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United Rentals, Inc. (NYSE:URI)

Q2 2014 Earnings Conference Call

July 17, 2014 11:00 ET

Executives

Michael Kneeland - Chief Executive Officer

William Plummer - Chief Financial Officer

Matt Flannery - Chief Operating Officer

Analysts

Seth Weber - RBC Capital Markets

David Raso - ISI Group

Scott Schneeberger - Oppenheimer

Steven Fisher - UBS

Jerry Revich - Goldman Sachs

George Tong - Piper Jaffray

Nick Coppola - Thompson Research

Joe O'Dea - Vertical Research

Tim Robinson - Susquehanna

Nicole DeBlase - Morgan Stanley

Operator

Good morning, and welcome to the United Rentals’ Second Quarter 2014 Investor Conference Call. Please be advised that this call is being recorded. Before we begin, note that the company’s press release, comments made on today’s call and responses to your questions contain forward-looking statements. The company’s business and operations are subject to a variety of risks and uncertainties, many of which are beyond its control, and consequently, actual results may differ materially from those projected.

A summary of these uncertainties is included in the Safe Harbor statement contained in the 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, 2013 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 forward-looking statements in order to reflect new information or subsequent events, circumstances or changes in expectations. You should also note that the company’s earnings release, investor presentation and today’s call include references to free cash flow, adjusted EPS, EBITDA and adjusted EBITDA, each of which is a non-GAAP term.

Speaking today for United Rentals is Michael Kneeland, Chief Executive Officer; William Plummer, Chief Financial Officer; and Matt Flannery, Chief Operating Officer.

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

Michael Kneeland

Well, thanks operator and good morning everyone and welcome. And I want to thank everybody for joining us on today’s call. In January, we laid out our plan for a year of profitable growth and a steady market recovery. We spoke about a balanced capital allocation program that supported both organic growth and acquisitions, the diversification of our services and our focus on return on capital. We set full year goalposts and anticipated well over $5 billion of revenue and more than $2.5 billion of adjusted EBITDA and significant cash flow generation. Last night, we confirmed that we expect to meet or exceed every one of our goalpost by year end. Halfway to the year, our plan has become a profitable reality for the second straight quarter.

We deployed over $1 billion of rental CapEx to-date and realized double-digit revenue growth on our fleet. We added an important new component to our specialty range with our acquisition of National Pump and we are well into our plan on cold start openings. And we are executing a market strategy that leverages our broader service offering as well as our scale. As a result we reported another quarter of significant higher volume on a much larger fleet with no erosion of time utilization. And more importantly better rates. Our adjusted EBITDA was the second quarter record for our company. And we revised our EBITDA guidance upward to a range of $2.65 billion to $2.7 billion for the full year.

Another one of our key metrics return on invested capital, showed real progress in the quarter, ROIC increased over 8% for the first time in our history and this has positive implications for our free cash flow. And last night you saw us raise our full year guidance for this range. These are results of the company that’s firing on all cylinders in an environment of increasing demand. And once again our performance is outpacing the recovery just as we did last year. Based on our current visibility, we now expect to capture a full year rate increase of about 4.5%, which is up from our original outlook.

Bill will discuss our results in more detail prior to taking your questions. But first I want to comment on the macro environment. I will start with the forecast from Global Insight which we agree with the salient points, Global Insight as many of you know provides a comprehensive forecasting service to our industry. Currently the expectation is for equipment and tool rental revenues in North America to grow by 7.7% this year. That’s slightly down from the earlier forecast, but it’s still very robust. The U.S. industry growth is estimated at 8% and Canada is just under 6%. By contrast the U.S. non-residential construction spending is expected to grow at a rate of 3% to 4% in 2014. This reflects a slow start to a year has been picking up steam since March. So in short, demand for rental equipment is projected to exceed the upswing in non-residential construction by more than two to one. Contractors are changing the way they source equipment and as the largest provider we are in a position to capitalize more strongly on that change.

I want to make one related comment to industry growth. We are seeing very strong market for used equipment this year. Our adjusted second quarter margin on sales was up almost 49%. As we said before time utilization, rates and used equipment prices are the three main indicators of demand for equipment in our industry, so it’s a very good sign to see all three of these metrics are strong. For our part we intend to remain very disciplined about our $1.7 billion of new fleet capital we are buying this year. We have high expectations for this capital and we are managing these purchases for maximum returns.

There is no question that our end markets are getting back on track. And in second quarter all but one of our regions saw rental revenue growth and the majority of our regions had double digit growth. Demand from the energy sector is strong across the board with power plants, oil and gas and renewables such as solar and infrastructure projects have been steady. We are also seeing an upswing in commercial and office construction. When the primary project is complete, such as corporate headquarters, we can often capitalize in after growth for surrounding hotels, schools and retail centers.

