing about some E&P CapEx cuts for next year. Want to gauge the risk of any further surprises there and then how you would manage that.

Sure thing, Steve. There's been some challenges that we've absorbed but as you look at -- I referred to slide 6 before where you see it's pretty much bottomed out and actually may even be slightly above the trough that we hit in July. When you think about it, some more rigs come down or there's further capital project cuts, I think that the fleet in those areas has moderated quite a bit. There'll be a little less supply in those areas.

But more importantly, the dynamic for us is that we still want some business in oil and gas plays right now. Throughout many of the different shales there's some more direct business that may be going on. So the dynamic of how the end-users are being supplied is giving us an opportunity as well.

The other thing I would add to that is we don't expect oil to go up or increase over the next year or two. And as I mentioned earlier on the pump business, we're expanding other verticals and we've had some good success. If you look at our investor deck on pump specifically, we've -- expanding their verticals. As we stand today they're only down 9.6% on a year-over-year basis after having over 50% of their business coming from oil.

Not that we are going to vacate oil, but I think where oil for us in general has been on drilling the holes and we saw that drop significantly. We don't spend a lot of our rental equipment around existing facilities. Once they're established they're maintained. It's de minimus as far as the rental capacity that we have there.

That's helpful. And then, Bill, you talked about the $1 billion of share repurchase. Just wondering how you think about the balance between doing those repurchases versus your internal investments. I know on your slide you're still showing a nice healthy $700 million-plus of free cash flow next year. Is it the expectation that your cash flow will be sufficient to meet both the repo needs -- repo plan -- and any of your investment desires?

Absolutely. That free cash flow number is after our CapEx plan. That CapEx rate right now, we've guided you next year's CapEx $1.6 billion. We think that will be plenty of free cash flow to support capital plans for next year and to execute the share repurchase on the pace that we talked about.

I am not concerned at all about being able to spend on share repurchases to that 18-month timeframe. Depending on how free cash flow plays out, if we have excess cash flow beyond that speed of spend on share repurchases, then we can make some more decisions about paying down debt while also doing the share repurchase. We think we've got a lot of flexibility in doing all of the above over the course of the next couple of years.

Great, thanks a lot.

Nicholas Coppola, Thompson Research.

Hi, Good morning. Bill, used sales margins were down year over year and in your opening comments you talked about the channel mix. Is there anything you could add about the used price environment and what that might mean for broader trends in the industry?

Used prices are still at very high levels. If you just take the proceeds of $142 million and divide into the original cost that we sold which was, what, $247 million? Somebody help me out there. That's well north of 50% proceeds, $0.50 on the dollar equipment that's seven years old. That's an implication that the values are still very high.

Have the perhaps ticked down from the absolute peak that they achieved a few months ago? Maybe. But they're still at levels that represent very attractive opportunities to sell when you need to sell used. That dynamic is still very, very supportive of what we try to do as a Company.

The only thing I would add is obviously companies are readjusting either age or their fleet mix, particularly in places that are heavily in the oil. And as we go through this quarter and into the first quarter, first quarter if you recall, the biggest auctions typically take place in February where most of the companies spend a lot of their time and effort to send their fleet to.

I just want to remind everybody not everyone in our industry has the channel mix that we have. We do retail equipment. Unlike a lot of our competitors, they don't have that capacity or lean on that capacity. That's a preference they have in their strategy. You are going to get mixed results, but as Bill mentioned, our retail was pretty healthy.

And then maybe just an update on lean initiatives. You're $22 million into your $100 million target, what's progress look like there? And any color you can add about operational improvement.

Yes, Nick, the $22 million run rate at the third quarter, as I'm sure you've noted, is down from where it was in the second quarter. We can certainly talk about the drivers there. But in terms of the initiatives that we're pursuing, they're very much similar to what we talked about in the past. We've implemented all of the important components of a lean program.

