Earnings Call: Q3 2018

Oct 18, 2018

Good afternoon, and welcome to the United Rentals 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. Yeah. The company's business and operations No, it's actually using bundles. are subject to a variety of risks and uncertainties. They cannot get more than that. Many of which are beyond its control, 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 press 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, 2017, 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 press 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. Please refer to the back of the company's recent investor presentations to see the reconciliation from GAAP to non-GAAP financial measure to the most comparable GAAP financial measure. Speaking today for United Rentals is Michael Kneeland, Chief Executive Officer, Jessica Graziano, Chief Financial Officer, and Matt Flannery, President and Chief Operating Officer. I will now turn the call over to Mr. Kneeland. Mr. Kneeland, you may begin. Good morning, everyone, and thanks for joining us. As you know, we often start these calls by talking about profitable growth. Today, we have another strong quarter to discuss. We have measured our performance in concrete ways, including our ability to get attractive margins and returns. In the third quarter, we achieved both of these objectives with results that were solidly rooted in the sustainable advantages, such as fleet management, vertical strategies, and productivity gains, as well as an effective strategy for M&A. Our acquisitions of NES and Neff are still young, but they are already returning good value for our shareholders. The Baker integration is going well, as you will hear later in the call. Underpinning these initiatives is a robust and durable cycle that continues to propel industry growth. It is important to note that we are outperforming both the U.S. equipment rental industry and the construction marketplace, both of which are estimated to be growing in the mid-single digits. By comparison, our pro forma rental revenue in the quarter increased by almost 11%. My remarks this morning will be followed by Matt, who will talk about our operating landscape, and by Jessica, who took the reins as our CFO last week. Turning to the third quarter results. Both total revenue and adjusted EBITDA increased significantly in the quarter. Our adjusted EBITDA margin improved by 20 basis points to 50%. If we exclude the impact of Baker, we are up 80 basis points to 50.6%, which would have been the highest margin in any quarter in our history. Looking at the underlying drivers, we had a 7.4% increase in pro forma volume of equipment on rent year-over-year, and a healthy 2.1% increase in rental rates, with gains across all 15 regions for both the quarter as a whole, but for each month individually. We have grown our rates sequentially every month since March. The key point is that we have been able to convert these higher rates into strong improvements in margin. The third quarter metric, time utilization, was 70.9% in the quarter. This was essentially unchanged from a year ago on a pro forma basis, even though we had a spike in last September from the hurricanes. So overall, we are maintaining time utilization in the core business at a very high level. As you saw in our press release, our underlying metrics did their job in driving returns, and they point to consistently strong customer demand. Given these positive dynamics, we raised our guidance yesterday for full-year revenue, adjusted EBITDA and CapEx. Our new outlook is based solely on our belief that we will outperform our earlier expectations for revenue and adjusted EBITDA. As for BlueLine, Jessica will give you the expected impact separately in her remarks. Operationally, we are well positioned to manage that growth. We have built a powerful engine for organic expansion and for assimilating future M&A. The disciplines that we have instilled through technology, process improvements, and our safety culture have kept our priorities front and center while smoothing the way for acquired operations. In the third quarter, even with the integration underway, our team turned in an excellent safety record. Our recordable rate in September was a low of 0.74, and our rate for the year remains well below one. I applaud all of the employees for that. In summary, all indications point to a solid fourth quarter with continued momentum. If anything, our avenues for growth have expanded given the recent investments we have made in our Gen Rent and specialty segments. We are not only larger, but we are also more diverse in terms of the solutions that we offer. That makes us a valuable partner to construction and industrial customers. At the same time, we have maintained a robust capital structure, and we are on track to generate significant free cash flow this year. These are all company-specific strengths, largely independent of the macro environment. We'll be talking more about our growth initiatives at our 2018 Investor Day that we'll host in New York on December 11, and I hope you'll join us there. For now, I'll end my comments where I began, with a promise that we're flexing every muscle in our operations to drive attractive margins and returns. We're executing nicely on that goal, and we want to keep raising the bar on the metrics because, while we're gratified by producing