Our Specialty segment continues to turn in exceptional performance. As you know specialty rentals are an important focus for us going forward and these are high margin businesses with very attractive return on capital. They are cornerstone of our strategy to deliver superior value to shareholders. In the second quarter year-over-year our revenue from trench safety rentals was up more than 21%. And power and HVAC was up 54%. Our same store performance in these two businesses combined increased 22% over last year. So we are getting tremendous organic growth.

And revenue from our tool assets which are rented across our regions was up almost 10%. From a market facing standpoint, the primary value to customers lies in the quality of our service and our technical expertise rather than the equipment itself. This makes specialty rentals less sensitive to price pressure particularly when it comes to providing engineered solutions. In May we added to our power HVAC group with the acquisition of Blue Stream Services, four location business based in the Gulf. Blue Stream serves a good diversity of end markets, oil and gas, disaster recovery, construction, industrial, and entertainment and it will be integrated into our network later this month.

And of course the most significant change to our specialty segment was our acquisition of National Pump on April 1. The pump operations moved on to our IT platform in June and we are now serving customers as United Rentals Pump Solutions. Pump customers have access to our complete range of fleet and we are expanding our cross-selling of pumps to a broader customer base. We are pleased with the caliber of the pump acquisition. It brought a great team on board and it’s off to a strong start. In fact, it’s outperforming our plan. In the second quarter, rental revenue was up almost 62% year-over-year with an EBITDA margin of more than 50%. This acquisition also gives us an ideal platform for expansion to cold starts and at least three of our specialty openings planned for this year will be in pump.

I also want to update you on our few internal initiatives we have in progress. First is our lean program, which I discussed last quarter and this is based on the Kaizen philosophy of improving even the best operations. So far, we have completed Phase 1, which involved 306 Kaizen events at 141 of our branches. And though it’s still early, we see measurable improvements in productivity in areas, such as driver turn time and shop flow. And we feel that our targeted run rate of at least $100 million in efficiencies in three years is very achievable. Second, we are operating our business more safely than ever with a recordable rate of just below 1 through June and a 32% reduction in injuries year-over-year. And I am proud to say that we reduced our injury count more in the last six months than in the full 12 months of 2013.

In last month, we also launched our United Academy, which is an online customer portal for safety training and certification management. Two weeks ago, we added our first blended learning programs, which provide a combination of online training with practical experience at our branches. United Academy is going to be a powerful force for safety in our industry.

In closing, I want to say that clearly we are seeing the immediate benefit from the execution of our plan. At the same time, our strategy is built for the long-term to service well beyond 2014. We are looking at an up cycle with multiple years of industry growth. And when we apply our model to that forecast, we are excited about the kind of returns we can generate. And that’s just a broader goal of value creation, but also the components of that value such as substantial free cash flow and a higher return on capital. And by all accounts, we are in a very good place with a long and profitable runway ahead.

So, with that, I will turn the call over to Bill for the financial results and then we will take your questions. Over to you, Bill?

William Plummer

Thanks, Mike and good morning to everyone. I will center my comments around bridging our rental revenue performance for the quarter, our EBITDA performance for the quarter and then updating the outlook and along the way we will throw in hopefully some useful information about couple of other items.

So, starting with our look at revenue performance, rental revenue in the quarter was up 16.8%, so very robust performance. Obviously, that was aided by the addition of the acquisitions in the quarter, but still when you exclude the acquisitions, pretty robust rental revenue result for us in the quarter. So, 16.8% rental revenue growth, that’s $170 million of year-over-year rental revenue growth. Within rent revenue, re-rent and ancillary items accounted for 0.7% of that 16.8% growth. Ancillary in particular had a robust quarter for us. Ancillary revenue was up $24 million year-over-year within that 0.7%. Re-rent was up about $5 million, so $29 million improvement year-over-year from those two items.

When you look at the owned equipment revenue growth that 16.1% that remains, it was driven by rental rate performance and that was up 4.9% in the quarter that was worth about $43 million of the year-over-year increase. Volume growth was very robust at 10.3% volume growth. This year, that’s worth about $90 million of the year-over-year revenue and again that includes the acquisition of the acquired entities this quarter, but even if you strip out the National Pump acquisition, that volume growth was still pretty impressive at 7.6% ex-pump. So a nice volume quarter for us.

We have been breaking out fleet inflation and the impact of that year-over-year on revenue and that this year was about 1.7 percentage points negative headwind, which resulted in about $15 million deduct from year-over-year rental revenue and probably the best way to think about that fleet inflation as we have talked before is as a net against the volume growth. FX was another headwind for us in the quarter. The Canadian dollar year-over-year was down to the extent of about 0.9% impact on our year-over-year revenue growth. So a negative 0.9% from FX or about $8 million of year-over-year deduct from the Canadian dollar move.

The remainder, mix and other was a robust 3.5% positive in the quarter. And that positive really reflects the impact of National Pump. National Pump’s volume growth is included in the 10.3% volume that I referred to earlier. And given that they have a higher dollar utilization of the fleet that they add, they substantially improve the mix result for the quarter. So, 3.5% mix and other impact in the quarter positive that’s equivalent to about $31 million of year-over-year benefit from mix. So, add all those up, you get the $170 million of year-over-year rental revenue improvement, and again, it reflects what was a very good rental revenue performance for us in the quarter.

