Oct 22, 2015
Executives
Michael Kneeland - President and CEO William Plummer - EVP and CFO Matt Flannery - EVP and COO
Analysts
Tim Robinson - Susquehanna Seth Weber - RBC Capital Markets Justin Jordan – Jefferies Bernan Jack - Goldman Sachs Scott Schneeberger - Oppenheimer George Tong - Piper Jaffray Steven Fisher - UBS Nic Coppola - Thompson Research Joe Box - KeyBanc
Operator
Good morning, and welcome to United Rentals' Third Quarter 2015 Investor Conference Call. Please be advised that this call is being recorded.
Before we begin, note that the Company’s press release, comments made on today’s call and responses to your questions contain forward looking statements. The Company’s business and operations are subject to a variety of risks and uncertainties, many of which are beyond its control, and consequently, actual results may differ materially from those projected.
A summary of these uncertainties is included in the Safe Harbor statement contained in the Company’s earnings release. For a more complete description of these and other possible risks, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as well as to subsequent filings with the SEC.
You can access these filings on the Company's website at www.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
Good morning everyone and welcome. I want to thank everybody for joining us on today's call.
I'm going to use some of the time today to share how we’re thinking about the opportunities in 2016. But first let's start with the results that we reported last night.
As you saw from our press release, there is mix dynamics in the quarter as well as some strong positive. Our revenue was up just slightly year-over-year but we made the most of every dollar and delivered substantial profitability.
In fact, it was a record quarter for us with adjusted EPS of $2.57 per diluted share. And an adjusted EBITDA margin of over 50%.
This is the Company record not only for the third quarter but for every quarter on our history. In addition, our Trench Safety and Power & HVAC businesses' had stellar results.
And our nine months free cash flow stands at robust $508 million. So there is a lot to like about the quarter and as you saw last night we reaffirmed our outlook for 2015.
But we also dealt with some ongoing challenges to our topline most notably upstream oil and gas and a weak Canadian economy with a negative impact on FX. In addition there is a still an oversupply of fleet in our industry and these three dynamics taken together have put pressure on rates and utilization.
This all unfolded pretty much as we expected and we’re running the business with great cost discipline in this environment. And as the number show, we stay true to our strategy by taking a balanced approach in a competitive market environment.
That's what our focus is today and that's what it will be as we can continue to be in 2016. We’ll issue our outlook in January as usual, but I think it's valuable to start that dialog now.
So before Bill goes through the quarter, I like to give you some insights and for the current marking condition and our perspective on the coming year. First, while our industry grew steadily through 2015, the demand for equipment rental in North America is far from hitting its peak.
In the third quarter we once again increased our volume of equipment in our rent and while time utilization eased year-over-year, it was still a healthy 70%. About half of our regions had year-over-year rental revenue growth in the quarter.
Our Mid-Atlantic region was particularly strong with double digit growth. Activities in this regions anchored by large manufacturing plants under construction in South Carolina and Tennessee, as well as data center work in solar farms.
Industrial activity remains strong with year-over-year growth and an attractive pipeline project. Our utilization in industrial has been in the mid-70s for the past four to five weeks.
Now looking at our specialty businesses, our two largest lines, Trench Safety and Power & HVAC trench both had an exceptional quarter. Trench generated year-over-year revenue growth of more than 16% and Power & HVAC delivered 20% growth.
These increases were primarily driven by same-store growth which is another indicator of demand. All of our specialty businesses benefited from Greenfield expansion this year.
To date in 2015, we have opened a total of 15 new specialty branches in trench, power, pump and tools and another three are in construction. In our pump network, we are pursuing a penetration strategy with new and existing verticals.
Many of our pump cold starts in 2016 will be co-located with the existing branches where customer relationships can leverage for cross-selling and if we have good success in developing a customer base for pump and verticals that deal with the exposure of upstream oil and gas. The business is now shifted to less than 50% of upstream and is growing in other areas.
Another positive indicator of demand is the performance of our national accounts which showed a year-over-year revenue increase in the quarter. And we have had good success in selling to high growth verticals to just chemical processing, power and multi-family residential construction.
National and strategic accounts are driving some of this business but these verticals are also benefiting from a broader customer base. So those are some of our observations in the quarter and we expect the remaining months of the year to play out with a typical seasonality.
Now looking forward, our industry is in a very good place. Forecasters such as Global Insight, Dodge and other see multiple years of up-cycle ahead.
A number of factors are working in our favor. For example, a fair amount of U.S.
construction growth is being driven by large multi-year projects with price tags of 50 million or higher and this is in an area where our scale really works to our advantage. In the U.S., spending on plant maintenance project is ticking upwards which adds to industrial demand and industrial spend in Canada is forecasted to begin a modest but steady recovery starting in 2016.
This is all very positive but the disconnect between demand and revenue of course is supply. And as I mentioned earlier, we believe that our industry has continued to fleet up slightly ahead of demand in anticipation of a long cycle ahead.
