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United Rentals Inc. (NYSE:URI)

Q4 2009 Earnings Call

February 04, 2010 11:00 am ET

Executives

Michael Kneeland – Chief Executive Officer

William Plummer – Chief Financial Officer

Analysts

Henry Kirn – UBS

David Wells – Thompson Research

Scott Schneeberger – Oppenheimer

Emily Shanks – Barclays Capital

David Raso – ISI

Philip Volpicelli – Cantor Fitzgerald

Chris Doherty – Oppenheimer & Co

Operator

Good morning and welcome to United Rentals’ fourth quarter and full year 2009 investor conference call. Please be advised that this call is being recorded.

Before we begin, please 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 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 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, 2008 as well as to subsequent filings with the SEC.

You can access these filings on the company’s website at www.ur.com. Please note that United Rentals has no obligation and makes no commitment to update or publicly release any revisions to the forward-looking statements in order to reflect new information or subsequent events, circumstances, or changes in expectation.

You should also note that today’s call will include references to free cash flow, adjusted EPS, EBITDA, and adjusted EBITDA, each of which is a non-GAAP term. Speaking for United Rentals is Michael Kneeland, Chief Executive Officer; and William Plummer, Chief Financial Officer.

I will now turn the call over to Mr. Kneeland. Mr. Kneeland, you may begin.

Michael Kneeland

Good morning everyone and thank you for joining us today. With me is Bill Plummer, our Chief Financial Officer, and other members of our senior management team. Bill will discuss 2009 financial performance, which as you know from the release, we showed a loss for the year of $0.98 per share. That’s obviously not where we want to be, but 2009 was more about controlling the things that we could control, and in that regard, our performance included numerous accomplishments. This morning I want to spend some time on the improvements that helped us outperform almost every target that was part of our outlook.

As reported last night, we reduced our SG&A expense by $101 million in 2009 year over year. The reduction and cost of rentals excluding depreciation was $227 million. Our free cash flow was very strong at $367 million, and our net rental capex showed a modest outflow of $31 million compared to the net zero we projected because we saw opportunities to make strategic investments and the right kinds of rental fleet. This was a solid performance. With the cost of rentals, we fell short impart because our rental revenues were higher than we expected in fourth quarter. Now Bill is going to go over and discuss this further in just a minute, but still as I mentioned, we took cost of rentals down by $227 million, which is still a big number. As you’ll hear from us today, the numbers are only part of the story. I want to use our time this morning to talk candidly with you about where we are taking this company and how our strategy is intended to transform United Rentals into a company that is much better equipped to create value. It began with Operation United more than a year ago.

Operation United is the foundation of our strategy that defines United Rentals as first and foremost an equipment rental company. It mandates that we continuously improve our cost structure and our fleet management on the basis of profitable growth, and it challenges us to win customer loyalty to customer service leadership. If anything, our strategy intensified in 2009 as we continued to analyze our opportunities. We’re now operating with these specific objectives—first to continue to engineer efficiencies throughout the business; second, manage our rates for the maximum return on fleet; and third, to leverage our size and to serve the right customer segments.

When the economy does better, even partial realization of these objectives would benefit our topline and bottomline. In the current environment, the impact is more modest but still apparent. For example, our rental revenues declined in 2009, but we still outperformed our peers for the first nine months. The idea of resilience is a big part of our story today. We didn’t just weather 2009; we showed the financial and operational discipline to outperform the industry in an economic trial by fire, and before I move on to operations, let me tell you where we stand on 2010.

Realistically, it’s going to be another tough year. In our opinion, a turnaround in construction will happen sometime in the back half of 2010, but we won’t see any significant improvement in our end markets until 2011, and when that happens, we think the recovery will be slow and steady, and that seems to be the consensus of the industry forecasters as well, and if the worst of the cycle is behind us, then most of the heavy lifting has been done in terms of branch closures and workforce reductions. The same goes for fleet.

We’ll continue to de-fleet this year but at a slower pace. However, if the downturn drags on longer than expected, we won’t hesitate to pull all the leavers at our disposal. Our plan takes the economy into account, but it’s also about the optimization of our operations, branches, fleet, sales force, and corporate infrastructure.

Last year, we closed 64 branches and opened four specialty locations where we saw market opportunity. We also reduced our average fleet by 9% based on OEC, but if you unbundle that number, you would see investments in earth moving, light towers, and other strategic purchases. Now for us, optimization is about making sure that we have the right types of ranges, in the right markets, with the right fleet, serving the right customers.

Now, I want to turn to three objectives I mentioned a minute ago—efficiency, rate management, and customer segmentation. There is no question that we became much more disciplined with our cost in 2009. You saw that in the numbers we reported last night. Now, I want to share some metrics that were not in the press release, so you understand how serious we are about weeding out inefficiencies.