Before I leave revenue entirely, just a quick touch on used equipment sales for the quarter, another good quarter for us on used sales, proceeds of $138 million and a margin which was very robust, 48.6% is the adjusted gross margin from our used equipment sales, that’s 660 basis points better than last year. And obviously, it reflects what is a continued strong demand for used equipment in the marketplace as well as our continued focus on selling through our retail channel, which is the most attractive margin channel for our sales. So, a very nice result in used equipment for the quarter and it certainly does support the macro environment comments that Mike made about the continued strength.

If we turn to profitability next, first looking at adjusted EBITDA, year-over-year adjusted EBITDA was up $114 million to $663 million in the quarter. That’s a margin of 47.4%, which is a new record for the second quarter in our company. And looking at the breakdown of that improvement in EBITDA dollars, $114 million total year-over-year improvement. We attribute $41 million of that $114 million to rental rate, the 4.9% rental rate increase that we saw in the quarter. Volume contributed another $61 million of year-over-year growth. Netting against that would be the fleet inflation impact at EBITDA of negative $11 million.

And then as you look at the other items in the year-over-year growth, the mix impact that I called out in revenue resulted in about $16 million of EBITDA improvement and again a very nice contribution from the addition of National Pump. The ancillary growth, that I referred to earlier, resulted in about $12 million of EBITDA benefit in the quarter and used sales also contributed nicely, about $11 million of year-over-year EBITDA growth. Working against that was our cash incentive compensation accrual in the quarter, which was up year-over-year about $12 million, so a $12 million headwind as our incentive programs reflect our increased expectations for performance over the entire year. So, it’s a classic good news bad news story. Performance is better, that’s great, but the incentive comp represents little bit of a headwind against that. Still the overall impact is very positive. And the remaining $4 million headwind is merit increases and some other small other nits and nats. So, all of that adds up to the $114 million of year-over-year EBITDA improvement, driving that margin which was a 190 basis point improvement in margin up to as I mentioned the 47.4% EBITDA margin in the quarter.

Flow-through in the quarter came in at 59.1%. And in fact, it’s a flow-through result in the quarter that makes us comfortable to continue to look for about 60% flow-through impact for the full year. Obviously, the flow-through reflects all of the factors that I touched on in revenue and in our EBITDA performance. It is worth noting through thought that flow-through impact in the quarter was weighed down by the addition of National Pump. As we have said before pump revenues come at about 50% EBITDA margin, so as we added in the quarter National Pump revenues we added EBITDA at about $0.50 on the $1 for those revenues. That weighs down the overall flow-through of the company and resulted in that 59.1% flow-through for the quarter.

If you were to exclude pump the flow-through in the quarter for the full company would be more like 63%. National Pump had about four percentage point impact, negative impact on our flow-through in the quarter. We expect something comparable for the full year effect of adding National Pump this year somewhere in the 4% to 5% range for the full year impact of adding National Pump to adjusted EBITDA.

Real quickly I will just touch on EPS for the quarter, very strong result for us at $1.65 in the quarter that’s up from $1.12 in the second quarter of last year and obviously reflects all the operating points that we talked about earlier. On liquidity, capital structure, free cash flow we had a very strong free cash flow result in the quarter in the first half. First half free cash flow was $240 million and that of course reflects all the free cash flow remaining even after our CapEx spend this year. Rental CapEx was for the year-to-date period the first half was just over $1 billion of our total $1.7 billion expected spend for the year. So a pretty robust free cash flow result of $240 million for the half and puts us well on track to achieving our outlook for the full year, that free cash flow helped to maintain our ABL balances and maintain our liquidity overall. We finished the quarter with total liquidity of $1.2 billion and that includes ABL capacity of about $1 billion available to us. Along with that we also had about $170 million of cash on the balance sheet at the end of the quarter.

Our share repurchase program continue to pace in the second quarter. We bought $185 million worth of our common stock in the second quarter. That brings the cumulative program purchases to $237 million through the end of the quarter. Nice progress puts us well in our way to executing the $500 million total program that we are operating against and well on our way to executing what we have said is going to be $450 million in calendar 2014 of repurchases. So our plan still is very much to complete the program overall by April of next year.

Before we move to the outlook just a real quick comment on ROIC, ROIC finished the quarter at 8.1% on a trailing 12 month basis through June 30 and that’s an increase of 1.1 percentage points over the past year, so very nice year-over-year improvement in the trailing 12 month view of ROIC. And we continue to expect to drive ROIC higher as we go forward. It was benefited slightly by the impact of National Pump in the quarter. Excluding pump ROIC would have been right at 8% for the quarter, so it bears out the premise for investing in National Pump as we go forward.