What we are about now is rolling that out to a broader set of locations across our business and touching more of the processes in the business. The $22 million number is reflective of all the work that we've done so far, much of which was focused on improving the productivity of each dollar of cost that we spent rather than actually taking out absolute dollars of cost.

Given that volume hasn't developed quite the way we thought it would this year, the improved productivity hasn't delivered the same amount of save that we originally thought. So now we are pivoting to look at whether there're actual dollar costs that we need to take out in order to continue to drive that productivity result. And so that's being discussed as we speak right here and now.

We still are very comfortable guiding to that $100 million run rate impact by the end of next year because we can look across the business and still see places where we haven't implemented fully all the lean initiatives, or where we have but we haven't gotten as much out of them as we might have anticipated. We are still comfortable saying that we expect to see the $100 million impact by the end of next year.

It all makes sense. Thanks for taking my questions.

Joe Box, KeyBanc.

Hi, guys. I want to ask a couple of hypothetical questions here. One, if you guys don't see the equipment getting reabsorbed by the seasonally slow 1Q, does 2Q then become a significantly lower CapEx quarter as well?

Joe, I think given the way we're thinking about managing our decisions around CapEx next year, if we don't see in the first quarter what we expect to see, I think it's highly likely that we will get aggressive around the second quarter capital spend as well. Is that fair, guys?

We'll also sell more too.

Absorption is going to be a big focus for us next year.

Okay. I can appreciate that. What are you guys specifically looking for from your end markets to maybe take a change in your capital allocation plans and ultimately put a greater percentage of free cash flow toward debt pay down?

In my earlier comments I talked about the macros being an important backdrop for us. If we get a sense that the macro environment is not developing such that our industry could reasonably expect in the mid to high single-digits growth next year, then we're going to have to reassess. That will be step one.

Step two, if we get early in the year and we're not seeing the absorption of fleet that we talked about getting utilization up, then we're going to have to reassess. That's step two.

We'll continue to look at that. Step three might be if we're not seeing the market offer a rate environment that we would expect. Early in the year rate's always a challenge because of seasonality, but if it's more of a challenge than what we have going into the year then we will have to reassess. Those are the things that are going to be swirling around in our heads as we think about how we execute the CapEx and other components of our plan for 2016.

Thanks, guys, that's helpful. And then one quick one, if I can. Bill, you've already talked about the cost of rental line and the number of different components there, but can you walk through some of the additional puts and takes like fuel, incentive comp? Ultimately are we still looking at some nice leverage here where we can see some margin expansion on the gross line?

There's an incentive comp component of the cost of rent benefit as well. Certainly that was at play but it wasn't the entire explanation for the cost of rent improvement that we saw. We did have a little bit of a fuel benefit in the quarter as well, that showed up primarily in cost of rent. And so call it a couple of million dollars in the quarter there as well.

But I'll remind you that fuel as it plays through cost of rent, is a pass-through for the rental fuel, the fuel that's actually in the equipment we rent. The customer pays for that, so it sort of a natural hedge. The fuel component of our delivery cost, that's a pass-through to our delivery charge as well, so it's sort of a natural hedge. The impact may not be as large as you think from fuel.

What else? I called out overall delivery costs, of which fuel is a part. Wage and benefit saves were really just about headcount, not particular headcount action but the natural turnover of headcount in our business, as well as some efficiencies that we're realizing from some of the cost-save initiatives that we talked about earlier.

Those are the primary drivers within the cost of rent saves. We think we've got the opportunity to continue to drive more saves as we go forward.

Appreciate it, thank you.

This does conclude the question and answer session of today's program. I'd like to hand the program back to Mr. Kneeland.

Thanks, Operator, and I want to thank everybody for joining us today. As we stated earlier, that was a very exciting quarter for us. We've also updated our investor materials. Make sure you go to our website and download both our financial deck and the background information. If you have any additional questions or would like to go to any of our facilities, you can reach out to Fred Bratman any time with you questions, in our Stanford office. With that, Operator, we'll end the call. Thank you.

Thank you. And thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.