Our repair and maintenance expense was 17% lower in 2009 than 2008. Some of that comes from decline in our fleet size, but there were also other drivers including new technology that lets our service departments communicate in real time with the front counter, so that’s a good story especially given our fleet aged three months, and while we’re spending less, we still kept our preventive maintenance currency above 90% for the year.

Our OEC available for rent improved to 90.2%, so we know for a fact that we are servicing our fleet more efficiently in the shop. Equipment transfers among branches are proving to be very valuable in managing our fleet. Transfers allow us to allocate our rental capex more efficiently and to act more quickly to capture business that might otherwise go to competitors.

In 2009, we leveraged our footprint and transferred 36% of our fleet each quarter on average compared to 30% in 2008, so these are just four of many examples I could name, but we’re doing a lot of things right in the field, and we have 8000 employees to thank for that progress.

I want to move on to the second objective—rate management. I’m very passionate about rates because they are such a powerful force for us as a company but also as an industry, and over the last four months of 2009, our rates were essentially flat on a sequential monthly basis, which shows that we’re successful at pushing back against the environment. Now bare in mind that seasonality always affects our business in the winter. In 2009, market activity went deeper into the red because new projects were tailing off while existing projects were wrapping up, so the pressure on rates was coming from several different directions, but we managed that pressure aggressively.

For the full year, we reported last night our rates were down 11.8%, and clearly we are not satisfied with that number, and we’re doing something about it. You could say that our approach to rate management is a mix of brains and brawn. By brains, I’m referring to our strategy, and it’s focused on profitability. Every pricing decision we make takes margin into account as well as the customer relationship. The brawn is being provided by our new price optimization program, and this is just one of the technologies that are helping us transform our business along with salesforce automation and additional changes to our branch operations.

As most of you know, we put optimized baseline rates in place in all of our branches in early September including hard stops for price exceptions. In a few weeks, we will review and refresh those rates. We’re also testing dynamic customer centric placing in ten of our branches with plans to roll it out companywide later this year. As part of that pilot, we’ve implemented new tools so that price optimization extends from the counter to the field where our salesforce reps will be able to quote rates on their Blackberries.

From rates to fleet to customer mix, we’re looking at our business very differently that we had in the past. If a transaction isn’t profitable after taking all costs into account, we don’t want to book that business. Our people understand that we’re not trying to add to our topline at any price. The goal is to grow our revenues by using customer service to earn a premium price for our services and even in this environment.

The third in many ways the most important part of our transformation has to do with customer segmentation. Earlier I mentioned Operation United the original initiative in our strategy. We now know for a fact that Operation United is moving us in the right direction, focusing on customers that best fit our vision for growth. These are large national accounts as well as regional accounts, industrial accounts, and to a lesser degree government business. Let me explain why.

Our analysis has shown that large customers can be very profitable for us if we serve them properly, and they share similar characteristics. They rent equipment for longer periods of time, they pay in a more timely fashion, they return equipment with less damage, and they see our broad North American footprint as an advantage. In addition, larger accounts often prefer to place their orders to a centralized point of contact. Our customer care center in Tampa handled more than 368,000 calls in 2009 and wrote about 30,000 reservations, which helped our branch teams focus on customer service during the fulfillment process.

Of the 233 national account agreements we signed in 2009, 62 were industrial companies. This increased our national account base to more than 1200 customers. Our national account revenue was 24% of total revenue in 2009, and our industrial account revenue was 18%. Both represent an increase over prior year on a percentage basis. Also we note that we increased our share of wallet with our top 25 customers in 2009. That tells us that even if rental demand declines again this year, we’re billing the right kind of customer base for long-term profitability.

Customer segmentation is far more than a sales strategy for us and extends into our entire operation. For example, our fleet mix and fleet management are changing because our strategy calls for something different now. Large customers understand where our priorities lie and it is earning a larger share of their wallet, like the contract that we recently signed with one of the world’s largest civil engineering companies. This national account liked what they saw from us and gave us the opportunity to earn their business on a major rail project in the US.

We won the contract because we persevered as a team at the national level, regional, district, branch, and corporate. It’s a perfect example of Operation United in action. At the same time, we’re working to optimize our transactional business. By that I mean, the occasional or one-off rentals that come our way in local levels. When we get these requests, we want to make sure that we quote a price that reflects the real cost of fulfilling these transactions. If the standard is met, even a small rental has a place in our strategy. Small customers represent the potential to grow with us over time.

On our last call, I gave you an overview of our customer focus scorecard, which measures branch performance in five dimensions that customers value most. These metrics are largely universal, meaning that they are important to our customers of all sizes. The scorecard was rolled out in June 2009, so the data is relatively recent, but I want to give you a couple of metrics to illustrate how quickly we can move our field operations along the path of continuous improvement.

