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United Rentals (NYSE:URI)

Q2 2010 Earnings Call

July 21, 2010 11:01 am ET

Executives

Michael Kneeland - Chief Executive Officer, President, Director and Member of Strategy Committee

William Plummer - Chief Financial Officer and Executive Vice President

Analysts

Philip Volpicelli - Goldman Sachs

Matt Leach

Henry Kirn - UBS Investment Bank

Seth Weber - RBC Capital Markets Corporation

Emily Shanks - Lehman Brothers

Christopher Doherty

Scott Schneeberger - Oppenheimer & Co. Inc.

David Wells - Avondale Partners

Operator

Good morning, and welcome to the United Rentals Second Quarter Investor Conference Call. [Operator Instructions] 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 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, 2009, as well as the 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 forward-looking statements in order to reflect new information or subsequent events, circumstances or changes in expectations. 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 today 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

Thank you, operator. Good morning, everyone, and welcome. On the call with me today is Bill Plummer, our Chief Financial Officer and other members of our senior management team.

I want to start with a quick overview of the results we reported last night, and then focus on the metrics that indicate changes that are starting to take effect in our markets and within our company. I'll talk about the drivers of change, the seasonal, cyclical and our strategy in particular, and share some insights into what kind of demand we expect to see over the next six to 12 months. But still too early to speak in absolutes, but the second quarter did shed some light on the cycle

As you saw in our press release, we had a strong quarter. The environment is better. Our strategy is taking hold. We're more optimistic than we have been for some time, and we appear to be seeing the early stages of an upturn. And while we continue to bear down on cost, our focus is now on growing the business. So let's start with the results

We made money in the second quarter. Last year, revenues were slightly higher in the period but gross profit was lower and earnings per share was negative. So it's clear that we've improved the business from top to bottom. EBITDA is up. We reported a significant increase in adjusted EBITDA margin for the quarter from 24.4% last year to 32.1% this year. There's a lot of discipline behind those numbers starting with the revenue line.

Our rental revenues outperformed the operating environment in the second quarter. Total non-residential construction spending, which includes both private and public construction was down 16.1% in April year-over-year and down 15.2% in May. And you compare that to our rental revenues, which were down less than 1% for the quarter. At the same time, our same-store rental revenues were actually up 2.7%. So going hard after the business that's out there, implementing our market strategy, identifying and going after the right types of customers and winning more profitable jobs, but we're staying very aware of the quality of our revenues, not just the quantity. We'll talk more about our strategy in just a moment

Now on the cost side, we took $11 million of SG&A expense out of the business compared to the second quarter last year. We also brought down our cost of equipment rentals x depreciation by $4 million. Bill will talk in just a moment about where we are in these initiatives and what we see for the balance of the year. With CapEx, we've a lot of bandwidth to react to the market conditions. We bought $125 million of new fleet in the second quarter. We also sold $80 million of used OEC at 24.3% margin. And we ended the quarter with $3.8 billion of fleet with an average age of 45 months.

So we're very disciplined around the use of our capital and CapEx. At the same time, managing our liquidity very carefully and despite buying more fleet then we originally planned, still generated positive free cash flow of $8 million in the quarter.

Now I'll spend a few minutes to talk about the two dynamics that drive our numbers. Rental rates and utilization. As you saw, rates were down 2% in the quarter year-over-year. Still a lot of pressure on pricing out there but if you dissect the quarter, the sequential trends are promising. We are continuing to focus very intensely on rates. It's a huge priority for our business, and I would say for the industry as well.

We estimate that every point of rate is worth about $18 million of annual EBITDA to us, so I can assure you we're doing everything in our power to reverse the year-over-year trend on rates. Our approach is very informed and very disciplined. We're working to achieve the optimal price on every contract. We're also walking away from unprofitable deals and we're implementing the price optimization software, which we call core, which if you recall is about dynamic pricing, each price subject to that type of customer. The core is currently rolled out to 75% of our branches and we'll complete it by the end of August. Right now, short-term transactional business is trending upwards as it always does in the spring and summer. Smaller construction projects coming on line, they typically are daily and weekly rentals and they involve less price negotiation, better rates

In the second quarter, about 70% of our business was monthly. Monthly rates are always going to recover last because equipment stays out for longer periods of time at fixed rates. Monthly rates are still a good long-term strategy for us and are more profitable over time, but they also recover last. Still, 30% of our districts in the U.S. and Canada showed a year-over-year rate improvement in the second quarter

The other dynamic I mentioned is utilization. As you know, a combination of rates and time utilization drive dollar utilization in our business. Yesterday, we reported a record second quarter time utilization of 65.4%. Our dollar utilization increased to 46.7%, which is 1.8 percentage points higher than last year. It's worth noting that we had $40 million of original equipment [ph] (22:34) cost on rent more compared to last year. And even though the average size of our fleet actually decreased by $186 million.