Our outlook you all saw we updated last night. We revised the revenue rate and free cash flow and EBITDA guidance I will leave you all to read it in detail, but we did narrow the range of total revenue that we expect in the quarter, it’s now $100 million range centered around $5.6 billion. Rental revenue is within that, obviously it will be impacted by our rate expectations. We have raised our rate expectation for the year to about 4.5% from what was previously about 4% for the year, so reflecting the nice momentum that we have seen rates in the first half.

Time utilization we continue to expect to finish the year at about 58.5%. Free cash flow, we have raised that range a little bit. We are now expecting between $450 million and $500 million of free cash flow for the full year. And our view of adjusted EBITDA is now higher. We expect adjusted EBITDA of between $2.650 billion and $2.700 billion for the full year. So, those are the key points that I wanted to make. If I missed anything that you all want to talk about, please raise them in Q&A.

So, at this point, operator we can open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And our first question comes from Seth Weber from RBC Capital Markets. Your line is open. Please go ahead, sir.

Seth Weber - RBC Capital Markets

Hey, good morning everybody.

Michael Kneeland

Good morning, Seth

William Plummer

Good morning

Seth Weber - RBC Capital Markets

Wanted to focus a little bit on the specialty business if we could, in the press release where you are talking about the National Pump deal, you cite that purchase price of $853 versus the $780 at the time of the announcement. So, I assume that reflects confidence or line of sight to the earn-outs. Can you talk about, I mean, you said you are running ahead of plan, so should we assume that you are going to hit that first earn-out in 12 months?

William Plummer

Seth, it’s in the Q if you look at it, the $853 is comprised of $777 I think it is of cash consideration. It excludes the stock component of the purchase. And then the remainder is the contingent consideration, it’s the earn-out. It’s the way that we have to account for the earn-out. So, that $76 million is an expected weighted average of the earn-out that we expect to pay discounted back to present value. Did that help?

Seth Weber - RBC Capital Markets

Yes, thank you. Okay. And is it possible to parse out how much of the upside on the rate increase goes to the 4.9 in the quarter? How much did the pump acquisition contribute to the strength in rate in the quarter? Is it possible to split that out? You kind of qualified it for their ROIC, I am wondering, if you could do that for rate?

William Plummer

There is no impact of rate from pump. Remember, the ARA standard calculation you used the prior year weighting for the various classes and we didn’t have pump last year, so its weighting was zero in the rate calculation.

Seth Weber - RBC Capital Markets

Okay. And then just sticking on the specialty business, last quarter you talked about specialty getting about $240 million of the growth CapEx, I think it was a $560 million number, has that – has your thoughts around how much capital you are committing to the specialty business changed at all, you obviously didn’t change your full CapEx number this year, but I am just wondering if you are committing more capital to the specialty business than you previously thought?

Matt Flannery

Yes, this is Matt. We are absolutely continuing to fund that business. And we were even exclusive of the pump acquisition, but we will continue to fund that business and we feel we can do that without having to raise our overall capital anymore than the guidance that we changed earlier in the year when we announced the acquisition.

Seth Weber - RBC Capital Markets

But is it still in that $240 millionish range or is it going to – I am trying to understand what percentage of the pie it’s getting?

Matt Flannery

So, it’s still in that range this year, because we don’t have to fund as many cold starts in the power business that we did last year. If you recall we started a lot of power cold starts last year and not as many this year. So, it will still be in that range, but we expect as we go forward, we will – that range could increase. We are hoping it will increase actually.

Seth Weber - RBC Capital Markets

Okay. And with the increased free cash flow guidance for this year, does that I must truly assume that your M&A could pickup or how do you envision spending that extra capital?

Michael Kneeland

Well, this is Mike, Seth. I think that we are always going to be on the horizon looking as I stated in my opening comments, specialty is the cornerstone for our strategy right now. We will look and we just did the Blue-Stream, but just as I said this more than once that the bar is pretty high to get over the hurdle for us to think about it. We pass on more than we go deep in. That being said, I think our cash flow will be used right here now as to kind of pay down our debt at this point.

Seth Weber - RBC Capital Markets

Okay, thank you very much guys.

Michael Kneeland

Yes, thank you.

William Plummer

Thanks.

Operator

Thank you. (Operator Instructions) And our next question comes from David Raso from ISI Group. Your line is open. Please go ahead.

David Raso - ISI Group

Good morning. The free cash flow target we used to speak of the $1.5 billion from 2013 and 2015, is that still a number we should think about as a target for the three years?

William Plummer

Yes. Hey, David. Yes, we continue to think about that same number. Obviously, we are enhancing our chances of getting there as we raise our outlook for free cash flow this year and we will continue to work hard to hit that number and do even better if we can.

David Raso - ISI Group

It implies then free cash flow for ‘15 as north of $650 million and even if you do payout the earn-out to the full $125 million, you have finished the last $50 million for repo. It’s going to leave your net debt at the end of ‘15 probably at or below the low end of your leverage ratio to 2.5 to 3.5 that you target. So, I was just curious if you can maybe give us some insight on where are you targeting ending ‘15 leverage? Is that math right there really tells you unless EBITDA is wildly off from when you think it would be, you are going to be below the low end of your leverage?