In our Southwest region, the total response time improved by more than 15% in the fourth quarter. That’s the time it takes a machine up and running at the customer’s job site after he puts a request in for service. It’s a huge deal for our customers, and in Northeast Canada, on-time delivery improved by more than 17% in the fourth quarter. This is a meaningful improvement based on real life expectations of our customers, but we’re not done yet. We believe that the customer service analytics available through our scorecard are the most comprehensive in our industry. We can track how we are doing at any level—branch, district, region, and company—and by the end of this month, we will be able to drill down and look at how we perform for individual customers, not just key accounts, any customer. This is the major differentiator that gives us real ammunition in our battle for customer loyalty.

Even with these focused objectives, we’re still keeping an open mind. Markets are never static, and an underpenetrated rental market has more potential than most. Our most profitable customer segment five or ten years from now may not even be on our radar today or a new kind of equipment may come available with applications in completely new markets. I can tell you thirty years ago, I drove an aerial machine around to contractors who had never seen a lift and had no intention of renting one. Today, everyone in construction has an appreciation for aerial equipment, so I know it happens.

Looking back to late 2008, we stood on the brink of a downturn and decided there was no good reason to set our engine on idle while the economy turns around. We have chosen to take advantage of these volatile times by showing that we know how to steer a steady and purposeful course, and by the way, we are not the only ones acting now with an eye towards the future. We share the same strategy thinking driving large projects where we have a presence; for example, the Philadelphia Convention Center. That’s a $786 million expansion with 440,000 square feet of exhibit space, and we had more than 100 aerial machines on rent with customers for a year now. When the facility opens in 2011, it’s going to give Philadelphia a huge advantage in competing for convention business, and we like that kind of thinking, but 2010 is not a new roadmap for us. Operation United already has us moving in the right direction. This year, it’s about executing with increasing precision on the roadmap we already have.

In January, we brought all of our branch managers and field leaders together with senior management and board members at our annual meeting in St. Louis. It was an intense three days of preparation for 2010, and by the end, it was evident to our employees who were as inspired as we were about the possibilities for a new United Rentals. I saw more than an acceptance; I saw real excitement. We’re moving forward together, United as one, in total agreement about our goals. Let me tell you what I told our managers. This path that we are on takes courage and it takes willpower. We have deliberately set a course that makes demands on our leadership and our willingness to innovate.

Right now, the economy is working against us, but our strategy is more enduring to any environment and is being executed by a seasoned management team that brings the right mix of executive ability and industry experience to the job at hand.

Every objective we set in 2010 builds on the fundamentals of Operation United. Every opportunity ties to our competitive advantages of customer service and size, and we’re taking our core business to a more profitable place with the ultimate objective of creating value, and we’ll create that value by delivering the most efficient and customer-focused services in the equipment rental industry.

With that I’ll now pass it over to Bill who will review our results, and then we’ll go to Q&A and we’ll take your questions.

Bill Plummer

As Mike said, I’ll provide more detail on our fourth quarter and full year financial results, but before I do that, I’d like to comment on the timing of this call. Those of you who have followed the company for a while may note that this call is happening about three weeks earlier in the month than it has historically, and I just wanted to point out that that is the result of a tremendous amount effort on the part of people within the finance organization here at United Rentals.

Our view is that the sooner we can get through the reporting process, the sooner we’re able to refocus on driving improvement in the business and so we have set an objective of continuing to report on an earlier basis, so you’ll see our annual reports happen along about this time every year going forward. You’ll also see the quarterly reports happen a week sooner in the quarter than we have historically as well. This is no accident. It’s the result of a lot of hard work by a lot of people at United Rentals, so I wanted to take this opportunity to say thanks to all the folks who made it happen.

Let’s turn to our performance against the targets that we have been laying out for 2009. Starting with SG&A, as Mike noted, we delivered $101 million of SG&A reductions for the year, and that included $20 million of reduction in the fourth quarter alone, consistent with what we saw through 2009, those savings in SG&A came in nearly every line of our SG&A total. We had reductions in salaries, benefits, travel and entertainment, professional fees, marketing spend; again anywhere you look in SG&A, we had improvements.

On cost of rent excluding depreciation, we reduced cost by $227 million for the year, and that included $51 million of reduction in the fourth quarter, and like SG&A, the reductions came in virtually all lines—salaries, benefits, delivery cost, fuel, repair and maintenance, facility costs; again, just about every line in our cost of rentals ex depreciation. Mike mentioned that that $227 million reduction fell a little short of our target of $240 to $250. Quite honestly that was disappointing for us, but there are a number of puts and takes that happened at the end of the year that resulted in the $227 million that I reported. Part of it is good news.