So where's demand coming from? We believe that we're seeing the early stages of a cyclical uptick on top of the normal seasonal benefit. The tight credit markets are also helping us with our access to capital, more contractors are renting equipment as opposed to buying it. And from a macro standpoint, we're definitely seeing more spending in public construction. The public transportation sector in particular is showing year-over-year growth in spending --

Residential construction is recovering in some trade areas but it's not a big market for us, but everything else. Infrastructure jobs are now beginning to come online and energy and hospital construction is holding steady. The weak link is commercial construction. There's very little activity and we expect it to recover last. Now taking a look at it from a geography standpoint, our key indicator is same-store rental revenue and six of our nine operating regions showed a year-over-year growth in the second quarter. Canada continues to be strong especially northeast Canada. And in the U.S., we're seeing activity increased by trade area rather than broad regional patterns. But revenues increased in parts of the Southeast driven by demand for general construction equipment. And the Southeast had year-over-year growth and rental revenues

In the Gulf, we saw choppy growth and the region, as a whole, is basically flat. However, if you set aside the impact of Mexico, which we sold the Briggs halfway through the quarter, rental revenue for the Gulf was actually up year-over-year. Now our weakest geographies are still the Southwest and some of the markets to the central part of the U.S., although we're beginning to see pockets of opportunity in both those regions

Now I want to mention our Trench, Power and HVAC business, which reported a 13% increase in rental revenues in the second quarter; obviously, getting a boost from stimulus spending. Our Trench business has equipment currently, today, on 194 stimulus jobs. They're mostly infrastructure projects and we expect to see stimulus spending last for at least another 12 months or maybe longer

The Power and HVAC rentals is a growth area for us in that business. Our teams responded to floods this spring in Rhode Island and Tennessee and we're currently, supplying power and climate control to a number of cleanup camps in the Gulf. Right now, we're averaging approximately $250,000 of rental revenues per month related to the oil spill. So basically, it's very choppy out there but things are getting better. We can sense it in the field as well. Customers are telling us they're bidding more jobs although it's still extremely competitive. Now we're cautiously optimistic but a little less cautious and more optimistic than we were in April.

At the same time, we're not relying on the external environment. we're taking control by driving some of the performance from the inside, using our customer segmentation strategy to focus on building relationships with large construction and industrial customers service to our single point of contact. And we know from experience that large customers are less cyclical and more stable. They appreciate our broad footprint across North America and they almost have an untapped share of wallet that we could earn at a lower cost.

Now we signed 130 new National Accounts to June 30. Now 40% of those were industrial accounts. Now as you can see, we're moving closer to our goal of 30% of revenue from the industrial market. It will take some time to get there but each quarter brings us closer and I have all the confidence that we'll achieve our goal. Now segmentation is a larger part of our go-to-market strategy called, "Operation United". It includes optimization of our fleet footprint, corporate operations and most importantly, our customer service capabilities

Now I said many times, service is a critical differentiator for us, particularly in our industry. If we get service right, the revenues will follow. And we received some good news with service recently with our net promoter store. They told the customers, especially larger customers, are recognizing how committed we are to customer service. That's gratifying for our employees because they're the ones on the front lines driving customer satisfaction.

Now I mentioned that we're pivoting the company toward revenue generation. That's going to be the story going forward, it's about growth and value creation. In addition to segmentation, we have a number of revenue initiatives underway, some of which I started talking about in the first quarter. An aggressive push to new business. In the second quarter, we signed 6,600 new accounts. That's a 25% increase over last year. We also reactivated dormant accounts, and year-to-date, we reactivated 6,100 dormant accounts and generated $16 million of rental revenue from this group alone. And we continue to optimize our branch footprint, positioning our branches in promising markets where they have the opportunity to perform well. And we're close to consolidate at 10 branches in the second quarter.

However, we also opened two new cold starts and we didn't exit any markets in that process. Now we also intend to grow our power HVAC presence this year and into next. So as you can see, all the various parts of our strategy are starting to mesh. And our employees have been exceptional in pursuit to this goals. Our second quarter performance is really a credit to their hard work, great attitude and their professionalism. They really embraced our strategy. It's only appropriate I want to tip my hat to all the employees who are on this call today, and they deserve it.

Now so to summarize, we said in April that we believe the first quarter was the lowest point in the cycle and so far, that appears to be true. Now I want to be very candid with everyone. This is an environment that is still uncertain. there are challenges but things are getting better. The second quarter started well, we got better as we moved through the quarter. Construction spending is still spongy and our activity will shift up and down for a little. But our current advantage point today, we expect many of our end markets to show modest growth as the year progresses moving toward a broader recovery in 2011 and 2012. So when you look at our second quarter performance in this context, frankly, we're very encouraged.

Now in that note, we'll now shift you over to Bill to review our results and then, we'll take your questions after that. So over to you, Bill.

William Plummer

Thanks, Mike, and good morning to everyone. As usual, I'll give a little bit more detail on the financial results for the quarter and then I'll update our outlook for the remainder of the year.