For our part, we can control which is quite a lot. We can adjust our CapEx, up or down in real time.
We can manage our used equipment sales together with CapEx for optimal fleet size. We can adjust the timing of our spend and we can move ideal fleet to areas of higher demand.
In addition, we can continue to drive cross-sell and invest in our sales force. And we will be even more stringent on cost controls and take any number of other actions.
We'll be making decisions against an industry backdrop that continues to look very positive. We expect to benefit from the growth and demand for at least the next several years driven by construction and industrial activity and secular shift towards rental.
And as far as withstanding any headwinds, we are looking at 2016 as a clean slate with every option on the table including the timing and the amount of capital spend. We already know that we will spend significantly less CapEx in the first quarter of 2016 than in Q1 of this year.
And we will be watching demand very closely and we will make sure we continue to meet our customer needs as the year unfolds. In our opinion, the best way to grow the business is to go in the year with a strong understanding of the market but with no pre-conceive notions as operators.
Our goal is and always has been to drive higher returns and we have a tremendous flexibility in the path we take to meet that goal. So with that, I'll ask Bill to go over the financial results and then we'll take your questions.
So over to you Bill.
William Plummer
Thanks Mike, and good morning to everyone. As has been our custom, I’ll try to add some color to the information that was released last night and to Mike's comments and also leave plenty of time for questions if we don't get to something that you’re interested in.
So starting with rental revenue, within rental revenue - rental revenue grew overall 0.8% year-over-year. It’s about $11 million of increase versus last year.
Within that we had rerenting ancillary items this year essentially flat to last year. So no contribution to grow from rerenting ancillary combined or individually.
It was all about OER growth and that was driven by the rental rate experience that we posted last night, rates being down at 0.10% of a percent year of year. That cost us about $1.5 million of year-over-year rental revenue.
Our volume growth was still solid 2.4% volume growth, that's growth in what we see on rent and that translates into about $29 million worth of year-over-year revenue increase. Replacement CapEx inflation was about 1.7 percentage point headwind.
Good for just under $20 million of year-over-year revenue decline as an offset to the volume increase. And then everything else we are calling mixed and other was an increase of about 0.3% or about $3.1 million year-over-year and that includes the mix of our business as well as a little bit of FX.
Most of FX shows up in the volume measure in this way of breaking things down but a little bit drops down into that mix and other line. Speaking of FX, we continue to have headwinds from the Canadian currency being down materially.
It was down about 17% in the quarter compared to last year and that was worth about $26 million of revenue decline year-over-year sprinkled amongst the other components that I already mentioned. If you took out CapEx from the quarter, our rental revenue growth would have been 2.8% and certainly more in line with what we’ve seen in terms of fleet growth and the other components.
So those are the comments that offer regarding rental revenue. Just to touch a little bit more on some of the operating measures, time utilization in the quarter finished at 70%, and as I said that reflected rental - fleet on rent growth of about 2.4% year-over-year.
$6.27 billion was our average fleet on rent during the quarter. That 70% utilization was down a 150 basis points versus last year comparable to the decline that we saw back in the second quarter, maybe a touch more.
That's clearly an area of focus for us as we go through the fourth quarter and into next year and certainly you'll hear us talk more about focusing on driving that utilization improvement wherever we can. For used equipment, solid quarter for used equipment sales in the quarter, $142 million in the quarter.
That’s basically flat with third quarter of last year. And an adjusted growth margin of 44%.
That's down about three percentage points from last year. The primary driver of that decline is the mix of channels that we used.
We sold about 52% of our used equipment in the retail channel and we did a little bit more in auctions than we have been doing historically and certainly more than we did last year in selling used equipment in the quarter. So, that combination was the primary driver for the margin decline year-over-year.
The auction increased, I wouldn't go too far with that. We used about 12% of our sales through auction in the quarter that compares to something like four or five last year and it’s consistent with our focus on making sure that we dispose the fleet that we need to dispose of during the course of 2015.
Moving on the profitability. Adjusted EBITDA was $780 million in the quarter and very importantly as Mike said 50.3% margin to be precise.
That represents about $19 million of improvement over last year at a margin improvement of 100 basis points. To break down that year-over-year increase of $19 million, we saw rental rates as a headwind in its contribution to EBITDA of about a $1 million.
Volume, that volume revenue drove about $20 million worth of volume impacted EBITDA. The full year inflation headwind there was 14 million against that and the margin decline that I called that earlier in used sales cost us about $4 million year-over-year.
The impact of our merit increases, we've been calling that out as about $6 million per quarter. It's again 6 million in this quarter and the two big positives in the quarter this year were the incentive compensation adjustment that we’ve made in the third quarter this year as incentive programs have come down – our accrual incentive programs have come down reflecting the somewhat – while the weaker performance than what we had in our original plan.