The fourth quarter revenue was actually stronger than we had in our forecast when we gave the $240 to $250 range. Variable costs that came with that stronger revenue explain part of the variance, but there are also other puts and takes in several non-cash, nonoperating lines. For example, we had a $4 million adjustment in a self-insurance reserve, so between the extra revenue and the self-insurance reserve, that’s the bulk of the miss versus the $240 bottom of our range.

Despite the shortfall though, $227 million of reduction is real money, and it’s a result of a lot of work, so we’re proud of that performance in 2009. We simplified, we streamlined, we automated more of our renal processes, and we think there is opportunity to continue to drive cost out of this business. On net rental capex, we finished the year with a net outflow of $31 million, which was slightly above our target of about zero for the year. That additional capex reflects what we talked about in the third quarter which was our effort to take advantage of opportunities that we see in the market and reinforce those opportunities with investment as appropriate. As Mike mentioned, the equipment that we bought during the quarter immediately was put on rent at high utilization levels, and again that supports the extra revenue that we saw in the fourth quarter.

Turning to free cash flow, we delivered $367 million of free cash flow. That was better than our target of $350 million, despite having spent the incremental amount of rental capex. Within free cash flow, we generated $440 million of cash from our operating activities.

Our abilities to overachieve on free cash flow despite the additional capex shows that we have built flexibility and to our ability to manage the company and manage the cash flow of the company, and we exercised that flexibility in the fourth quarter. You can expect us to continue to exercise that flexibility and respond to investment conditions as we go through 2010 as well.

Now a few thoughts on our capital structure and liquidity. In this area, we made significant progress in 2009. As many of you’re aware, in November, we issued a total of $673 million of new debt that included a half a billion of senior unsecured debt and another $173 million of convertible notes that we issued out of our holding company.

When you combine that November activity with half billion dollars of 10-7/8% notes that we did in June, plus the redemption of our 14% holding company notes that we did in the fourth quarter, we substantially improved the profile of our debt maturities over the next several years. We don’t have at this point significant maturities other than the 6-1/2’s in the next several years, and as again many of you have noted we have already announced that we will be calling the 6-1/2% senior unsecured notes on February 16, 2010, so that will be $435 million worth of maturities in 2012 which will be called and removed from the maturity profile, so you put all this together, and you can see that we’ve proactively addressed the capital structure throughout 2009. We don’t have any significant maturities until 2013, and the decks are very well cleared for us to be able to respond to any level of investment that we might need over the next several years.

On liquidity, we continue to have a very strong liquidity position. We ended the year with over $1 billion of total liquidity that includes $954 million of availability under our asset base loan facility, plus $169 million of cash on hand, and I just mentioned the redemption that we’re going to do of the 6-1/2’s. That will eat up a part of that available liquidity, but even after redeeming the 6-1/2’s, we’ll still have about $700 million of total liquidity available to us, so that puts us in a very strong position for a company of this size in a cycle at this point in the cycle.

A few thoughts on our fleet; we continue to manage the fleet consistent with our fleet management strategy during the quarter. We continue to aggressively transfer fleet, as Mike mentioned to optimize the use of the capital that we have invested in fleet, so we transferred $1.4 billion of fleet in the quarter, and that represents about 36% of our overall fleet size. As Mike said, this is a nice lever that we have to address our customer needs with greater utilization rather than putting more capital into the business.

At the end of December, our overall fleet age was 42.4 months. That’s up a month from September, but it’s still below the 43 months that we previously guided to at the end of the year, and again that is consistent with the approach that we have decided to take in managing the fleet.

On a year-over-year basis, our overall fleet size was down by 9%, while on a unit basis, the OEC was down 26,000 units or 11%, again consistent with the strategy we’re taking. We wanted to size the fleet last year appropriate to the level of demand, and we think we have done that well.

With all of that as background, let me address few of the financial results. First on revenues, rental revenue was down 26% in the quarter, and within that, rates were down 9.6% year-over-year for the quarter. Time utilization was down 2.4% points, and dollar utilization for the quarter came in at 46.0%, which is down 2.7 percentage points from the third quarter which is the seasonally strong quarter for us.

For contractor supplies, revenue was down 40% year-over-year, and that reflects our continued strategic focus on the higher margin contractor supply sales along with the overall soft operating environment. We did improve margin. Gross margin improved for the quarter by 130 basis points compared to last year.

On used equipment sales, we generated $37 million of proceeds during the quarter. Although that’s down slightly from the third quarter, our sales were in line with our fleet strategy, and our margins were sequentially consistent with the trend that we saw in the third quarter. So when we put all that together, with the cost performance that we talked about earlier, our adjusted EBITDA for the quarter came in at $149 million, and the margin on that EBITDA was 26.8%. And even though that’s not where we want to be on a margin basis, it’s still allowed us to end the full year with a margin of 26.6%, in a very challenging environment.