First, looking at our revenue performance, in the Rental line of business, as Mike said, this was a strong quarter for us. No revenue was down less than 1% in the quarter. And as you'd expect, it's about the interplay of fleet size, fleet utilization and rental rates. On the fleet side of things, the average size of our fleet was down by about 5% in the quarter compared to last year. But despite that smaller fleet, we were able to put more OEC on rent. OEC on rent for the quarter was actually up by 2% versus last year in the quarter

So more OEC on rent, smaller fleet size, put them together and you get what was really impressive time utilization for the quarter. 65.4% is a record for the company in the second quarter. That's up 4.1 percentage points versus last year and as we look closer at that increase, we saw very nice improvement in certain key categories.

Earthmoving equipment, for example, was particularly strong. The OEC on rent, dollars for earthmoving equipment for the quarter was up 11% compared to last year. So that helped drive that overall 2% improvement in OEC on rent. And we take heart from that because, as you know, earthmoving equipment tends to be earlier in the cycle when things are improving.

While when we look at our rental rates, as Mike mentioned, we were down 2% year-over-year on rental rate. Although on a sequential basis, the second quarter was about flat with the first quarter of this year. As you look within that and take a look at each month sequential improvement during the quarter, it was an improvement. So every month in the second quarter was better than the prior month in the second quarter. And that follows the first quarter where the pattern was the opposite. In the first quarter, every month sequentially was a little worse than the prior month. That turned around in the second quarter, and so the net effect in the quarter was a quarter that was sequentially flat with the first quarter. By the way, that string of sequential month improvements in the second quarter so far continues into July.

So you put that rate performance together, and while rates are not where we want to be long-term, the trend is positive. And it fits with the view that we've expressed about the sequence of a recovery. So first, we expected to see used equipment prices recover. That's been going on according routes and others. Then you'd expect to see utilization rebound. Certainly, you'd have to say that we got a nice rebound utilization. And then we expect to see rates improve. Hopefully we're at the early stage of a sustained improvement in rates

When you look at rates on a full-year basis, we're still saying what we said at the last quarter. We expect the full-year rate performance to be only modestly down. We're still calling it down something in the low single digits compared to the year.

When you look at our used equipment activities this quarter, we generated $37 million of proceeds from our used equipment sales. And though that's down significantly from last year, remember last year in the second quarter, we were aggressively downsizing the fleet. And so we were selling a lot of equipment. We sold $271 million of OEC last year compared to only $80 million of OEC this year.

Our margins have shown a dramatic improvement. The 24.3% margin that we realized in the second quarter compares to a negative 9.5% last year. That margin performance reflects both a shift in channels and also overall an improved pricing. In terms of channel mix, our retail contribution was 60% this quarter. That compares to only 26% last year

From the flip side, the option channel this quarter was only 22% and that compares to 52% option last year. Pricing meanwhile has improved across nearly all categories and that certainly is reflected in the activity that we're seeing in the used market. And you can see that in external sources such as Ralph's reports.

Turning to our cost performance, Mike mentioned we delivered $11 million of SG&A reduction this quarter. And consistent with what we've seen over the last number of quarters, that reduction came across the great majority of lines within SG&A. In particular, we had benefits in salaries and benefit expense. Those came down in line with headcount reductions that we've realized since last year. We also had a nice quarter in professional fee reductions. We've been more disciplined and focused on use of service providers and professional fees came down nicely as a result. But we also had contributions in the SG&A save from many other lines as well.

So given the trends that we've seen, even though the top line performance is stronger than what we expected earlier in the year, and therefore there's going to be pressure on selling cost, even with all that, we still are comfortable reaffirming our target for $40 million to $50 million of full year SG&A reductions. And as always, we'll keep looking for more and drive that as much as we possibly can.

On the cost of rent lines excluding depreciation, that story is a little bit more complex. We did reduce cost to rent x depreciation by $4 million versus last year. And within that, salary and benefit cost were our main driver. Again, headcount reductions being a main component there. We also had lower facility cost as we see some of the impact of the closures that we've had since last year. But when you look at the full year for cost of rent, we're taking down our estimate for the full year reduction by about $40 million. So right now, we're looking for full year savings and cost of rent in the range of $30 million to $50 million

That's not great news on the surface but there are some real positives when you look into the details. That reduction in the expected save really has driven by variable cost that flow from higher volume. We got more rental transactions than we expected. We're running at a higher time utilization than we expected. We've got more OEC on rent as a result and so you put all that together and the variable cost components are going to be higher. And so our ability to save versus last year is reduced. In particular, repair and maintenance expense, delivery expense and overtime are the biggest drivers of our revised outlook.

Turning to EBITDA and EPS performance, first on EBITDA. Our adjusted EBITDA up for the quarter was $179 million and that was at a margin of 32.1%. Very nice improvement in the margins, 770 basis points versus last year. That's especially significant given that our total revenues were down 9%.