William Plummer

So, all we have said so far, David is that we will be toward the low end of that range without giving out any new guidance for 2015 I think I will stick to that. But I would just add we feel very comfortable about all of the comments that we have made about ‘15, including the contribution ‘15 makes to the $1.5 billion three-year cash flow, including the leverage being in the area of that the low end of that range. And so I won’t go any further there right now. As the year plays out and as we get ourselves prepped for our Investor Day, maybe we can say more as we get later in the year.

David Raso - ISI Group

Well, I guess that’s the related question then. Is there anything we should start thinking about the message for the December 4 meeting? There is a couple of milestones people are trying to think about, obviously at this level is there a stock split thought process, is the entry into the S&P 500 isn’t really up to you, but you would think that’s something that could be out there that’s obviously potentially could happen, obviously some of the leverage numbers I was talking about for next year. I mean, there are some things we should be thinking about already as a framework for the message on December 4?

William Plummer

Okay. Five months in advance, he wants the message already. I would say stay tuned. We’ll develop those thoughts as we go. Mike, I am sorry.

Michael Kneeland

Yes. So, David, we are still concentrating on this year and we will frame up our discussion points for the September meeting. You raised one there is other investors who are asking other questions as well. So, we will try to make sure that we can – we will try to answer as many as we possibly can as long as we get closer. As you know in December, we will have our understanding of what the 2015 will look from the roll up of our budget, so it will be an appropriate time in early December to have that discussion.

David Raso - ISI Group

Okay, I appreciate it. Thank you.

Michael Kneeland

Well, thank you.

William Plummer

Thanks, David.

Operator

Thank you. And our next question comes from Scott Schneeberger from Oppenheimer. Your line is open. Please go ahead sir.

Michael Kneeland

Hey, Scott.

Scott Schneeberger - Oppenheimer

Thanks Good morning guys. Hey, one question but a couple of parts in it, I will ask it all upfront. Can you address how rental rate growth will flow over second half just a bridge the 4.5% rate guidance for the year and then the follow-ons to that are how you are thinking about rental rates long-term just with a strong year again this year with specialty. National Pump mix team and more specialty to come, what’s the long-term view on that? And then lastly just kind of still on the rate theme, what the competitive environment feels like out there. It sounds like you guys are being good leaders, but just any anecdote there. Thanks. I will cut it there. Thank you very much.

Michael Kneeland

Thanks, Scott. So, I will start with the near-term and what gave us the confidence to set a target 4.5 for ourselves for the balance of the year. If you think about that sequentially and what we would have to do, we will have to do 0.5 sequentially for the base – for the balance of our peak season, so July through October, 0.5 and then flatten out to down in November and December, that delivers a 4.5 result for the year. So, it’s not a slam dunk so to speak, but we feel confident that’s why we raised that guidance. As far as long-term, we hadn’t put a long-term target out there yet. I will let Bill speak to it some.

William Plummer

Sure. But just add on to the short-term statement, so if we did that 0.5 through October Scott that would put our year-over-year third quarter rental rate performance in the high-4s and not quite 5% but in the high-4s. And that would put the fourth quarter year-over-year in the lower half of the 4s. So hopefully that gives you a little bit better sense as the second half gains year-over-year rate. For the longer term I think we have talked for a little while now that we continue to see rates over the long-term trending down from the year-over-year growth rates that they have been achieving recently, down to something that looks like 3% a year sort of a steady state. That’s the way we think about our long-term forecasting. I am not saying that we will get that 3% next year, if we finish this year at 4.5 say that will be pretty good momentum carrying into next year and maybe do a little bit better than 3% next year everything else holding – the macro holding in the kind of growth rate that we are experiencing right now. But as we think about ’16, ’17, ’18 something like 3% we think makes a lot of sense as a modeling assumption. And obviously the macro can swamp that for the better or for the worst, but that’s how we think about the long-term.

Michael Kneeland

I would only add Scott that as far as the competition, I think everyone is being good stewards and marching forward. When you take a look at the Rouse report we have a bandwidth in which are leading the charge. What that band seems to be consistent by all of the report month to months which tells you that as we are growing our rate, the industry is growing our rate as well. And then I think everyone else who is public has been reporting positive number. So I think from our perspective that’s how the industry has been reacting. I will also say that it’s necessary because inflation kicks in prices go up and we have to earn over our cost of capital as an industry. So I think it will continue that trend. And to Bill’s point the macro environment will be one of the ones that we will be able to monitor and judge the rate improvement. But I am also pointing out one last point that is we are always as a company strive to maximize our return and also on our rates.

Scott Schneeberger – Oppenheimer

Great. Thanks guys.

Michael Kneeland

Thanks Scott.

Operator

Thank you. And our next question comes from Steven Fisher from UBS. Your line is open. Please go ahead.