Those are the remarks that I wanted to make on 2009 very briefly. On 2010, we’ll continue to execute the strategy that Mike mentioned. Driving efficiency is a prominent part of that, but also the customer segmentation strategy is key as well. The environment continues to be challenging for us in terms of visibility for our outlook, and so we’ve chosen to continue the same level of guidance we’ve given throughout 2009, and it will focus on the same metrics.

For SG&A, we expect to continue to reduce SG&A this year by another $25 to $35 million. On cost of rent excluding depreciation, we expect to reduce another $70 to $90 million for the full year compared to 2009. Put those together, that $110 million worth of additional cost reductions in 2010, and if you look back over the last couple of years, 2008 and 2009 combined have resulted in nearly half a billion dollars of total cost reduction for the company. That’s consistent with the strategy and certainly going to be a continuing focus in 2009.

On fleet, we expect the fleet to age into the high 40s during the course of this year, but again we don’t expect any significant impact of that aging to our ability to generate revenue. We’re keeping our fleet well maintained, and that’s really all that matters to the customers.

For free cash flow, we expect to generate $175 to $200 million of free cash flow in the year. That will be after investing about $100 to $120 million of net renal capex during the course of the year. That will also include by the way about $40 million of a net cash tax refund for the year. And like in 2009, we’ll use that free cash flow to pay down debt.

So those are the comments on 2010. Before I open for Q&A, I’d just like to reemphasize the points that Mike made. We’ve got a clear strategy. We’re focused on driving it, and we believe that we’ve got a lot of good momentum built up. We certainly have the people to execute on the strategy, and we feel confident that we’re going to make progress in a challenging environment in 2010 and position ourselves for better performance when better times come.

With that, I’d ask the operator to open up the call for Q&A.

Question and Answer Session

Operator

(Operator Instructions). Your next question comes from the line of Henry Kirn – UBS.

Henry Kirn – UBS

Could you talk a little about how you see nonresidential industrial demand for renal is as we go through 2010, maybe compared with what you saw in the fourth quarter?

Michael Kneeland

We continue to see a decline in our primary markets. That came through the back half of 2009. The rate of decline seemed to have mitigated itself, ever so slightly. As I’ve stated before, we do believe that we will hit bottom in 2010 and begin a slow climb out, but it’s not going to be until 2011 before you really see any meaningful comparisons on a year over year basis. We’re going to continue to defleet Henry, as we go through this year, but just not at the pace we did last year, so that will obviously have some impact on our revenue generation.

Henry Kirn – UBS

How should we be thinking about the capex for nonrental PPE, and how should we be thinking about interest expense as we go into 2010?

William Plummer

For non-rental capex, I think you can look for us to continue to be aggressive in how we manage that number, and so compared to 2009, I think that’d be starting place but we will be aggressive in trying to shave non-rental capex against what we did in 2009.

Henry Kirn – UBS

And on the interest expense?

William Plummer

You see all the components of debt. You can probably do the math as well as I can. I would expect that on a GAAP basis, interest expense will be up slightly compared to 2009 simply because we had so many of the gains on debt repurchases that flowed through interest expense in 2009. If you adjust to take out those gains and other amortization writeoffs from the 2009 number, I think you’re looking at interest expense being again just slightly down from that adjusted basis. So it’ll be up slightly on a GAAP basis, let’s put it that way.

Operator

Your next question comes from the line of David Wells – Thompson Research.

David Wells – Thompson Research

Could you walk us through the difference in your rental margin between Q4 and Q3? I am just trying to get a sense of given the topline decrease, we saw I guess a greater decrease in margin, and was that just a deleveraging effect or were there some factors in that?

William Plummer

Renal margin Q3 was 32%, Q4 was 26.2%. Within that, it’s a seasonally soft period for us, so revenues in general will come, so you will have less ability to amortize fixed costs over the revenues. So that’s just sort of a normal seasonal pattern for us. We did have as I noted greater investments in some of the fleet, and so we had a little bit of incremental cost to get that fleet out into rental status. We had the nonoperating adjustments that I referred to as well. The $4 million of insurance reserves that we took in the fourth quarter contributed to the margin reductions, and then a host of other puts and takes that really are a lot of small ones. So those are the key things that I pointed out.

David Wells – Thompson Research

Looking at the free cash flow guidance for year, I’m trying to get a sense of where the swing is coming relative to 2009. I guess your Capex is going up $70 million plus. Presumably you’ve got $100 million of additional cost savings, so where is that differential of $150 million relative to ’09 coming? Is that just softness in operating results or are there some other factors at work there?