So that was worth about $13 million of year-over-year improvement. We also had a mix and other improvement of about $11 million and that came from a variety of cost save items that Mike referred to.
In our cost of rentals, we had nice performance in delivery cost during the quarter. Some wage and benefit saves during the quarter and some puts and takes elsewhere that overall resulted in a very nice cost of rentals performance.
And on top of that, we also had a nice SG&A performance in the quarter with SG&A lines like TV expense, professional fees, little bit of improvement in bad debt expense of adding up to a nice contribution there. So, all-in-all, it was a pretty good quarter on the cost front and when you add those two benefits of incentive cost decline and mix and other gets add up to the overall $19 million of EBITDA improvement that we saw versus third quarter last year.
Currency is sprinkled throughout those different lines of EBITDA bridge as well. Currency had an unfavorable impact of about $8 million when you’re talking about EBITDA in the quarter.
So, it continues to be a material headwind. Flow through in the quarter, it's hard to even say some of these numbers sometimes but flow through in the quarter was very high.
317% for that quarter and obviously it’s a very sensitive calculation driven by the fact that we had a fairly small denominator in the year-over-year change in total revenue. So that 317% was heavily benefited by the incentive compensation accrual adjustments.
If you take that out in the quarter, flow through would had been 86%. Still pretty robust and therefore reflecting some of the other cost saves that we had.
But as we said all along, you shouldn’t look at flow through in a one quarter lens, you should think about it longer term. If you look at our year-to-date flow through, the total number including the incentive comp adjustments that we’ve made is 84%, still pretty high.
If you take out the adjustment incentive comp, year-to-date flow through would be about 62% and that’s very much in line with roughly 60% that we’ve been guiding to. So good flow through story for the quarter.
Just real quickly on EPS. As Mike mentioned $2.57 adjusted EPS for the quarter was a company record.
That’s up 17% over EPS in the comparable quarter and that I’ll remind you includes the effect of the currency headwind. Currency cost us about $0.05 per share in this $2.57 EPS quarter.
So, continue to deliver a nice result at EPS, even with the various impacts that we’re talking about. Moving on to free cash flow.
Year-to-date we generated $511 million of free cash flow. Once you exclude the $3 million impact of merger related payments which is the way we talk about it.
That compares to $328 million on the same basis in the first nine months of last year and we continue to feel very comfortable with our free cash flow view for the full year. The primary drivers of the free cash flow result this quarter were the better EBITDA performance, a little bit less CapEx than the year-to-date period last year and a little bit better interest expense - cash interest expense in the year-to-date period as well.
Gross rental CapEx just to mention that for the third quarter was $409 million and that brings the full year-to-date period of CapEx spend to $1.4 billion. Actually the actual numbers was $1.425 Net rental CapEx for the third quarter was $268 million and that brought the full year-to-date net rental CapEx number to a $1 billion.
Moving on quickly to our capital structure and little bit on liquidity. At the end of the quarter, we had liquidity of just over $800 million.
That included ABL capacity of about $620 million and a roughly $170 million of cash on the balance sheet. So we feel that we are well positioned with regard to liquidity.
A real quick update on the share repurchase program. We continue to execute purchases under the $750 million authorization.
In the quarter, we bought back $167 million and that brings the total against this program at quarter end to $740 million, leaving $10 million to complete during the course of the fourth quarter. We do believe we will finish that in the fourth quarter and as we’ve said before the new billion dollar authorization that we have from the board, we will commence buying on right after we complete the existing 750 program.
Our thinking now is that the billion dollar program, we will execute on a fairly steady basis and as we called out before, we expect to complete that program over 18 months once we start it. Last quarter I did remind you - mentioned to you all that we need to be mindful of limitations on the amount of share repurchases that we can do under our debt covenants.
I will just update you there as we have said at the end of the quarter, we had roughly $500 million of available capacity for repurchasing shares or other restricted transactions. That includes restricted payment baskets in our debt facilities, as well as the cash capacity that we have up at the holding company level of URI.
Just real briefly on ROI fees for the quarter, 8.9% in the third quarter. That's trailing 12 month number as you all know.
And that’s up 50 basis points compared to the same period of last year and flat with where we were at the second quarter of this year. Not going to spend much time on the outlook because we didn't change anything in the outlook.
So, certainly the numbers remain operative there. Certainly, if you have any questions about the outlook, we can address them in Q&A.
So, I’ll stop there with my comments and again welcome any questions on the things that I didn’t touch on or more detail on things that I did. But just want to echo the commentary that you heard from Michael and the results in the quarter we feel very good about.
Certainly the profitability, certainly the margin and we feel like we are on the right track in dealing with the environment that we are in and we certainly are thinking very much about how we finish out the year strong and have good momentum going into 2016. So, with that, I’ll ask the Operator to open up the call for questions and answers.
Operator?