Steven Fisher - UBS

Hi, good morning. I am wondering Bill you talked a little bit about return on invested capital, I am wondering if you are still targeting double digits by the end of 2015 and how you see the trajectory of getting to that metric, is it sort of a steady 100 basis points a quarter or now you tend to be more of a hockey stick at that end and why and I guess related to that this National Pump is the interesting in that, you are taking a local high margin product service and leveraging it across your network is part of a key element to the plan on getting to that return on invested capital you need to do more of the these things that’s sort of a new business model for acquisition for you?

William Plummer

So, on the ROIC, just to be clear I think what we said about ROIC is that certainly we are targeting double digit 10% is our internal hurdle rate. And we have talked about achieving that in the material that we put in our investor deck achieving that over a 3 to 5 year period. So 2015 is a little more sudden than what we would say, we would expect to achieve double digit ROIC. Not impossible but that’s not what we have talked about historically. I do believe that growing in the specialty areas is going to be an important component of us achieving that high level of ROIC. Again in the material we put in our investor deck there is a contribution that we have there from business mix and other and part of that business mix is from growth in the specialty areas either organic growth or indeed if we do any further acquisitions. The material we put out does not assume acquisitions, that’s purely organic growth but acquisitions certainly could help accelerate that process if we found the right ones. So, I think that’s the way we talk about specialty and its contribution. Specialty certainly will be an important driver, but it’s not the only driver of us getting to the levels of return that we want to get to. There are things that we can continue to do in our base business and we are working very hard at those everyday.

Steven Fisher - UBS

And just to follow-up, what was the starting point for that three to five years, is that back from our Investor Day in 2012 or is that sort of just been ongoing?

William Plummer

Yes. So, that’s something that we have put out in our investor material, I don’t know, quarter, two quarters ago. It’s based on 2013 ROIC. So, 2013 and we have targeted a three to five-year horizon of getting above 10% and we have talked about the components that we think will drive us there.

Steven Fisher - UBS

Okay, great. Thank you very much.

William Plummer

Thank you.

Michael Kneeland

Thank you.

Operator

Thank you. And our next question comes from Jerry Revich from Goldman Sachs. Your line is open. Please go ahead.

Michael Kneeland

Hey, Jerry.

Jerry Revich - Goldman Sachs

Thank you. Good morning. Michael, can you talk about out of the lean initiative that you mentioned what would the impact be on fleet available for rent, though it looks like in your long-term bridge you are looking for 100 basis points of utilization improvement per year? Is that the driver, I know you spoke about the cost benefit, but maybe you can touch on the utilization opportunity of the results?

Michael Kneeland

Well, I think what you are referring to is as we go to the lean process we are talking about the shop flow and turnaround time, which will be a component of not available for rent. And we – if we were to take down 2 points, that would be a substantial amount of freed up cash to deploy to put on rent. That’s part of the strategy around the lean. As I mentioned, we have had 141 branches. We are seeing nice improvements in efficiencies there. And we are going to continue to focus on that. So, that’s part – that would be part of our plan. I think the other part of our plan around the not available for rent is really just about discipline and fleet management. And when we took a look at the best of both worlds between United Rentals and RSC, we merged the two together. We have a gentleman who came over from RSC who is managing our fleet with the field and is doing a very good job of implying and putting that process to work. So, our processes have changed as well in the way in which we deploy capital and move our fleet, but those will be the two dynamics that we are focusing on. And if you take a look at our size of our fleet, 2 points is real money.

Jerry Revich - Goldman Sachs

Okay, thank you. And can you just talk about on the capital allocation side, which regions you are seeing outsized capital allocation, still where you are seeing the most of maybe still in the top two or three regions within your company?

Michael Kneeland

Yes. Matt?

Matt Flannery

Yes, sure, Jerry. So, regionally, you could imagine where the hotspots are. And although we have had broad-based growth as a matter of fact we had 12 of our 15 regions show double-digit growth and that’s exclusive of pump will also obviously have robust growth. So, we are spreading the capital, but there are couple of hot pockets, where you could imagine the energy sector and not just upstream gets a lot of talk, but we are seeing capital projects at a high level in the energy sector overall, whether it’s power plants or LNG plants. So, those hot pockets along the Gulf Coast and then some spots up in the Northern Midwest are certainly getting their fair share of capital, but I wouldn’t point to just one or two spots where we are seeing robust growth in many of our end markets.

Michael Kneeland

Yes. I would only add that the only other thing that we are doing differently on a capital allocation is around contribution margin, not only by asset, but by customer. And that is probably one of the key takeaways of the changes in the way in which we are putting our fleet to work. So, under the gentlemen I mentioned earlier, that is being implemented through the field. They understand it. And it’s a different way in which we look at the world. And therefore the monies that we talk about that the capital allocation that’s one of the reasons why we will continue to make sure that the specialty businesses are well-financed and well funded for their growth. And doing it both organically as well as through cold starts and we have done two acquisitions. So that’s kind of how we think about it.

Jerry Revich - Goldman Sachs

Thank you very much.

Michael Kneeland

Yes. Thank you.