William Plummer

You have to remember that we’re defleeting during the course of this year, so our average fleet size is going to be down significantly from ’09 to 2010; so smaller fleet, less fleet on rent, less ability to generate operating capex. We’ve also got rate carryover ’09 to ’10. Our rates came down during ’09, so even if we kept the rates at a constant level throughout the entire year, there’d be a negative carryover effect from rate, and a point of rate is worth a decent amount of EBITDA and cash flow, so those are probably the two big offsets to the benefits that we’ll have from lower cost and the other good things that are going on in the company.

David Wells – Thompson Research

Lastly, given what you’ve scene on the rate front over the last four months, would you anticipate that you’d be able to push rates up on fleet to combat the incremental piece of fleet that goes out the door, or is it just too early to tell?

Michael Kneeland

It’s still too early. We’re right in the thick of the lowest part of the cycle—our seasonality in the first quarter, and we come back and see our rates every day. As Bill mentioned, our rates were down 11.8% for the year, so that’s not where we want to be. We do have systems in place. Having said that there are opportunities and areas where we are seeing demand. We are taking full advantage of that. So where we’re spending our capital and where we see demand in the field, clearly that’s where we see the opportunities to improve rates. It’s still challenging. It’s something that we as an industry have wrestled, but the reality of it is, we continue to struggle with all the competitors out there for various reasons, but the actions that we’re taking we think will bear some fruit. What do I mean by that? I do that the ability to change our rates systematically with one switch overnight will give us the opportunity to react quicker and to adjust our rates. So that’s where we’re going, and also having that discussion before you make that rate has also helped us. It’s an ongoing process in our industry and for the company.

Operator

Your next question comes from the line of Scott Schneeberger – Oppenheimer.

Scott Schneeberger – Oppenheimer

Bill, congratulations on the faster reporting. It’s symbolic of the improvement going on there, so nice work. Just following up on some of the free cash flow questions, how do you think about it with regard to your spend? I view it as potentially conservative if we have another tough year. There will be a lot more fleet reduction and therefore you will be spending less on growth and there could be upside from that. Of course, there is the offset of the lower cash from operations, but how did you build that up and would you say that it comes at a conservative level?

Michael Kneeland

I think that we’ve always been labeled as being conservative, and we try to be down the fairway. The one thing for both Bill and I, if we can wrap our arms around it, we’ll update you as we go forward. What we see right now to address your question on spend, it is really driven by demand that we’re seeing from some of the customers that we’re bringing in, these national accounts, these industrial accounts, areas where we’re positioned well. It’s a balancing act, and it’s balancing against what demand and where we anticipate it going. Keep in mind, you’re right, we could always sell more fleet. We could spend less if need be, and I think we’ve proven in 2009 that we’re willing to do that if we have to. For 2010, we think that we’ll start to see the bottom and see some improvement. We’re making some strides with some of our customers, and we see that as opportunity, so the way we look at it today and it can change obviously, and we’ll update you, but with costs, it’s what we can wrap our arms around. If we get more, we’ll report it and we’ll say we can do more. With regard to our spend, if demand is there, we’ll spend it. If it’s not there, we won’t, and if we have to balance that against selling something today in the market for 30 or 40 cents on the dollar and say next year you have to spend 100 cents on the dollar, that’s the ongoing process that we go through every day. So it’s not a perfect answer to your question, but we’re balancing it, but we have the vision of looking at what our customer demand is.

Scott Schneeberger – Oppenheimer

With regard to industrial, could you speak to developments you’re seeing in pricing there relative to the nonindustrial business? Are the pricing trends similar, or are we seeing a spread between the two emerging?

Michael Kneeland

Our average is not dynamically different from our company average, and again what’s attractive is the fact that they keep it out for longer periods, they don’t damage it, that’s less costly for us to turn it around. So that’s the opportunity that we see out there on the rate side of things.

Scott Schneeberger – Oppenheimer

With regard to industrial, and I’m going to tie national accounts into this, you said industrial in the past had a goal of 30%. I think it’s at 18% if I’m recalling correctly. How quickly do you get there based on what you’re looking at for 2010? What pieces of your mix of industial, nonindustrial, other do you see going up and down over this coming year, and then just tying in national accounts as well in the end?

Michael Kneeland

Of the 233 national accounts, 62 were industrial. We have to continue to earn that business every day. Joel Dickson and his team, I continue to focus with them to sign more accounts to bring them into us, and then our management team has to go out there and continue to earn not only their business but their share of wallet, and that’s what we’re focusing on. Our goal is to be at 30% in two years. That’s our goal. It’s a stretched goal, but I think we can get there. I think that we’re setting the stage today as an organization, that we’re focused on the customer, and that we’re driving the metrics that will attract that customer and hold that customer, but that’s where we stand and that’s our internal goal.

Scott Schneeberger – Oppenheimer

On national accounts, any particular goal for 2010? Is it at 24% right now?

Michael Kneeland

It’s at 24%. We don’t publicly come out with what we expect every year. Our goal over the next several years would be somewhere in the vicinity of 40-45%.