Although 32% is not where we want to be long term, it certainly is a significant improvement and it gives a sense of a very nice operating leverage that we're building into the business as we focus on driving those key customer relationships and continuing to manage cost. In fact, to put it into some perspective, 32.1% margin this quarter is higher than the second quarter margin that we achieved in the second quarter of 2007. And arguably, you could call that the peak of the last cycle. So we feel good about the EBITDA performance we delivered this year.

Looking at EPS, we delivered EPS on a GAAP basis of $0.18 in the quarter. And as we noted on the release last night, that $0.18 includes the effect of a tax benefit of $9 million taken in the second quarter. That benefit arises out of a change in our full year projection. As we look at the full year now and we calculate the expected tax that we will have to provide over the course of the year, we get an effective tax rate for the full year of about 55%. And as we apply that 55% rate to the first half performance as GAAP requires, it resulted in the benefit that you saw in the second quarter

Even when you adjust for that tax matter by the way, we still feel good about the quarter that we just delivered overall. The only other point I'll make on EPS is that the number of shares and the diluted EPS calculation went up as we went into a positive net income. You have to include more share. So the share count for the quarter was 68 million shares in the diluted EPS calculation

Now some thoughts on our fleet. We continue to drive our fleet strategy. First, on leveraging the existing fleet to the max, we're transferring fleet as we have been for the last several years. We're transferring fleet very aggressively. We transferred $1.6 billion in fleet in total in the quarter. That's about 42% of our overall fleet moving around during the course of the quarter. We continue to execute our life cycle management approach by selling older equipment from our fleet. Our used sales during the quarter were made at an average age of 71 months. And again, that's consistent with our view that we should be selling the older equipment as we manage the fleet to be more effective for our customers. By the way, that 71 months is slightly lower than it's been over the last few quarters, and that really reflects the impact of the sale of equipment in Mexico. The average age of the equipment that we sold in Mexico was a little less than normal. If you strip out Mexico, the average age of the other fleet that we sold is about 74 months, not significantly different

In terms of our rental spend, we spent $125 million of gross rental CapEx in the quarter. And we're buying categories with that spend that we expect to perform well in the near term. So for instance, we're buying forklifts, we're buying light towers, compressors, excavators, really a host of general rental and earthmoving products and skewing away from aerial products in the spend. We are spending a little bit on aerial but doing so in specific categories like big booms, which are still in good demand.

We're also buying categories, quite honestly, that fit with the demand we're seeing from our customer groups. As we look at specific customers and specific projects and we have visibility to the fleet that's needed to support those, we've been spending more money on those types of situations.

In terms of our full-year CapEx expectations and given the strong demand that we're seeing and couple that with the focus that we have on support in the key accounts, we decided that we should raise our outlook for full year net rental CapEx. We're now expecting to spend between $160 million to $180 million of net rental CapEx. That's up $60 million from our prior range.

And as I mentioned, that strong demand that we're seeing is expected to continue into the back half, and we are confident that as we do put that new CapEx into our fleet, that we'll be able to put that fleet on rent right away. So that's our strategy on fleet. We're going to target the spend on specific categories. We're going to support specific accounts, and we're going to really focus on driving returns out of the investment

A couple of real brief thoughts on free cash flow. We generated $8 million of free cash flow in the quarter and, while that may not seem like a big number, it's impressive given our fleet spend that I just spent some time on. We think our full year, when you put all together the time utilization, the impact of our cost of rent changes, the greater fleet spend, the full year free cash flow still feels good to us at $200 million to $225 million. So we're maintaining our forecast for $200 million to $225 million for the year. And as always, we're going to look for more and we'll share it to you as we identify it.

Real briefly and lastly on liquidity, we maintain a very strong liquidity position. At the end of the quarter, we had $800 million of total liquidity. Principally that was from availability under our ABL Facility, so we're well-positioned to be able to support whatever capital investment need that we identify.

So those are my key comments on the quarter. I'll stop talking, open it up for Q&A right now. But before we do that, I guess I'll just reemphasize that as we look at this quarter, it was a strong quarter and we feel very good about what we are able to deliver. Continue to be cautious about our outlook going forward but we're going to be there to take full advantage of whatever the market offers to us.

So I'll stop there and ask the operator to open up the call for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Henry Kirn with UBS.

Henry Kirn - UBS Investment Bank

Wondering if you could chat about rate improvement by equipment category and by geography?

Michael Kneeland

Well, we don't have the specific geographies to outline it. What I would say is the way that we saw the levels of activity that I went through on in geography amount, which would be in Canada, particularly in northeast Canada, and then pockets where we saw the year-over-year improvement. That's kind of where you would land on where the rate improvements were seen. As far as categories, I don't necessarily know that we broken them down to specific categories, unless -- Bill, you got that?

William Plummer

We haven't talked, Henry, specifically about rate changes by categories. I think it's fair to say that the level of demand that we're seeing in some of the key categories would support higher rates. I'll stop there.