strong results, we'll never be 100% satisfied with them. There will always be more that we can do, and that's a good thing for our shareholders. So now I'd like Matt to add his thoughts on the operations, and then Jessica will cover the numbers. So over to you, Matt. Thanks, Mike. A minute ago, you heard Mike speak about our focus on driving returns. I want to use my remarks to provide some specifics about how we achieve that, particularly in terms of adding value for our customers. We feel strongly that our broad offering of fleet, services, and technology differentiate the United Rentals customer experience. As you know, our specialty segment is a cornerstone of that offering. So let's start with that. Our acquisition of Baker adds new capabilities for fluid solutions, while the segment's robust organic performance in the quarter outpaced the company as a whole. Things are going well with Baker, and the combination is on track. The North American operations have been fully integrated and we plan to do Europe next year. We've retained Baker's key leaders and the entire team is proving to be a great fit. They're excited about our initiatives for branch collaboration, and they're sharing customers with our Gen Rent locations. We're actively engaged in the market for our new offerings of tanks and filtration systems. In looking at the specialty segment as a whole, we continue to gain critical mass. Baker added 56 branches to the segment, and we also opened an additional 26 cold starts this year. So together, this brings our specialty footprint to 319 locations in North America with another 11 in Europe. In the third quarter, specialty rental revenue increased over 39% year-over-year, including almost 18% organic growth. Now, these numbers include a significant contribution from cross-selling, which grew nearly 25% year to date. Our investments in the specialty align well with our company-wide commitment to drive returns in our core business while adding valuable services for our customers. That's what the team is focused on, maintaining our strong customer relationships through a comprehensive offering of products and services while keeping a keen eye focused on profitable growth. This goes far beyond our scale and service offerings. For example, we're growing our United Academy curriculum, which now stands at 435 training courses, and we're continuing to develop our customer-facing technology. This includes our digital capabilities, including our proprietary Total Control software. Last month, we held our annual Total Control conference in Dallas for more than 250 customers who use that software. The agenda focused on digital solutions that help our customers drive productivity, safety, and efficiency at their work sites. The customers also got to hear about our technology strategy, and we received a lot of great feedback from them. This was our 19th conference and our biggest one yet. The customers in attendance represented more than $400 million in annual rental revenue for us, and it's a great example of how our technology is a differentiator. Earlier, Mike spoke about company-wide specific strengths and how they exist independently of the macro. These levers become even more valuable in the demand environment like the one we have today. Virtually every external signpost is positive for construction, including the ABI and the Dodge Momentum Index, construction employment data, project backlogs, our used equipment pricing, and among other indicators. The industrial indicators are in the same camp. The various purchasing manager reports, such as the ISM and the Chicago PMIs, are above 50, which indicates expansion. I'd also like to share some of the data points that underscore the broad-based nature of the cycle from our vantage point. In the third quarter, all of our regions increased rental revenue year-over-year. The bulk of that revenue came from our key verticals within the construction and industrial sectors. In fact, almost every vertical that we measure was positive for us year-over-year. For example, infrastructure is a vertical that's been giving us a nice steady trend up for a while now. In the third quarter, we saw sustained demand from infrastructure projects throughout multiple regions in both the U.S. and Canada. Project diversity is another hallmark of demand. On the West Coast, the tech giants are building data centers, and we have four major airports that have work underway, including a $14 billion project at LAX. In the Gulf, there are continued opportunities across the entire petrochem complex, from upstream oil and gas to midstream pipelines to downstream refining and chemical processing. In Canada, our rental revenue growth stayed positive, up almost 10% over the prior year. There are some big projects on the horizon in Canada as well, including a massive $40 billion liquefied natural gas plant in British Columbia. We've been supplying the pre-work at that project for a while, and once it ramps up, we expect to be on site until about 2023. So that's a snapshot of our markets, healthy and growing. If you ask our customers, they'll tell you that things look good, and our branches feel the same way. We're confident about the fourth quarter and believe the cycle has plenty of gas left in the tank. Next up for us is the BlueLine integration. We're looking forward to welcoming the BlueLine team and moving into 