Operator
[Operator Instructions] Our first question comes from the line of Ted Grace from Susquehanna. Your question please.
Tim Robinson
Good morning, guys. This is Tim Robinson on the line for Ted.
Thanks for taking my question. First of all, I was hoping you could help me understand how your replacement CapEx remains at 1.1 billion squared up with your largest supplier comments about lower replacement demand next year.
I was just wondering if there is an opportunity for CapEx to be adjusted down in 2016 without actually impacting your strategic growth. And secondly, I was hoping to get your thoughts on the pros and cons of aging your fleet next year as a strategy to maintain discipline on CapEx while supporting growth.
Thanks
Matt Flannery
So, maybe I'll start and you guys can chime in. I won't offer any commentary on the OEMs view of what next year’s order pattern will look like but the billion one of replacement CapEx for us is the calculation of what it would take in order to just replace the units that we would be selling as used and so it’s a pretty straightforward mathematical calculation.
We make a separate decision every year about how much we will actually replace and that is driven by where the fleet stands versus what we calculate as its rental useful life, as well as how the used sales strategy fits in with our overall fleet management strategy. And those are the things that are going to drive how much we actually sell as used.
What that means to the OEMs, I'll let them comment on. The one thing I will point out that we do - obviously we feel the impact of prior year's purchasing patterns on any given year's rental use for life, and so we'll certainly be monitoring that dynamic as we go forward.
But again I'll let the OEMs commentary stand at their own commentary.
Michael Kneeland
Yes, I'll just add, this is Mike by the way. As I stated, we have no preconceived notions.
We have an open thought on how we look at next year and the years beyond. I think what you pointed out is that there is flexibility, and we will exercise our flexibility as we go forward.
Right now we're in the midst of our budget process, it's a ground up and that process is underway and then we'll have that discussion with our Board and come forward in January. But you laid out a scenario, various scenarios, but it really points out to the flexibility that we have.
Tim Robinson
Okay. Thanks guys.
Best of luck next quarter.
Operator
Thank you. Our next question comes from the line of Seth Weber from RBC Capital Markets.
Seth Weber
Good morning guys. I guess, first the clarification.
Is it possible to frame how much the incentive comp will help for the whole year this year and then does that become a headwind next year and if so, are you still targeting at 60% pull through margin next year, is that still the right way to think about it given the rate set up in the next year? That's just a clarification to start, thanks.
Michael Kneeland
Sure. So, the incentive comp impact $13 million in the third quarter, somebody's going to have to get me what we called out was $12 million in second quarter, and that's really where the adjustment started.
So, year-to-date it's $25 million and as a modeling starting point there probably wouldn't be far off to say that we get something like the $13 million in the fourth quarter as well. So, those are the impacts.
The question is - your question about whether it reverses next year. It certainly will reverse out, at least we hope it will reverse out next year as we perform closer to what we ultimately plan for next year, it won't be a full reversal though because remember last year we accrued to a very high payout level for our program, almost maxed out.
This year we're accruing to a below target payout level. So, to normalize next year back is something like target which is how we would model and plan around next year.
The snapback won't be quite as dramatic as the benefit year-over-year that we've seen so far this year. So, I think those are the thoughts that I would offer.
What's the another part of your question that I –
Seth Weber
Just as a tack on to that clarification, is the 60% pull through margin given the rate dynamics and some of these puts and takes is 60% still the right pull through margin to think about for next year?
Michael Kneeland
Yes, that's the way we're thinking about it Seth, right here now. And certainly if there is a significant impact from the snapback of the incentive comp, we would call out what that impact was next year just as we did just now.
But as you think about the rest of the business, 60% we feel is a good way to think about pull through next year.
Seth Weber
Okay, thanks. And then just my real question is on - just trying to get my arms around the oil and gas discussion.
Where do you think we are in that anniversaring that impact, I think last quarter you had talked about, you had repositioned something like $125 million of the $200 million of fleet, well I guess what's the update to that number. And as I look at your dollar utilization numbers by product category, the trends in other - the comparable got less bad this quarter relative to the second quarter.
So, I'm wondering are we past the worst of that as far as a negative headwind on dollar utilization and because the implication for your rate guide for the year suggests that rates are going to get step down here in the fourth quarter. So, I'm just really trying to understand where we are in the spectrum on the oil and gas market?
Thanks.
Matt Flannery
So, Seth, this is Matt. I'll take the oil and gas question.
We've increased our movements as we forecasted. We have moved year-to-date $170 million out from that $124 million number that you had previously stated.
Other than seasonal items like [indiscernible] light towers, we feel that we're mostly done there. You could look at one of the charts in the investor deck and it'll show you on Slide 6, that we feel that the oil and gas demand is pretty much flat and bit bottomed out.
If it goes a little bit lower, it's not going to be by lot, we're not terribly positioned from a fleet perspective. So we feel we have that mostly capturing finish it up through the winter season.