Operator

Your next question comes from the line of Emily Shanks – Barclays Capital.

Emily Shanks – Barclays Capital

Bill, I missed your comment. On your free cash flow, if I caught it correctly, includes a cash tax refund of what amount?

William Plummer

About $40 million.

Emily Shanks – Barclays Capital

When will that be paid out?

William Plummer

It will be in the first half; it could be first quarter, it could be second quarter.

Emily Shanks – Barclays Capital

What is the exact number of your OEC? The amount of outstanding, instead of the 3.8, can you give us more figures?

William Plummer

It’s 3763.

Emily Shanks – Barclays Capital

Speaking to the business itself, as you talk about the incremental COGS savings that you’re targeting for this coming year, where exactly are those coming from, or can you bucket those for us and give us a little sense of how you will go about achieving them?

William Plummer

Last year, they came just about in every line, and we expect that to be the case again this year, so we’ll continue to make decisions about salary and benefit levels, headcount levels underneath those. We’ll continue to be aggressive around our facility costs. We had some benefits there this year. Mike noted that R&M expense was down 17% year over year. We put in some new technologies that we think can help us take R&M expense again down this year. And again a host of other lines that we could point to that come out of process changes, out of technology changes, out of streamlining our processes overall, and out of automating that we think can play through the whole rental process. So it’s hard to describe what the program is for taking cost out because it’s so broad across the entire organization.

Emily Shanks – Barclays Capital

The last bucket of questions I have is around the borrowing base. It’s kind of two-fold; first, can you remind us how often the borrowing base is calculated, and then secondly comment on what trends you’re seeing around residual values please?

William Plummer

We have an audit and review every six months. The last one was in September, so we’re coming up again in March, so we’ll be looked at again at the end of March. With respect to trends, I think RALS would probably be a better source, and what they’ve seen is that values have increased over the last several months. I think the December RALS report was just out yesterday, for example, and I believe they showed an increase of about 1.6% over November, and that’s been the trend for the last few months. They’ve been up in that 1% area, so it seems like there is a little bit of an uptick in values. Let’s hope that that continues.

Operator

Your next question comes from the line of David Raso with ISI.

David Raso – ISI

I didn’t fully understand the answer about the reduced free cash flow for ’10. If we’re generally speaking of $180 million decline in free cash flow year to year, we can account for roughly 80 of it from the higher net capex, so focusing on that other 100, first $110 million of cost savings year over year from a P&L perspective, is most of that cash savings?

William Plummer

Yes. Most of it is cash cost flowing down.

David Raso – ISI

Then you also mentioned, I believe a tax cash saving of around $40 million?

William Plummer

Yes. There’s a cash tax refund based on the losses that we incurred in 2009 that we will realize in 2010. That’s part of the free cash flow for this year, and that was $40 million.

David Raso – ISI

So the analysis of how do I lose another $100 million of cash. So far, I’m up $150 million. So I have to find a negative swing of $250. If your revenues decline 11% next year and you lose every dollar of cash, meaning every cost you have is fixed, which obviously is not true, then I see the $250. How am I losing $250 million cash flow there somewhere? I must be missing something.

William Plummer

We’ve got a powerful de-fleet cycle going, and you have to really understand that to really be able to get into the cash impact of that. What we said in our press release was that our fleet would end the year at $3.6 billion as I recall, and that’s down from $3763 that I just gave at the end of 2009. The average size of our fleet during 2010 will be down as a result of that, so when you look at the reduction in size of our fleet, along with an assumption around time utilization which is, let’s just say time utilization stays flat year over year, that’s a pretty powerful negative impact on earnings and cash flow, so that’s a big chunk of that missing cash flow if you will, and then you have to look at the impact of rate. I mentioned that we’ve got a negative carryover effect from rate, and that’s assuming that rates stay stable throughout the course of 2010. If revenues are going down, to use your 11% number, you have to make it some kind of assumption about how rates are going to perform in that environment. They are likely to be down, so rate impact is very powerful in affecting cash flow as well, so the combination of de-fleet and rate challenges is probably the bulk of the delta that you’re trying to explain in free cash flow. There are other nicks in that; as I said interest expense would be up a little bit, so there will be a little bit of an impact from cash interest expense. It’s not major, and then there are some elements in terms of the mix of revenues that could have an impact. Those are the key missing pieces, and we’ve made our estimate for what 2010 is going to look like and that’s where the cash flow falls at. Does that make sense to David?

Operator

The next question comes from the line of Philip Volpicelli with Cantor Fitzgerald.

Philip Volpicelli – Cantor Fitzgerald

First question is what is the restrictive payments capacity to go from United Rentals North America to United Rentals, Inc., please?