2019 with a larger platform and even more capacity for growth. Now I'll ask Jessica to go over the numbers, and then we'll take your questions. Jess? Thanks, Matt, and good morning, everyone. I am pleased to be joining the call as our CFO, especially with such a solid quarter to discuss. One quick note before we get started. The numbers I will be reviewing are as reported, except for a few instances where I will call them out as pro forma. The pro forma numbers include our two most recent acquisitions, Neff and Baker, as if we owned them a year ago. Let's begin with rental revenue. Rental revenue for the third quarter was $1.86 billion, which is up 21.2%, or $325 million year over year. If we break that down further, OER grew 20.3%, which is an increase of $269 million. That growth came mostly from higher volume, which was up 17.8%, or $235 million. Better rates contributed 2.1%, or about $28 million. The impact from inflation on our replacement CapEx was a headwind, call it 1.5% or $20 million. That leaves the impact of mix and other, which was a benefit of 1.9% or $25 million. The positive change in mix is mainly due to the growth of our specialty business. Also included in rental revenue were re-rent and ancillary, both higher this quarter as well, benefiting from increased volume and the addition of Neff and Baker. Re-rent contributed about $9 million in the quarter, and ancillary was better by $47 million, the majority of which is from higher delivery revenue, coming in large part from recovering increased fuel prices. Those numbers were as reported, but as Mike noted, on a pro forma basis, rental revenue for the quarter was a robust performance, up about 11%. On to used sales, which were essentially flat year over year. Adjusted gross margin on used sales was 50%. That is down, excuse me, down from 56.8%. That is primarily due to the impact of selling the older, fully depreciated NES fleet last year. What is important to note is the used sales market continues to be very strong. Our sales as a percentage of OEC was 58.2%, and that is up 500 basis points. The increase was due to a strong pricing environment, up 6% year over year. To a lesser extent, we also benefited from the mix of equipment we sold. Moving to EBITDA. Adjusted EBITDA of $1.06 billion was up $180 million or 20.5%. That came in at a healthy margin of 50%, which was up 20 basis points. Excluding the impact of Baker, adjusted EBITDA margin improved 80 basis points to a record 50.6%. Let me walk you through the bridge on the changes in EBITDA. $158 million of the $180 million increase is from volume, with OEC on rent up 17.8%. Higher rental rates provided another $27 million, while ancillary revenue was a benefit of $23 million. The impact from incentive comp was a benefit of approximately $10 million in the quarter. So in total, $218 million of contributions to EBITDA, partially offset by four headwinds. We estimate that fleet inflation was a headwind of about $16 million. The impact from used sales was about $9 million, and our merit impact in the quarter was $6 million. So that leaves a $7 million decrease in EBITDA from mix and other. That $7 million is the impact of carrying fixed costs for Neff and Baker that were not there in the third quarter last year, partially offset by the positive revenue mix I mentioned earlier. I will briefly mention EBITDA flow-through for the quarter, which was 51%. If we exclude the impacts from Baker and used sales to isolate our core rental business, our flow-through for the quarter was 59%. A good performance across the core businesses, with operating costs coming in on trend and as expected. As for adjusted EPS, a good result at $4.74 compared to $3.25 in the third quarter last year. While $0.87 of the increase was related to tax reform, that still left us with a healthy $0.62 coming primarily from better operating performance. That equates to a 19% growth in underlying. Turning to CapEx. Rental CapEx in the quarter was $736 million, up $164 million from last year. The increase was in response to the broad demand we're seeing, as Matt mentioned. Our guidance for the year modestly increases the range on our growth CapEx spend to between $2 billion and $2.1 billion. Year to date, growth CapEx was just over $1.96 billion. I will mention that we would be looking at lower Q4 CapEx considering the fleet we pulled forward into last year to support Hurricanes Harvey and Irma. Free cash flow continues to be a good story, even with the higher CapEx spend I just mentioned. Year to date at September 30, free cash flow was $568 million, or down $66 million from last year, excluding the impact of payments we made for merger and restructuring. The majority of the $66 million decrease mainly stemmed from higher CapEx, as well as the timing on working capital needs. These impacts were offset in part by the improvements in our adjusted EBITDA. Let's move to net debt and liquidity. Net debt at September 30 was $10.1 billion. Now, that's an increase of about $2 billion since last September, mainly due to the Neff and Baker acquisitions. Our total liquidity at the end of the quarter was $910 million, made up of ABL capacity of about $836 million and cash of $65 million. Now turning to ROIC. ROIC for the trailing 12 months ended September 30 was up 210 basis points to 10.7%. Since we're still using different tax rates within that trailing 