Henry Kirn - UBS Investment Bank

Is there any way to categorize or quantify the stimulus benefit in the quarter? And how much visibility do you have on the stimulus as we go into the back half of the year and into 2011?

Michael Kneeland

Obviously, we've always said that as the stimulus dollars came forward and that projects started to break ground, the first area that we would see the benefit would be our Trench business, and that seems to be holding through. As you know, there's 32,000 projects that are related to the American Recovery Act [American Recovery and Reinvestment Act] that value $195 billion. 72% of those have been funded. It's broken down to various buckets, transportation, utilities, water infrastructure. Actually, the Trench segment alone is tracking, in pipeline alone, around 1,100 projects. They've got about 821 non-building projects, and they also have 153 projects that are non-residential that they're tracking. So as we go through -- the 194 projects are worth about $3 billion in value, and we estimate that we would generate somewhere around $3 million of revenue on those projects alone. It's coming. It has taken a while to come online, and we expect that to continue to go up from here and peak in 2011. I hope that I answered your question.

Henry Kirn - UBS Investment Bank

Could you chat about if the competitive dynamic stay as where the outset of the cycle held, how the nationwide competition looks compared to either a couple of years ago or at the outset of the last cycle?

Michael Kneeland

Well, I mean obviously, as you know, and this has been a very, very stressful downturn for the industry. Rates have come down and some of the regional players, as we all expected, felt the brunt of it. I would tell you that as we go forward, we're seeing the volume increase that we experienced in the second quarter. My sense is that our competitors will respond as well. I think there's an inherent need of our industry to get a better return on this capital, and we all need to focus more acutely on rates, and I think that will play out over time. Again, we went through a bad cycle. We started to get our fleets right sized across all of the players, sold off a lot in last year. Used prices were affected. Used prices seem to rebound and continue to hold, as Bill mentioned and all the reports that we're seeing from Ralph's [ph] and others plus ourselves. And then we're now seeing volume increases or time utilization improvements, which is the sequence that we said would play out is holding through. So my sense is it's still competitive out there, and there's pockets where we fight everyday. It's not easy, I understand that, and we all have to go out there and try to earn the best dollar we can.

Operator

Our next question comes from Scott Schneeberger with Oppenheimer.

Scott Schneeberger - Oppenheimer & Co. Inc.

Bill, do you have a rule of thumb for incremental margin or flow through for each of additional dollar of rental revenue? Is there a way we can think about that?

William Plummer

So as we talk about it internally, we generally talked about something like 70% flow through on the rental line. You'll note that the flow through on the improvement in the second quarter was better than that, and that reflects some of the cost actions that we've taken and the volume leverage that we're getting with improved OEC going on, on rent. But general, 70% kind of number, maybe 65% just to hedge a little bit, would be a general rule that you might use.

Scott Schneeberger - Oppenheimer & Co. Inc.

With regard to CapEx, incremental CapEx spend decisions, how do you guys look at that? Could you speak a little bit to what it takes to maintain the fleet age, where you are with the fleet age, where you're comfortable going, where you've been historically with CapEx, just some color around that topic.

William Plummer

So 45 months today, and what we've said about this year is that we can see it going into the high 40s. So call it between 47 and 49, 48 if you insist on a point of estimate. What we said is that we don't feel uncomfortable at that level even though it's higher than the optimum range that we talked about historically. Historically, we've talked about a 35- to 45-month optimum range. But operating in the high 40s or even low 50s, even mid-50s would not impact our ability to generate revenue. We're very convinced of that. In fact, again, if you refer to Ralph's about the industry data, Ralph's would tell you that the average rental fleet is already north of 50 months in average age. So we feel comfortable with what we've got on the plate for this year. Next year, we haven't sat down and really nailed a view of where the fleet age is going to go next year. And so we'll certainly talk about it as we get further into our planning process for next year. What I will say is that as a rule of thumb, in order to maintain the size and the age of our fleet constant through a course of a year, we would have to spend about $575 million gross rental CapEx. And obviously, the net would be less than that as you assume some reasonable amount of new sales, so $575 million gross to keep age and size constant across the year. And that will inform how we think about our spend is going forward.

Scott Schneeberger - Oppenheimer & Co. Inc.

Could you update us on Industrial business, how that's developing? I think it's a 30% target mix, just how are all the dynamics are affecting mix and ratio?

Michael Kneeland

Sure. This is Mike, Scott. Our industrial progress continues to march forward. If we take a look at the percentage, it's around 19%, up two percentage points on a year-over-year basis for the quarter. We continue to add more contracts. As I mentioned in our National Accounts, 40% of our signed National Accounts are industrial related. It takes a while to ramp those up, very happy with that. Our rental revenue alone is up 3.5%. So we continue to march forward, and very happy with our progress. We're earning more business everyday. And as Bill mentioned on the capital, you can imagine more some of the capitals going for these longer-term profitable deals, and we're going to react to those.

Operator

Our next question comes from Seth Weber with RBC Capital Markets.