William Plummer

The RP limitation right now is the most stringent one is in the 6-1/2s, which are still outstanding, and that as we have said in the past several hundred million dollars negative. The basket is negative by several hundred million dollars. Once we redeem that issue, the next most restrictive payment limitation will be in our senior subordinated notes. Both the 7 and the 7-3/4 have RP limitations. Their baskets are also large negative, several hundred billion large negative there. The good news there is that they are subnotes, so the limitation would only prohibit us from upstreaming cash to the holding company, but I also should point out that the new senior unsubordinated notes that we did, the 10-7/8 and the 9-1/4 have RP limitations as well, and their baskets are also negative, but slightly negative. They are only negative to the extent of net losses that we have incurred since they have been issued, so I think the 10-7/8s, the RP basket is negative in the tens of millions.

Philip Volpicelli – Cantor Fitzgerald

In terms of free cash flow, you said you were going to pay down debt. Is it continuing to extend maturities or is there something special that you plan to do with the cash flow?

William Plummer

We certainly will look at the best opportunities for paying down debt. We’ve got as I am sure you know a put on our 1-7/8s convertible note issue that is available to investors in October. We expect that to be put, so that’ll absorb $115 million roughly of the cash flow, and then we’ll look for opportunities beyond that that make sense for us. We don’t have a specific action in mind right now for using the rest of the cash.

Philip Volpicelli – Cantor Fitzgerald

In terms of overall fleet oversupply in the industry, it appears that it might be getting a little bit more in line with demand. How do you guys see that, and can you break it up possibly regionally?

Michael Kneeland

I would say that there’s still an oversupply of aerial equipment, particularly the smaller units. Large boom seems to be doing very well, and that would be across North American on balance. Earth moving is starting to improve. Earth moving is not just the big earth moving, but more like small excavators, loaders, skids loaders. You see pockets of that. It’s actually doing well on the West Coast and also up in the North East and in Canada as well. Florida I think is still ways off from needing any kind of equipment and probably still a little oversaturated, but I would say from a macro view, earth moving is doing better, as you would expect because it’s usually the first line into the business, or in the construction cycle, and aerial will be toward the tail end, and that’s also reflective if you take a look at the RALS report. The used prices are actually increasing on earth moving, and aerial is flat and in some products it’s actually down.

Operator

The next question comes from the line of Chris Doherty with Oppenheimer & Co.

Chris Doherty – Oppenheimer & Co

On your expectations for fleet at the end of 2010, at that point, do you expect that your fleet will be such that you’re running at what has historically been a 68 to 70% type target on utilization or do you think that there still be some fleet in their that will be able to absorb demand as it comes back into 2011?

Bill Plummer

Given the profile of 2010 that we’ve assumed right now, I would say it’s hard to imagine that a $3.6 billion fleet would be able to operate at high 60s, 67-68% utilization at the end of this year. Mike, feel free to disagree with me, but that would be a great environment if we were able to achieve it.

Mike Kneeland

That’s right. Are we building towards that? Yes. Are we changing our customer segmentation to maximize the fleet? Yes. Will it take time? Yes, but not in ’10.

Chris Doherty – Oppenheimer & Co

When demand does come back in 2011 as you expect, you probably won’t have to increase your capex spend to handle that. You’ll have some latent EBITDA growth there before you have to actually spend to service it.

Mike Kneeland

That’s a great point, and it’s something that I have mentioned when I was out on the road. You’re right. When people ask us about the needs for capital, we still have room to improve our time utilization, and we would get improvements in our rates at the same timeframe, so those are the two areas that you would see, first time, rate, and then you would see more investment needed.

Chris Doherty – Oppenheimer & Co

Your rates were down this quarter, I think you said 9 point something percent. If you think of the effect of mix on that, is mix a positive or a negative to that number?

Mike Kneeland

Mix has some of it. Geography has it as well, and it plays out all over North America, but some of the regions do better, but it’s all market driven. Mix is part of it, but not all of it.

Chris Doherty – Oppenheimer & Co

But that number that you gave does not include mix, does it?

Mike Kneeland

It’s constant.

Bill Plummer

It’s a constant mix calculation Chris, and so there is not an explicit mix impact there, but I think Mike’s comments are dead on. Even if we had a mix impact, it’s probably not the major part of the story.

Operator

I’ll like to turn the program back to management for any further remarks.

Mike Kneeland

I want to thank all of you for joining us today, and as you can see, while we are mindful of the economy, our focus is on the elements of our business that are within our control, and we also have updated our investor presentation on our website last night, so please feel free to download a fresh copy and call us with any questions here. Thank you very much. Have a great day and look forward to our next call.

Operator

Thank you ladies and gentlemen. This does conclude the program. You may now disconnect.

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Source: United Rentals Inc. Q4 2009 Earnings Call Transcript
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