12-month calculation, I will mention that ROIC would have been 11%, or up 70 basis points, had we used the 21% federal tax rate in all periods of that calc. So as Mike mentioned, we're very pleased with the increased returns we've generated in the quarter. A quick update on our share repurchase program. Our new $1.25 billion program started in July. Through September 30, we've repurchased about $210 million worth of shares on that program. As we mentioned when we announced the BlueLine deal, we expect to pause the repurchase program once the deal is closed while we get through the integration. I will touch on the impact of our two 2018 acquisitions. Baker closed on July 31, so we had two months of contribution in the third quarter. Baker added approximately $56 million of revenue and $16 million of adjusted EBITDA, both in line with what we expected in the quarter. We're on track as far as synergies with a run rate of about $14 million so far, and $1 million of that is already realized. As for BlueLine, we anticipate closing the deal this quarter. If we assume the transaction closes at the end of October, we expect that BlueLine will contribute in the neighborhood of $120 million of revenue and about $50 million of adjusted EBITDA to calendar 2018. We don't anticipate any significant CapEx spend for BlueLine before the end of the year. I'll finish with a comment on guidance. Just to be clear, this guidance does not include BlueLine for 2018. Our new guidance reflects our increased outlook for total revenue, adjusted EBITDA, and CapEx. That extra CapEx will help position us for what we believe will be a solid fourth quarter while kickstarting 2019 and still delivering robust free cash flow for the year of between $1.25 billion and $1.35 billion. A quarter of excellent results in a favorable macro and strong positioning for 2019. With that, I'll stop and open it up for questions. Operator, please open the line. Certainly. Ladies and gentlemen, if you have a question at this time, please press star then one on your touch tone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Ross Gilardi from Bank of America Merrill Lynch. Your question please. Great. Good morning, guys. Thank you. Morning. Hi, Ross. Look, I think the question on everybody's mind is used markets are extremely tight. You went through the numbers. Your end markets sound like they are extremely robust. Why isn't pricing even better? Realizing you do not guide on rate, not looking for that, but if you are reading the tea leaves correctly on your end markets over the next 12 to 18 months, what sort of steady state rate environment do you think we are in? Are we in +1% to 2%? Are we in flat? Are we in declining? Just thoughts on that would be great. Sure, Ross. Thanks. I will take a couple pieces of the question, and then Mike or Jess can add on. But when we think about rates, first of all, we see this as a good rate environment. Positive sequentials throughout each month in the quarter is certainly extrapolated in our brain into positive rate environment. We get that the pro formas or the year-over-year, on the year-over-year numbers, whether they are pro forma or as reported, have some tough comps, specifically in Q2 and Q3. We see that. That will moderate when we get into Q4. For example, if you lay last year's sequential rate improvement over this year's actual achieved for the first three quarters, which we have been challenged that in itself may even be conservative, but for modeling purposes, think about that last year's achievement would bring us a 2.1% rate for Q4. That would bring us into a 1% carryover into 2019 in what we think, as you have heard, will be a robust demand environment. To answer the latter part of your question, we certainly do think that this is a rate accretive opportunity, not dilutive. That answers that. As far as the sequentials, no doubt August probably came in a little bit lighter than we thought. The reason we stopped giving guidance is because there are so many thousands of variables and inputs that go into this that it changes. The good news is that is not an indicator of profitability. It is great directionally. If we had seen negative sequentials, that would be a concern for us. But when we get to translate this rate experience into record EBITDA margin, as Mike mentioned, and high returns, we feel very good about the end markets. Thanks, Matt. That's helpful. Then you just broke out some numbers where your underlying incremental margin in the rental business was close to 60% ex used and ex M&A. What is your guidance embedding in Q4 on incrementals on the same basis? Hey, Ross, it's Jess. Implied in Q4, if you use the midpoint, and I always caution on the midpoint, but if you use the midpoint, the implied Q4 flow-through is something in the neighborhood of about 62%, and that includes a drag from the Baker acquisition. Obviously, they're coming in with their fixed costs and a margin that was lower than the core business. If I exclude the impact of Baker in that flow-through, the remaining flow-through for the quarter ex Baker is very high. Let me walk you through a couple of the impacts there. I'll remind you that we will anniversary the Neff acquisition in the fourth quarter. Having done that we're going to have lower revenue growth quarter-over-quarter that's going to make flow-through very sensitive to any changes in EBITDA. For