Seth Weber - RBC Capital Markets Corporation

Actually, just to clarify what you just said Mike, did you say that the industrial rental revenues were up 3.5% for the quarter?

William Plummer

Yes, year-over-year, from Q2 '09 to Q2 '10.

Seth Weber - RBC Capital Markets Corporation

And is that the same, or the National Accounts up as well?

William Plummer

Our National Accounts, collectively, are up 6%.

Seth Weber - RBC Capital Markets Corporation

On the pricing, I think last quarter, you gave some monthly visibility to how the numbers trended through the quarter. I'm wondering if you'd be willing to do that this quarter for April, May, June. Really, what I'm trying to understand is, did June turned positive? I think March ended up -- it was kind of down 4% or so, 4.5%.

William Plummer

So last quarter, we gave the monthly year-over-year changes, so I'll just repeat that. For April, year-over-year, April was down 2.6%. May was down 1.8%. June was down 1.1%.

Seth Weber - RBC Capital Markets Corporation

And you said trends have continued into July then?

William Plummer

My comment was about the sequential trends in July, but I think it's fair to say that July is doing well. The problem with July on a year-over-year comparison is last year, July was a blowout month in terms of year-over-year positive. It was up last year, so the comp is covered [ph]. So tune in three months from now, you can ask me about the three months and the third quarter, and we can talk about July then, especially since it'll be done then instead of 2/3 from now.

Seth Weber - RBC Capital Markets Corporation

But just directionally, I assume you'd expect to see the same sequential margin improvement that you usually see in the Rental business from the second quarter to the third quarter. Is that fair?

William Plummer

I don't see anything that would keep us from having a normal sequential margin improvement in the third quarter.

Seth Weber - RBC Capital Markets Corporation

Just switching over, your aerial utilization is actually up, I think up to 70% or so this quarter. How high can you really push that? I mean, it sound like you're not drawing a lot of CapEx at that space, but your time utilization is over 70% for Booms and Lifts. So what's the kind of the trigger point there?

Michael Kneeland

I mean, obviously, Seth, we can run aerial at a higher time utilization. Yes, it's up and it's expected, what you see in the seasonal aspect of the business. Also keep in mind that we have also had de-fleeting, and we're changing our mix. And if you see the investor presentation, it's down a couple of points. The capital that we're spending year-to-date, as Bill mentioned, year-to-date, we've only spent 21% of our CapEx towards aerial. The rest is going to our other product lines. Our time utilization, to answer your question specifically, I find it unusual to get it into the 80s. It's challenging, but it's not unusual. It'll peak out over the course of the third quarter. So I wouldn't be surprised to see that go up a little bit as we went through into the third quarter. Having said that, there are pockets. As Bill mentioned, bigger booms, higher demand, then some of the other products that are related towards commercial construction, small scissor lifts and bigger scissor lifts towards big box. So it's a balancing act.

Seth Weber - RBC Capital Markets Corporation

Last quarter, you gave us, I think you called out $10 million of the CapEx was dedicated to strategic opportunities. Is it possible to clarify how much of this extra $60 million is going towards the strategics?

William Plummer

Yes, I think it's fair to say -- well, first, the extra $60 million is across the entire year. But at least half, let's just say at least half of the incremental spend is against specific strategic customers or projects that we've identified.

Operator

Our next question comes from David Wells with Thompson Research.

David Wells - Avondale Partners

First off, just looking at the expectations that you've outlined previously for kind of a cyclical peak number of a 40% EBITDA margin, given the performance that you've seen out of the business in the quarter and the recovery in margins, how are you thinking about that number now, relative to where you were thinking about it two, three months ago?

William Plummer

We still feel very comfortable that we can achieve a 40% EBITDA margin. After this quarter, I guess I'd say, there's some uncertainty around some of the assumptions underneath that 40% cyclical number. We feel less uncertain about some of those assumptions. For example, remember, we said that number assumes a 67% utilization across the whole year. Well, we just delivered a great second quarter, and that gives us more confidence in our ability to hit a full year 67%. So we feel very comfortable with the 40%, and we feel more comfortable today than we did when we first put it out.

David Wells - Avondale Partners

And then just coming back to an earlier question about stimulus-related projects, given the number of projects that you're tracking, and I believe it's something around $100 billion of construction spend that's not tied to highway specifically, do you feel like those projects alone could offset any continued increases in your kind of more traditional commercial forms of non-res [non-residential] construction as we go into the 2011 time period?

Michael Kneeland

It's really hard to pinpoint that, David. The question of timing, the timing of when these projects start, how they start. Certainly, it's value-added, and we'll take it to offset any of the declines that we've seen in the primary end market but it's really hard to quantify it in that form.

David Wells - Avondale Partners

And then on the National Account front within the new accounts that you're signing, any sense -- are these National Accounts signing a national agreement for the first time with United Rentals, or are you picking up shares from other competitors that maybe have faltered here in the downturn? Any sense of where the business is coming from?