Operator

Thank you. And our next question comes from George Tong from Piper Jaffray. Your line is open. Please go ahead.

George Tong - Piper Jaffray

Good morning.

Michael Kneeland

How are you?

George Tong - Piper Jaffray

Thank you for taking my question. I just want to drill a little bit deeper on rates, you mentioned that your pump business was not reflected in rate growth this quarter since it was not in the business a year ago, once National Pump does lap next year can you quantify the impact you will have on the rate growth?

William Plummer

George I don’t think it will be a significant impact one way or another the rate growth is not dramatically different than what we are seeing in other areas. The pump story is more about getting more fleet on that, it’s a volume story for us more like here now. And that’s the real opportunity if I can get out there find the customers who need pumps and get those pumps in their hand. And so that’s what we are chasing at. I don’t think you are going to see it moving our rate performance dramatically once it does start being included.

George Tong - Piper Jaffray

Very helpful. Thanks very much.

Michael Kneeland

Thanks George.

Operator

Thank you. And our next question comes from Nick Coppola from Thompson Research. Your line is open. Please go ahead.

Nick Coppola - Thompson Research

Good morning.

Michael Kneeland

Good morning.

Nick Coppola - Thompson Research

So I wanted to ask the one question on weather here and kind of in your conversations with customers how much volume in Q2 do you think could have potentially been from work pushed out from winter weather and really just some catch up activity occurring?

Matt Flannery

Hi Nick, this is Matt. We are not really seeing that as something that we are hearing from our customers, it’s really when you think about the cycle of a project you can ramp it up some and maybe condense the front end of it if you have a delivery date towards the end of the year and maybe you can condense some but you still got to go through the normal phases of construction. And I don’t know that you condense it enough, but it would have a real impact on Q2 revenue maybe some small projects that had a very short window of needs, but that’s not a monstrous spot of our portfolio. So I don’t think it’s a material and which we don’t think it’s a material impact.

Nick Coppola - Thompson Research

That makes sense. And then just my second question can you give us any color on what’s been going on through the first few weeks of July here and our utilization rate kind of trending in line with your expectations and any kind of incremental color on that would be helpful?

William Plummer

Sure, Nick, it’s Bill. Yes, the first quarter – excuse me the first parts of the third quarter early part of July things are trending nicely for us. So and very much in line with the outlook that we have given and what we expect. On the rate front, on the utilization front, volume front it’s trending well. And then Matt or Michael if you guys want to add anything.

Michael Kneeland

No, I think you said it.

Nick Coppola - Thompson Research

Alright. Thanks for taking my questions.

Michael Kneeland

Thank you.

Operator

Thank you. And our next question comes from Joe O'Dea from Vertical Research.

Joe O'Dea - Vertical Research

Good morning. First question I think is on the EBITDA incrementals into back half of the year, you had sort of expressed that there would be a little bit of a step down into 2Q and understand the National Pump impact, but as you go into the back half and sort of implying an additional step down, could you just walk through some of the components driving that?

William Plummer

So, in the back half I think the key things to remember are the impact that we will see on the year-over-year rental rates. I think I mentioned that before with the fourth quarter in particular being a little bit less of a year-over-year improvement than what we have seen in the first few quarters of the year in the lower half of 4s instead of in the upper half of 4s where we have been. We have got the year-over-year impact of items like our bonus accrual I mentioned that in our bridge of EBITDA. Compared to last year our bonus and the compensation expenses are going to be up a little bit. Used sales is a significant impact in the second half versus the first. Remember, if you go back to that first quarter our used sales were actually down year-over-year and used sales bring a lower margin than the rest of the company. So as they go down they actually help the flow-through. That was a pretty significant impact in the first quarter. And so that impacted the first half flow-through positively and therefore the second half should be a little bit less. What else, the pump acquisition obviously will be a significant impact I called that out already 4% to 5% impact, depressing the second half and therefore pushing it down versus the first half.

I think the important thing to focus on is the full year flow-through that we expect is still about 60% and that’s including the impact of pump. If you excluded pump the full year would be a little higher. And therefore the second half would be a little higher than what maybe you are calculating just based on the outlook that we have given. And truth told if you have put a gun to my head I said this last night to a couple of folks. If I had best weather it would be little higher or little lower than that 60%. I bet right now maybe a little higher. So I think that flow-through is shaping up nicely for the year.

Joe O'Dea - Vertical Research

That was really helpful. Thank you. And then just components of growth obviously the National Pump impact on mix in the quarter, I think from the Q it says that the mix effect is still a headwind on the general rental side, but just how to think about mix into the back half of the year and sort of net effective of inflation and mix to growth?

Michael Kneeland

But I think if you think about the back half as comparable to the second quarter from a mix impact perspective that will be a good start on how to model it. So as I said earlier about 3.5 percentage points of the 16.8 rental revenue growth that we had came from mix, I think if you did that again for third and fourth quarter that will be a good starting point.

Joe O'Dea - Vertical Research

Great, thanks very much.