example, we've called out we have a benefit that will show up in the fourth quarter for incentive compensation. That number's dropped a little bit, but we're still calling that somewhere in the neighborhood of about $9 million-$10 million of benefit from that reduced bonus. That has a significant impact on the flow-through for the quarter. So too the impact of Neff synergies that are kicking in, that obviously are realized within the quarter. A couple of drivers there that still maintain ex Baker a pretty high flow-through for Q4. Got it. Thanks. Just any thoughts on equipment inflation into next year? Realize you're going to be going into that, but you didn't seem too worried about it last call. Has that changed at all, or you still expecting a fairly benign equipment inflation environment despite all the cost pressures out there? We feel the same way that we did in Q2 call. We've got some great partners, good vendors, and we feel good that we'll continue working together, and we wouldn't model anything differently than we had last year. Got it. Thank you. Thank you. Thank you. Thank you. Our next question comes from the line of Rob Wertheimer from Melius Research. Your question, please. Hi. Good morning, everyone. Rob. Hello. I assume your share price looks fairly attractive to you all. The question is a little bit as you integrate BlueLine, it's a big deal, you don't want to get people nervous about how much debt you carry, et cetera. Do you have in mind a threshold on debt to EBITDA that you might feel like you step back into the market? Or maybe it's a year and you're working on integration and thinking about it or longer. Maybe just give us some sort of thoughts on how you trade those different opportunities off. Well, it's a great position to be in. As you pointed out, we do generate a lot of free cash flow. The way we framed it, we've said between 2.5 and 3.5, depending on where you are in the cycle. When we finish out this year, you can do the math and see where we're going to finish out. As we go into next year, we're going to be very comfortably in that range. With regards to where the share price is, the share price is the share price. We've been consistent on not looking at that as we've applied our acquisition of the share repurchase program. Could that change? It could, but right now, I think it's going to continue at the pace we've been doing. If we change, obviously, we'll come out and tell you otherwise. But we don't look at that ups and downs as something that we need to have a knee-jerk reaction to do something. To your point, you have to stop and think about it. Thank you. Then you may not want to answer this question, I understand, but does the acquisition of BlueLine mean that you don't need to spend on growth CapEx in a healthy environment next year? Or should we assume that you kind of operate the business as the business, not on the acquisition? Yeah. I would think with everything you've heard us say about the demand environment, it would not be a good assumption to think that we're not going to put capital into the business. We feel very good about it. It's one of the reasons why we feel comfortable acquiring the company. Even if you look at our pro forma, not just our acquired growth this year, but our pro forma growth this year of 10.9% Q3 Gen Rent revenue, I think that proves out where our focus is and how we think this larger footprint can only help us grow. It's all about the capacity, Rob. Great. The truck drivers, branch network, and sales reps we bring on board give us more growth opportunity. Rob, I will just mention that, as I know we have talked about, we are going to continue to be very disciplined in our approach to CapEx. As we think about the planning process for 2019, and we decide where we think the year will go, as a management team, we are talking constantly about whether or not that is the right level of CapEx for the business. Then, we are not afraid to flex up or down depending on what the business needs are. So far, it looks good. All right. Thank you. Thanks, Rob. Thank you. Thank you. Our next question comes from the line of Joe O'Dea from Vertical Research Partners. Your question, please. Hey, Joe. Hi, good morning. First question is just on kind of the margin path you're on EBITDA, and trying to think about, as we head into next year, some of the moving pieces around deal synergies that should contribute, I think ancillary that's been high this year and a bit of a margin dilutive effect there. BlueLine that might be a bit of an offset, but it seems like it's a setup for continued margin expansion as you move into next year. Just want to kind of get a better handle on that, given some of the moving pieces and the deals in particular. Hi, Joe. Yeah. As you think about the flow through for next year, I think it's reasonable to think about the core business will perform at or, kind of give or take, a little better, a little worse than where it is currently. We've talked about a flow through of something in the neighborhood of 60% being reasonable for the core business, and that's not going to change. What will change is the impact that we'll feel from a full year of the Baker acquisition, and then obviously the impact that BlueLine will have on us in 2019 as well. While obviously we're going to continue to drive benefit through both of those acquisitions, there will be