As far as your other question was –
Seth Weber
Well, so your dollar utilization for like the trench and other category got less negative in the third quarter relative to the second quarter. So, are we past the worst of the comps there?
How do we reconcile that type of move with the pretty severe rate decline that's implied in your maintained guidance for the year?
Michael Kneeland
I'll take the dollar utilization and maybe Will or Matt, will take over the rate. As you try to build out your model, if you recall that we had a tremendous amount of cold starts in the specialty arena as a result of that you bring fleet in and as it goes forward, it's going to be putting it out, you'll see that should improve as we go forward.
I think that's the biggest delta around the trench and other. Again building it out and putting what we put in place, now monetizing that and putting the stuff out on rent.
Matt Flannery
Yes, struggling with how to respond to what that might mean for our rate expectation going forward. I think it's pretty clear that the fourth quarter year-over-year raise that we expect as implied by our guidance is down materially, materially more than it was in the third quarter.
Honestly, Seth, I'm struggling with what more to say about that. So, if you got more detailed question maybe you can take it offline and we'll see if we can address it better for you.
Seth Weber
Okay. Thank you very much guys.
Operator
Thank you. Our next question comes from the line of Justin Jordan from Jefferies.
Your question please.
Justin Jordan
Hi, well done on the great quarter. Just kind of like following on some Seth just trying to get a handle on how we should be thinking about 2016?
When we think about time utilization which was done 150 bps year-on-year in both Q2 and Q3, just to give us comfort on I guess returning back to year-on-year positive rate in 2016, and give us comfort on how you think 2016 will be a growth year for URI. I'm just trying to understand, is that going to be you need to see time utilization at least being flat year-on-year before we're going to think about rate going positive year-on-year or what does the building blocks to getting rate moving positive again year-on-year, and moving to dollar utilization normalizing again as Seth was touching on.
Michael Kneeland
Hey Justin, maybe I'll start on this one as well. We start from thinking about what is the macro backdrop expected to look like in 2016, and all of the forecast that we see suggest that there is still going to be a solid macro backdrop.
So, that's a good starting point and it gives us the opportunity to continue to absorb whatever is left of the oil and gas dislocation, absorb any excess fleet that might have been built up in the early part of 2015. So, that starting point number one is that we think the backdrop will be positive.
Point number two is that we are very focused on the utilization performance of the Company as we think about next year. That's going to be a very important guide for us in thinking about what we're doing, where we're doing it, how much we're investing in the fleet to get it done.
So we will be I think in a better position to be able to manage rate if we're absorbing our existing fleet through utilization more effectively. So, that's going to be another, I think positive for us in how we approach delivering improved rate next year.
Obviously that will come along with a very intense cost focus, it won't directly impact rate but certainly will help us examine everything that we're doing and seeing as a way to be more effective inside the Company and therefore be more effective in the marketplace. So, those are the key things that I point to, guys what did I miss?
Matt Flannery
I just would say that it's always - you're trying to say what is the back fall I think it's everyone's strategy, and for us it is about driving profitable growth and it's the balance between utilization and rate. And that's our strategy and that's what we're going to be focused on.
William Plummer
Yes, and one other thing that I'd try is just, if you look at where we expect to exit 2015, we talked last quarter about it being somewhere in that quarter to a third of a point of carryover, negative carryover next year. That's not a huge deficit to make up, it's one point that I would make in terms of getting rate back to breakeven or positive rate next year.
So, that gives us some encouragement that it's not an impossible game to get rate back to being positive next year and if we're doing the right things in managing our fleet and the rest of our business and the macros there with this that's a reasonable to think about next year.
Justin Jordan
Thank you. Just one quick follow on, obviously you've talked macro but can I just get a better sense on what you're doing on SG&A, you told on slide deck $22 million run rate of lean cost savings, which is impressive.
Can you just give us some color what else you're doing on the SG&A just to really help on the EBITDA margins, which are up 100 basis points year-on-year which is a very strong performance.
William Plummer
Yes sure, I did talk about focusing on T&E and professional fees. And getting some benefit there year-over-year, we'll continue to look for opportunities to maintain on that front.
We're being very, very conscious about all the other lines within SG&A as well. We did have little bit of benefit in that debt expense, we'll continue to look for opportunities there and focusing on managing the age of our receivables which drives that measure.
So, we hope to continue to improve there, and then just general cost focus, it's ramped up in the Company over the last several months and I think that'll be the case going into 2016 as well. So, stay tuned and we'll call out more as we actually deliver.
Justin Jordan
Great. Thank you very much.
Operator
Thank you. Our next question comes from the line of Jerry Revich from Goldman Sachs.
Your question please.
Bernan Jack
Good morning, this is Bernan Jack on behalf of Jerry. In your slide deck you disclosed branches with significant oil and gas exposure is having about 400 basis points lower utilization in your other locations.