Michael Kneeland

It's coming from both. We're taking some people have faltered, some people are looking at more streamlined and larger players versus the smaller players. We have capital to go after some of these projects with them, and the consistency levels of service that we're providing for them. And I will also say the success we're having with a single point of contact, so it's both.

David Wells - Avondale Partners

I noticed in the presentation posted that you had upped your expectation for the permanency of your cost savings from 50%-ish, kind of a 50% range to 55%. What changed as you looked at those costs that you have taken out? Is it kind of the systems that you put into place that you feel like you can keep some of those cost out of the business? Any color there would be helpful.

William Plummer

You're catching me at a little bit of a disadvantage. Did we change the timeframe over the phase?

Michael Kneeland

No, it's 55%, David. It's the same number we had before. It's 55%, and it was still holding through.

William Plummer

I think at one point, we were saying about 50% and as we sharpened the precision around some of the numbers, I think we settled around 55%.

Operator

Our next question comes from Chris Doherty with Oppenheimer.

Christopher Doherty

Just a question in terms of the fleet size and your expectations for value. You upped the CapEx guidance, but in terms of talking about target utilization, you're still quite below that 67% plus, is the expectation that you're going to maintain the fleet size and focus more on driving rental rates at this point?

Michael Kneeland

Well, I think it's a combination of both, one of which is accounts that we're signing, which will provide us with longer-term duration, we want to make sure that we have the fleet in order to achieve their expectations, that's one. But obviously, yes, we want to get rates up. I mean, the rates is first and foremost on my mind, and anyone of my senior managers, the first thing on their mind as well. Are they looking for more capital? Absolutely. Are we giving it to them? No. We're going to be very selective and have a lot of discipline around where we spend our capital and how we spend our capital. So everyday, we're fighting on rate, and we're going to continue to march towards that number.

William Plummer

Chris, just to put it, your question kind of framed in the context of the 67% utilization goal, if you will. And I think it's fair to say that in the context of that analysis we did for the peak EBITDA margin performance, we did remember -- assume that the fleet size will increase over that time horizon, whatever it is. But we assume that it would do so in context with rates going up as well. And so that was the exercise that we went through then. As we look at what we're doing today and in the near term, it's everything that Mike just said. We want to make sure that we're making decisions about the fleet size that support our ability to drive rate, to drive utilization, to drive return, and we're going to be looking at that everywhere.

Christopher Doherty

And then so in terms of the operating leverage in the business, when do you think you have or have you achieved sort of the run rate cost savings? And I think you sort of brought this up, but I mean, one of the things I was impressed with this quarter was if you look quarter-over-quarter, implied volume was up about 16%, but yet your rental cost only increased by $3 million or 1% quarter-over-quarter which I think is a pretty good operating leverage metric when things are improving. Was there some additional cost cuts quarter-over-quarter?

William Plummer

Yes, I mean, we continue to look at opportunities. And so quarter-over-quarter, we had more headcount reductions, and we had a greater focus on making sure that we're optimizing around our delivery processes. We just continue to challenge ourselves everywhere possible. I think we'll continue to do that, and I think there's opportunity on the cost to rent areas to do more of that as we go forward. Obviously, I always caveat the volume component as to how it impacts our total cost dollars. But in terms of the impact on margin, better volume is going to flow through to better margin for us as long as we're sensible about managing the cost structure. So we're doing the normal things that we do. It had a very nice impact in the second quarter. We're looking for opportunities to keep driving it going forward.

Christopher Doherty

And then just one last question and it relates to sort of the guidance where you increased the net CapEx of rental by $60 million but you maintained free cash flow. Are you getting terms on that, or is there some working capital that benefits there, given that you've now increased the usage of cash by $60 million? Or is that just an improvement in EBITDA, your expectations for EBITDA, Bill?

William Plummer

I guess I have to say the words, it's certainly mostly an improvement in EBITDA. Some of that gets eaten up with the additional working capital, but there's an improvement in EBITDA, implicit in what we said.

Operator

Our next question comes from Emily Shanks with Barclays Capital.

Emily Shanks - Lehman Brothers

Just if I could start with a quick housekeeping item, for the affirmed guidance of $200 million to $225 million of free cash flow, that includes the $55 million federal tax refund, right?

Michael Kneeland

Yes, it does.

William Plummer

Yes.

Emily Shanks - Lehman Brothers

And then Mike, in some of your opening comments, you had commented how the tight credit markets are helping demand for your business. I was curious what your view was around tight credit market potential impact on residual values going forward.

Michael Kneeland

I haven't looked at it from that perspective, to be quite honest with you. What we look at is there is still a viable used market out there. I don't know where it's impacted. We've gone through tight credit market before, and I haven't seen it where it is impacted. The residual values, I think that if the contractor doesn't have the credit and you see an expansion in the secular side of the business, there's going to be an inherent demand for rental companies to probably add more fleet. Not everyone adds new fleet. A lot of the smaller localized will go to the used market. So I think it will still be a very robust market. Keep in mind that 60% of everything that manufactured still went into ownership. So we're just getting a bigger slice of that pie.