a dilutive effect, at least in the short term, on the flow through for next year, coming largely from those two deals. Now, that's going to be offset in part by the synergies that we realized from them in 2019. But again, there may be a bit of a drag. Got you. Net-net, do you have kind of a general sense of whether you can offset that drag with rate and core incrementals? Too early for us to tell. We hadn't even get a chance to really look at the under the hood of BlueLine, but we do think it'll be incremental to returns. Which is what we're really focused on, that profitable growth. It looks like the BlueLine margin that you're anticipating in Q4 is a little bit better than what you saw on the trailing 12 months when you disclosed that. Is that all BlueLine efforts? That's not anything that you would be anticipating on sort of aligning them in your rate structure? No. No, there's nothing in there for BlueLine. Unless I misunderstood the question. No, as far as the 120 and 50 that I gave earlier, no, that would be them coming in with about a 40% margin, which is consistent with what we've seen for them. Just one on kind of the CapEx timing where 2Q and 3Q, a little heavier CapEx than what you might normally do, I think, in response to just the demand environment. But then, some concerns that, was that a factor on the sequential rate over the quarter? Any kind of insight you can give into some of those variables you talked about with rate and some of what would've been a little bit of a headwind on those sequentials because of those other variables? Sure. No, we don't connect it at all. When you have a rate pressure because of too much demand, the gap isn't whether you get 10 bps, 20 bps, or even 30 bps of positive, it's that you go negative. So that's why we're not concerned about that. When we look at the markets overall, whether you look by product category or you look by geography, we're still seeing in every one of the regions that steady improvement throughout the quarter on a year-over-year basis, which is really what we focus on as a rate indicator. There's just too much noise in the inputs than individual months of sequential. You're absolutely right, the CapEx was there to supply demand, and as we said, we think that demand turned into profitable growth. Got it. Thanks very much. Sure. Sure. Thank you. Our next question comes from the line of Courtney Yakavonis from Morgan Stanley. Your question, please. Thanks, guys. Just wanted to follow up on the comment on cross-selling growing 25%. Was that all from the acquisitions that you guys have done from NES and Neff, or are you starting to see some organic cross-selling from some of the digital efforts that you've made on Total Control and UR Control®? I would say it's a continuation of the efforts that we've been driving for years, right? We'll just get deeper and deeper into the organization. Then some pickup, to your point, on the broader customer base that didn't have access to those. But it's definitely a both, not an either/or. We continue to be very positive about what we can do now with the bigger fluid solutions. We think there's some more cross-sell opportunity for that group that we should be able to improve upon in 2019. Okay, great. Thanks. Just on your Gen Rent gross margins, I think they were up 120 bps year-over-year. Can you quantify how much of the benefit was just from lapping NES versus some of the items that we talked about last quarter, freight and labor, getting those more in line? I would say it is more getting our costs in line. We certainly do have a benefit as we sunset any of the acquisitions. Jeff spoke about the flow through in Q4, or when we sunset the Neff acquisition. But the real driver for the margin challenge in Q1 were those cost issues you pointed to, and that we brought up, and we have remedied those. Feel very good about that. Great. Thank you. Thank you. Thanks, Courtney. Thank you. Our next question comes from the line of Stephen Fisher from UBS. Your question, please. Thanks. Good morning. Good morning. Hi. Just getting back a little bit of the why on some of the rate trends here. Because back in April on this call, we were talking about 2.5%-3% rate growth being reasonable for the year with potential for better. Now it seems like we're closer to 2%. So I'm really just wondering what changed, if anything, in the marketplace or how you're actually managing it. Because it just seems a little bit early in the cycle for rates to be decelerating given how robust it sounds like the opportunity set is on project activity. Yeah. As I said earlier, rates were about where we expected. We see 10 or 20 bps as negligible as long as you're getting the robust realized time utilization, the margins that you need, and the profitability you need. Admittedly, this year was much smoother than last year, and that's part of the comp issue you see. If you recall last year, and I think we even have it in the deck. We have it on slide 37. We really dug a hole in Q1. Then we had to aggressively backfill that hole, and you saw really low numbers in Q1 and higher sequentials in two and three. This year was a much smoother curve. If you actually, ironically, January through September of last year and January through September of this year, on an actual improvement basis, stand right on top of each other. We still see this as a good rate environment and think 