Do you expect that GAAP to narrow over the next few quarters, are you simply looking to reducing on equipment in those oil and gas regions?
William Plummer
So, we certainly expected to reduce whether that's the numerator or the denominator, rather it be that we put more fleet on rent, but we're going to react appropriately to the demand that's in the oil and gas, so if we can't move the numerator, we will pull more fleet out of there. It does look like it's bottomed out, the headwinds on a year-over-year comp will be there probably through the end of January or February, which is when we saw this year a lot of the rigs come off and then the fleets come off shortly thereafter.
So, we feel comfortable that we'll manage that GAAP even tighter this year.
Bernan Jack
Okay, thanks. And the second question, you've reduced CapEx guidance by about $100 million this year in response to about 250 basis point cut in rate guidance.
Can you comment on what level pricing you would need to see for you to significantly cut CapEx further?
William Plummer
Yes, I don't know that we would think about it as "X" amount of rate yields "Y" amount of CapEx. I do think that we try to look at the overall position of the Company and the environment that we're in to make that decision around CapEx.
I mentioned earlier for example that we're going to have a very bright light shining on our utilization of existing fleet in 2016, that's going to be an important driver alongside whatever rate we expect to yield. So, I guess I wouldn't think about it as being that tightly linked to rate as long as we've got other opportunities to drive improvement in our business like with utilization.
Matt Flannery
No I think Bill said it well it's about what rate and utilization do we need to have profitable growth and that’s going to be our north star that we will manage and some of the other metrics usually directionally supported, but it won't be as meiotic as a direct tie X rate brings Y capital growth.
Bernan Jack
Okay. Thank you very much.
Operator
Thank you. Our next question comes from the line of Scott Schneeberger from Oppenheimer.
Your question please.
Scott Schneeberger
Thank you. Good morning guys.
It sounds like you're progressing nicely on the oil patch absorption, but it sounds like the overall industry fleeting is going to linger in the next year. Could you give us a feel how long you expect that will persist?
What you are seeing from the competition obviously a lot of questions about what you might do. Would just the environment there and what you are seeing others with regard to price and how they are handling fleets.
Thanks.
Michael Kneeland
I’ll talk about, we are seeing obviously we as well as others have tampered their capital spending and then I think most recently there was one of the OEMs yesterday said that their AWP they saw an increase in the smaller categories of rental companies. It's not unusual if you think about it for a moment that the publically held company has always had access to capital.
The larger companies followed suit and then you would see the capital that comes into play to a much smaller fragmented section. Non unusual not alarming to me, but something we closely watch and we will adjust to our strategy and driving profitable growth.
I think I made a very clear that you’ll see a significant drop in capital spend in Q1 for us and as we come into January Scott, we will clearly will communicate our thoughts going forward. But we watch it.
We understand that the oil had disruption. We also understand and experienced the fleeting up within the industry and good thing is that there is multiple years of expansion left and we will have to play and we will make our calls.
Scott Schneeberger
Thanks Mike. Just following up on that.
This is the time of the year where you are negotiating with OEMs for the following year. Anything unique you're seeing this year.
Are they very disciplined on pricing might we see some increased inflation coming to you next year? Is there any thoughts or commentary on this year may be different from past.
Michael Kneeland
So Scott we are in the middle of the negotiations with our strategic suppliers right now, but we certainly don't expect to see increases coming in the next year for a lot of reasons and will be very diligent about making sure that we are reacting and we are having our partners react to the current environment.
Scott Schneeberger
Thanks. I’ll turn it over.
I appreciate it guys.
Operator
Thank you. Our next question comes from the line of George Tong from Piper Jaffray.
Your question please.
George Tong
Hi, thank you. Good morning.
Switching over to the demand side of the equation, can you talk about how trends you are seeing in rental demand have evolved for you over the past quarter or so with the commercial, industrial, and infrastructure?
William Plummer
George, it's Bill. Ask that question again for me.
George Tong
I was just trying to get a sense for how aside from the rental supply issues you have seen, how rental demand is evolving for you along your main verticals of commercial and industrial.
William Plummer
It continues to be a solid demand environment for us. I mean we are – you heard some of my comments right about some of the industrial demand that we are seeing in the drivers there.
The commercial side of the house still has a got solid tone it and that is supported by whether use non-res construction or some of the other measures by economic data. So the demand environment is still pretty solid.
It's indicated to us both by what we are actually putting on rent, but also the commentary that we would get from our customer base. It's still very much supportive of growth in the next near term period and we expect that to continue to be the case end of 2016.
Michael Kneeland
Yes, the only thing I would add is the equipment we have is very universal applied to multiple verticals to give you some industrial manufacturing, automotive, some distribution, some fabricated metal product, heavy manufacturing, semiconductors and transportation systems, and chemical processing continue to show some areas of growth and expansion. LNG we had some numerous projects as particularly in the beginning of the year and starts and LNG starts, but again all of the fleet that we have in general is universally applied to the verticals that we are talking about.