William Plummer

I think about it very simply. If credits' tight and people can't find financing to buy their own equipment, then that means that they're going to be demanding our equipment and there's going to be less used on the market, and that should support residual values overall. So I hadn't thought about it. I'm like Mike, I haven't thought about it from a prospective of residual values, but I could very quickly convince myself that that's not something I'd be concerned about.

Emily Shanks - Lehman Brothers

I just wanted to ask, and this is maybe a question for Bill, around the Canadian inter-loan cash movement. I just wanted to understand the 160-ish million that moved, was that the cash that was used for the open-market repurchases of the bond? And then secondarily, can we still look at that $55 million intercompany receivable between URNA and URI as the amount that you can use towards future bond repurchases, or should we be looking at another bucket? I wasn't sure how the two are related.

William Plummer

The intercompany loan, Canada to U.S., I think you should think about it separately, then the intercompany loan, URI to URNA. The intercompany loan from Canada to the U.S. is strictly a cash management move where we bring the money back into the U.S. temporarily to keep the average balance of our ABL down and certainly, that continues. We'll continue to manage that within the rules set out by the tax authorities. In terms of thinking, and we did not use any of that cash directly from the intercompany Canadian U.S. loan to repurchase the subnotes that we repurchased in the second quarter. On the subnote repurchases, that was done out of URI. It used part of the cash capacity at URI to execute those, and we had to because of the limitations on our restricted payments basket that arises out of various debt facilities. We used roughly $24 million, $25 million of that cash capacity. At the end of the quarter, if you look in the Q and the guarantor statements, you'll see that, that cash capacity stood at about $55 million at the end of the quarter, and so that's what we have available to make further repurchases. A very confusing topic, I hope I cleared it up for you.

Operator

Our next question comes from Philip Volpicelli with Deutsche Bank.

Philip Volpicelli - Goldman Sachs

My question is with regard to acquisitions. Clearly, some of the smaller competitors out there are probably facing Chapter 11 or Chapter 7. Are there any fleets out there available for sale that you can pick up at a discount and maybe refurbish? And then I guess as a corollary to that would be in terms of the OEMs, do they have any equipment they've purchased in the open market and have refurbished that might be available to you?

Michael Kneeland

The answer is yes. We go out and we buy used equipment on the open market, and we're not partial to [ph] whether its vendors or going to auction, picking things up. So yes, we've taken opportunities to go out there and buy assets. We continue to do that. Our fleet management team is always looking at what's available out there. So yes, we do take a look at it from an acquisition standpoint. Keep in mind, that usually when companies get distressed, the first thing that they fault around is their services. So we're very cautious to make sure if it's the right asset.

Matt Leach

And in terms with, I guess, your outlook brightening a little bit and still some free cash flow are strong for your cash flow generation, are you looking to make in tuck-in acquisitions or would you consider a larger acquisition?

William Plummer

I think that we always get that question. So the caution is around -- this is a company that as you know, was founded on acquisitions, and grew up in that era. It has to be strategic, whether it's large or small or medium. It has to be strategic with our long-term vision, and that is expanding our geographic -- our diversity around our customer mix. We just don't need to add more physical locations. We don't need to add it to every market. We're in 99 in the 100 markets with the exception of Hawaii. It has to be strategic. Are we open to it? Yes, we'll always look at it. But again, the discipline around is making sure it is our longer term strategy.

Matt Leach

With regard to maintenance expenses, is there kind of like a cliff where if equipment gets above a certain average age that, that maintenance goes up dramatically? Or maybe as a different way, can you give us a sense of as month, the fleet gets older, whether that equates to in more maintenance cost?

William Plummer

To your first question, there's not a cliff. It is not a point where it dramatically rises. What we think about is, as a rule of thumb, something like an incremental $2 million to $3 million a year for an extra month of age on the fleet. So a month maintained over a year will cost you another $2 million to $3 million of incremental R&M. That number does arise a little bit as you get older, but it's not like it goes to 10 to 12, as you go from 45 to 50 months, say.

Operator

Thank you. This concludes today's Q&A session. I'd like to turn it back to our speakers for any closing remarks.

Michael Kneeland

Thanks, operator. First of all, I want to thank everybody for joining us today. I also go back to wanting to thank all of the employees who are on the call listening to us today as well for their hard work and the production of numbers that we produced on the second quarter. Our investor presentation has been updated on our website and it reflects our latest numbers. So please visit and download. And as always, you're welcome giving us a call, get a hold Fred, so if any additional questions or comments you'd like to share with us. Thank you very much and have a great day.

Operator

This concludes today's conference call. You may disconnect at anytime. Thank you for joining us, and enjoy the rest of your day.

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Source: United Rentals Q2 2010 Earnings Call Transcript
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