2019 will be similar. Okay. Then maybe just on CapEx, if you could just talk a little bit about what the specific metrics are that you're looking at that guide the decision to increase CapEx. Because there's some that would feel that growing CapEx is inconsistent with a moderating rate growth environment. But I'm sure you're looking at it in a broader way. If you could just talk to some of the specific metrics that tell you, okay, we can still grow CapEx even if rates are moderating. It's margins and returns, right? That's part of the challenge in why we stop trying to forecast the individual operational metrics of rate and time. Don't get me wrong. We manage rate aggressively. We manage time very well, and they're both very important indicators. But when you think about whether it's our mix impact from renting more specialty fleet, that in itself is a $25 million positive in the quarter. Has much more impact and about equal impact to the 2% year-over-year rate carryover. There's other variables when we look at how we can translate our business into the type of performance that we have than just the rate. So I get the focus on it from an outward-in perspective. I'll repeat, we do not see that as a decelerating environment. We've generated, as Mike said in his comments, record EBITDA margin, if you take out the impact of Baker, and record returns, even if you take out the impact of tax reform. So we really love the environment that we're in and think we'll continue to turn it into dollars for the company. Just a quick clarification on free cash flow. I think earlier this year, you've talked about next year being potentially better than 2018. What do you think about that at this point? This is Mike. Obviously, as Matt mentioned earlier, we're still going through. One, we haven't finished the year. Two, we're going through the budget process. But I think it's fair to say that it'll be better next year. That's a fair statement. Terrific. Thanks, guys. Yeah. Thanks, Steve. Thank you. Thank you. Our next question comes from the line of David Raso from Evercore ISI. Your question, please. Hey, David. Hi, David. Good morning. Just a simple question. Just to level set expectations going into 2019, the mix of your business, be it customer size, long-term rentals versus short-term rentals. As you are going through the capital budgeting process, seeing the opportunities that contractors and customers are telling you what they need for next year, can you give us some insight on the mix of businesses, duration of rentals, things that you are eyeing up already that could help us all level set how we think about the implications on time utilization, rate, and so forth? Just because obviously, people are focused on rate and ute. At least help us some of those nuances that could improve it, make it more difficult next year, because mix obviously plays a big role. Sure, David. This is Matt. The customer profile continues to look similar. I think where there is some movement, and I referred to it in the last answer, is as we continue to grow our percentage of specialty business. Not all the improvement and profitability that we get from specialty shows up in the rate metric. I pointed to the $25 million of positive mix improvement in Q3 as an example, but also in time. Specialty products actually dilute our time utilization, and we have been offsetting that headwind for years, and we will continue to do so. But it is by far a great business decision because of the profitability that it brings with it. As far as the striations of customers, really, we are getting growth and expect to in 2019, broadly throughout our strategic accounts, our national accounts, and our local customers. Projects not too dissimilar from what we've seen. When you think about our day, week, month mix, very similar to what we've experienced. Not a lot of movement there. The biggest movement would be in the mix of our fleet dynamics. The growth of specialty above Gen Rent, what was the implications on rate, not ute, on rate for the quarter? Just so, again, level set, if specialty is going to continue to be a focus to grow faster than Gen Rent, that's a drag on these historical metrics that obviously the stock cares a great deal about. If you could help us isolate a bit what mix is doing to those metrics, I think it'd behoove all of us to understand, for example, what did specialty impact rate on for the third quarter? We talk about the inputs that make it hard to forecast rate. It is exacerbated in specialty because you can price different service offerings in different ways, whether it includes bulk, doesn't include bulk. How much is solution base versus asset base? It is actually really hard for us to predict, and we just respond to the customer's need, price it appropriately. We don't really take that into account. Not that we don't pay attention to the rate, and the year-over-year rate in specialty is positive as well, and I wouldn't want to call that a drag. I just don't think all the value of it gets captured in rate is what I'm saying. But it's not a drag overall in the year. It's not really a drag on rate. Baker will drag us a little bit, but that's okay. We'll give pro forma numbers and call that out. I think overall, I wouldn't call it a huge variable, as much as I would not fully appreciate the ancillary items and the mix positive that comes with