So with the exception may be some of the pumps and we have talked about pumps in the past.
George Tong
Got it. And Bill following up on your 60% EBITDA target flow through next year.
What are the conditions loosely around re-growth and time utilization that you would need to see for you to be able to deliver on that.
William Plummer
Yes George, I think it’s fair to say that any reasonable range of rate growth and time utilization that we we're thinking about gives us a real good shot at 60% so that's still very much within our thinking here about 2016. Obviously if you don’t get rate or time not as strong as you would like then it puts more emphasis on the cost level, but we feel like any reasonable combination that we're likely to see next year we can think about 60% of the flow through.
So that’s why we are communicating it.
George Tong
Thank you
Operator
Thank you. Our next question comes from the line of Steven Fisher from UBS.
Your question please.
Steven Fisher
Thanks. Good morning.
Just a follow-up again on the oil and gas question. Matt, it sounds like you are saying that you're expecting activity to be pretty flattish next year.
Can you just may be give us any color on what gives you that confidence because we are still hearing about some EMP CapEx cut through next year, want to gauge the risk of any further surprises there and then how would manage that.
Michael Kneeland
Sure thanks Steve. So, there has been some challenges that we have observed, but as you look - I referred to the Slide 6 before we see its pretty much bottomed out and actually may even be slightly above of a drop that would hit in July.
But when you think about if some more rigs comes down as there is further capital project cuts, I think that the fleet knows areas has moderated quite a bit, there will be a little less supply in those areas, but more importantly the dynamic for us is that we still own some business in oil and gas place right now throughout many of the different shelves there is a little some more direct business that may be going on so the dynamic of how the end users are being supplied is giving up an opportunity as well.
Matt Flannery
Yes. The only thing I would add to that is we don’t expect oil to go up or increase over the next year or two.
As I mentioned earlier on the pump business, we are expanding other verticals and we had some really good success. We take a look at in our investor deck on pumps specifically.
We have expanding their verticals as we stand today. They are only down 9.6% on a year-over-year basis after having 50%of their business coming from oil.
So we would not tell we are going to vacate oil, but I think where we - oil for us in general has been drilling the holes and we saw that dropped significantly. We don’t spend a lot of our rental equipment around existing facilities.
Once they are established they are maintained. It's to minimus as far as rental capacity that we have there.
George Tong
That’s helpful. And then Bill you talked about the $1 billion of share we purchased.
Just wondering how you think about the balance between doing those repurchases versus your return on investment, I know on slide you are still showing a nice healthy 700 million plus of free cash flow next year. So, is the expectation that your cash flow will be sufficient to meet both the repo need, repo plan and any of your investment desires.
William Plummer
Absolutely. There are free cash flow numbers after our CapEx plan and that CapEx right now we guided you next year’s CapEx $1.6 billion.
So we think that, that will be plenty of free cash flow to support the capital plans for next year and to execute the share we purchased on the pace that we talked about. So I am not concerned at all about being able to spend on share repurchases to that 18-month time frame and depending on how free cash flow plays out, we have excess cash flow beyond that speed of spin on share repurchases then we can make some more decisions about paying down debt while also during the share repurchase.
So we think we got a lot of flexibility in doing all of the above over the course of the next couple of years.
George Tong
Great thank you a lot.
Operator
Thank you. Our next question comes from the line of Nic Coppola from Thompson Research.
Your question please.
Nic Coppola
Hi. Good morning.
So used sales margins were down year-over-year and in your opening comments talked about the channel mix. Is there anything you can add about the used price environment and maybe what that might mean for the broader trend in the industry?
Michael Kneeland
Yes, used prices are still at very high levels. If you just take the proceeds 142 million divide into the original costs that we saw, which was 247 million, somebody help me out there.
That’s well north of 50% proceeds $0.50 on the dollar for equipments that’s seven years old. So that’s an implication that the values are still very high.
Have they perhaps ticked down from the absolute peak that they achieved a few months ago, maybe, but they are still at levels that represent very attractive opportunities to sell when you need to sell used. So that dynamic is still very, very supportive of what we try to do as a company.
Matt Flannery
The other thing I would add is obviously companies are readjusting either age or either fleet mix particularly places that are heavily in the oil. And as we go through this quarter, in the first quarter - first quarter if you recall, the biggest auctions will typically take place in February were most of the companies spend a lot of time and effort to send their fleet.
I just want to remind everybody, not everyone in our industry has channel mix that we have. We do retail equipment and so unlike a lot of competitors, they don’t have their capacity or lean on that capacity.
That’s a preference they have in our strategy. So you're going to get mixed results, but as Bill mentioned our retail was pretty healthy.