Michael Kneeland

Thank you.

Operator

Thank you. And our next question comes from Tim Robinson from Susquehanna. Your line is open. Please go ahead.

Tim Robinson - Susquehanna

Hi guys, good morning. Thanks for taking my call.

Michael Kneeland

You’re welcome.

Tim Robinson - Susquehanna

I just want to ask real quick about SG&A and it (picked) up, it sounds like it was mostly incentive comp and I am assuming acquisition out of the costs as well, I was just wondering if there is anything else and that we should be aware of and how you would encourage us to think about the 187 as a run rate going forward?

William Plummer

Nothing else major to call out Tim in SG&A, the incentive comp was the big driver. As you go forward again there is nothing major that I would call after the second half. So I think you can safely use the run rate obviously we will have the impacts of the selling cost based on your revenue estimates, we will have puts and takes incentive line items. But nothing major that we point out.

Tim Robinson – Susquehanna

Got it. And then real quick if you would hit your rate guidance for the year, what would that imply for a carry over the pricing heading into 2015?

William Plummer

Give me second Tim here and we will dig that up. Its normally in the 2% area maybe a touch higher but we will dig it up real quick and through it out before the call end.

Tim Robinson – Susquehanna

Perfect. Well, thanks a lot. That’s all I have.

Operator

Thank you. And our next question comes from Nicole DeBlase from Morgan Stanley. Your line is open. Please go ahead.

Nicole DeBlase - Morgan Stanley

Yes. Good morning guys. So just a question on CapEx I know we talked a little about the potential for our additional M&A with your free cash flow for the rest of the year, but I am just curious what would cause you guys to take up your CapEx plans from the $1.7 billion for 2017, is there anything or is that pretty much you would say like locked and loaded for the year?

Michael Kneeland

This is Mike and I will ask Matt to join in and Bill too as well. But for me I would like to see both rate and time utilization grow and particularly as it applies to our contribution margin in areas that we can really get nice returns on. But those are probably the two dynamics. That being said it’s also I want to make sure with the management team that we are not just buying for today. We are buying for multiple years. So but they can put that equipment to use longer term and but rate and time utilization that combination may give me the opportunity to think differently.

Matt Flannery

And I think so, this is Matt, Nicole. I somewhat passed earlier about what kind of impact lean could have on OEC NA and OEC not available. So, as we continue to drive our lean initiative throughout the organization we are about 20% to 25% of our stores impacted already. We actually hope will create more capacity for growth within the capital that we have. So, we really have gotten our team away from the thinking that I need $2 of capital to drive $1 of growth revenue and that’s really part of our goal and part of the reason why we want to stay disciplined on our capital spend.

Michael Kneeland

And the only thing I would add, Nicole, is that all of those factors we would mix in along with the impact on cash flow. We take cash flow pretty seriously. And as long as we don’t feel that we are doing significant damage to our cash flow and in the long run we are enhancing our cash flow as a company that would be a factor in deciding to spend more capital as well. Just to go back to Tim’s question about carryover rate if we did 4.5 this year, I think 2% is probably a good number to use right here now. So, just Tim, I wanted to follow up on that.

Nicole DeBlase - Morgan Stanley

Okay, thanks for the color on the CapEx guys. And just one more for me, I mean, Mike’s comments about commercial construction were pretty bullish, I am just curious are you guys actually seeing real tangible signs of that recovery or is that more a reflection of just customer confidence and their recovery getting better?

Matt Flannery

Hi, Nicole, it’s Matt again. I would say it’s both. So, you see in our deck that our customer confidence is the best results in our survey that we have seen all year, including last year. And we also have seen a robust pipeline of large projects and that’s a core competency, not just of ours, but of our key accounts. So, we expect to get our fair share plus of participation in those projects. And I had mentioned earlier all the jobs in the power sector and the LNG probably the most renowned one is the (indiscernible) project down in the Gulf Coast, but we have got stadiums popping up in different markets. We have got large retail popping up in different markets and really a robust pipeline of major projects throughout the country.

Nicole DeBlase - Morgan Stanley

Okay, great. Thank you guys so much.

Matt Flannery

Thank you.

Michael Kneeland

Thank you.

Operator

Thank you. I am showing no further questions at this time. I would like to hand the conference back over to Mr. Michael Kneeland for closing remarks.

Michael Kneeland

Well, thanks operator. I want to remind everyone that our annual Investor Day in New York has been scheduled for December 4. So, I hope you all attend and join us on our webcast, but more information will come forward as we get closer to that date. In the meantime, please download our current investor update or our updated investor presentation that we have. And as always, you can contact us here in Stanford if there is something you want to discuss. So, operator, you can end the call now. Thank you.

Operator

Thank you, sir. And ladies and gentlemen thank you for participating in today’s conference. This concludes our program. You may all disconnect and have a wonderful day.

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Source: United Rentals' (URI) CEO Michael Kneeland on Q2 2014 Results - Earnings Call Transcript
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