Nic Coppola
And then may be just an update on lean initiatives since your $22 million or $100 million target, what's progress look like there and in your call you can add about operational improvements.
Michael Kneeland
Yes Nic. The $22 million run rate at the third quarter as I'm sure you have noted as down from where it was in the second quarter.
And we should certainly talk about the drivers there but in terms of the initiatives that we are pursuing, they are very much similar to what we talked about in the past, right. We have implemented all of important components of a lean program and what we are about now is rolling that out to a broader set of locations across our business and touching more of the processes in the business.
The $22 million number is reflective of all the work that we have done so far much of which was focused on improving the productivity of each dollar of cost that we spend rather than actually taking out absolute dollars of costs. Given that volume hasn’t developed quite the way we thought it would this year, the improved productivity hasn’t delivered the same amount of save that we initially thought.
And so now we are pivoting to look at whether there are actual dollar costs that we need to take out in order to continue to drive that productivity result and so that’s being discussed as we speak right here now. We still are very comfortable guiding to that $100 million run rate impact by the end of next year, because we can look across the business and still see places where we haven't implemented fully all the lean initiatives or where we have, but we haven’t gotten as much out of them as we might have anticipated.
So we are still comfortable saying that we expect to see the $100 million impact by the end of next year.
Nic Coppola
And that all make sense. Thank you for taking my questions.
Operator
Thank you. Our next question comes from the line of Joe Box from KeyBanc.
Joe Box
So, I will ask you a couple of hypothetical questions here. One, if you guys don’t see the equipment getting reabsorbed by the seasonally slow 1Q, does 2Q then become significantly lower CapEx quarter as well.
William Plummer
Joe, I think given the way we are thinking about managing our decisions around CapEx next year, if we don’t see in the first quarter what we expect to see, I think it’s highly likely that we will get aggressive around the second quarter capital spend as well. That's fair guys?
Michael Kneeland
Absorption is going to be big focus for us next year.
Joe Box
Okay, I can appreciate that. And then I guess what are you guys specifically looking for from your end markets.
To maybe take a change in your capital allocation plans and ultimately put a greater percentage of free cash flow toward debt pay down.
Michael Kneeland
I think in my earlier comments I talked about the macros being an important backdrop for us. If we get a sense as the macro environment is not developing, such that our industry could reasonably expect in the mid-to-high single digits, your kind of growth next year then we are going to have to reassess, right, so that will be step one.
Step two, if we get early in the year and we are not seeing the absorption of the fleet that we talked about getting utilization up, then we are going to have reassess that's step two. And we'll continue to look at that.
Step three might be if we are not seeing the market offer a rate environment that we would expect. Early in the year rate is always a challenge because of the seasonality, but if it’s more of a challenge than sort of what we have going into year, then we will have to reassess.
So those are the things that are going to be swirling around in our heads as we think about how we execute the CapEx and other components of our plan for 2016.
Joe Box
Thanks guys. That’s helpful.
And then just one quick one if I can. Bill, you already kind of talked about the cost of rental line in a number of different components there, but can you maybe just walk through some of the additional puts and takes like few incentive comp.
Ultimately, we are still looking at some nice leverage here where we can see some margin expansion on the gross line.
Michael Kneeland
Yes. So there is an incentive component of the cost of rent benefit as well and certainly that was that play, but it wasn’t the entire explanation for the cost of rent improvement that we saw.
We did have a little bit of a fuel benefit in the quarter as well, that showed up - primarily in cost of rent and so call we call it a couple of million dollars in the quarter there as well. But I’ll remind that fuel as it plays through cost of rent is a pass through for the vessel fuel.
The fuel that’s actually in the equipment we rent, right, the customers pays for that. So it’s sort of natural hedge.
And the fuel component of our delivery costs that’s a pass through to our delivery charge as well. So it’s sort of natural hedge.
So the impact may not be as large as you think from fuel. What else, I called out overall delivery cost of which fuel is apart.
Wage and benefits saves were really just about headcount not particular headcount action, but the natural turnover headcount in our business, as well as some efficiencies that we are realizing from some of the costs saves initiatives that we talked about earlier. Those are the primary drivers within the cost of rent saves and we think we have got the opportunity to continue to drive more saves as we go forward.
Joe Box
I appreciate it. Thank you.
Operator
Thank you. This does conclude the question-and-answer session of today's program.
I would like to hand the program back to Mr. Kneeland.
Michael Kneeland
Well, thanks operator. I want to thank everybody for joining us today.
As we stated earlier, that was a very exciting quarter for us and we've also updated our investor materials. Make sure you go to our website and download both our financial deck and the background information.
If you have any additional question or would like to go any of our facilities, you can reach out to Fred Bradman anytime with your questions in our Stanford office. With that Operator, we will end the call.
Thank you.
Operator
Thank you. And thank you ladies and gentlemen for your participation in today's conference.
This does conclude the program. You may now disconnect.
Good day.