specialty. David, Matt's exactly right. I think this is actually a great topic that we could have a discussion, and point out at our Investor Day, because we are changing the company, and we've talked over the years. We're leveraging our customer, and we're bringing the specialty businesses into our customer base, and we're growing it, and the results are there, the returns are there, Matt talked about. But I do think at our Investor Day, we can spend some time on that subject. Yes. Yeah. Look, end of the day, we can talk about return on capital and cash flow all we want, but you just beat numbers, raised guidance consensus probably going up, and your stock's down 10%. I know there's some macro things going on, obviously beyond your control. But appreciating how specialty, and you're going to continue to focus in 2019 to grow specialty more than Gen Rent. Understanding that, I think, is pretty important to the story. Lastly, the M&A landscape. Obviously, touched on a little bit earlier about looking at your stock and where the leverage is exiting 2018, especially in pro forma, thinking about BlueLine. But you said it yourself, 2.5x-3.5x leveraged based on where we are in the cycle. How should we interpret your view of M&A going forward and where you think we are in the cycle? The cycle, we still think there's legs to our cycle, number one. Number two, capital allocation is extremely important, whether it be fleet or acquisitions. And clearly, we've seen acquisitions as an opportunity. And we will continue to focus on that. We have a very robust pipeline that we're reviewing. We'll be very disciplined in our approach, and nothing's going to change there. But clearly, we still are very much in that game. I maybe ask more directly. If we're going to end this year below 3x, would you be willing to go above 3x leverage next year? For the right acquisition, yes. Okay. All right. I appreciate it. Thank you. Thank you. Thank you. Our next question comes from the line of Seth Weber from RBC Capital Markets. Your question, please. Hey, Seth. Hey, good morning. Good morning, everybody. Sorry if I missed this, but just back on the specialty discussion. Maybe this is for Matt. Gross margins were down, I think, 250 basis points this quarter. I think they were down year-over-year. I think they were down 110 in the second quarter. Can you just give us some color on what's going on there? It seems like it's more than just Baker, and where do you see that kind of settling out? Yeah. So it is primarily Baker, so 170 bps of that is Baker. Then there's another 70 bp. I'm sorry, did you have another point, Seth? 170 of the 250? Yes. Okay. And then fuel, believe it or not, was 70 bps of that change. What that means is fuel is more of a pass-through. So you get the revenue, but you do not get the profitability on it. It is a smart thing to do for us to recover that, but it does, from a margin perspective, put some tailwinds on that. So 240 of the 250 bps are explained by just Baker and fuel. Okay. So next year, call it back half of next year, you would expect margins to be flat to up year-over-year then? Assuming fuel and whatnot is kind of nor- Yeah, we will still have to work through the Baker issue. We just do not know yet. But that is the anniversary. Yeah, when that anniversary. Towards the back half of next year, absolutely. Okay. Yeah, there's no underlying issue with the margins of our specialty businesses. They're still growing well, showing great margins, and very profitable for us. Okay. Then it looks like you bumped your branch count up to 36 for this year. I think it was 18 as of the last quarter's presentation. Is that all organic, or is there any color you could share there? Yeah, the real change there was we added some spot cooling business in our existing footprint. So it is technically right. Branch counts are businesses that you write contracts out of, but we are sharing a lot of real estate, so not a lot of additional costs there, but we think additional opportunity to serve customers with a broader product. That was the change from the 18 that we had targeted. Okay. That is helpful. Thank you, guys. Appreciate it. Yeah. Thank you. Thank you. Our next question comes from the line of Stanley Elliott from Stifel. Your question, please. Good morning, guys. Thank you all for fitting me in. Quick question. I think you may have spoken to it earlier, but in terms of resuming the share repurchase kind of post BlueLine, how should we think about time frames into next year when you might look at resuming that? Hey, Stanley, it's Jess. We're not sure exactly when that deal is going to close. What we will do is we'll keep that program paused until we've had a chance to not only look under the hood of BlueLine, but also assess our needs through the integration period. The plan is definitely to turn it back on once we've had a chance to do that. I can't pinpoint the time per se, but I wouldn't be surprised if you saw us turning it back on as early as sometime in the first quarter of next year. Was there a kind of a window period where you were looking to complete it, or was it If you could refresh my memory? Before the pause, we had talked about finishing it by the end of calendar 2019. By early next year. Yep. Yeah. Okay. Lastly, you talked about the cycle and the breadth of the growth that you're seeing and the momentum there. This is more just out of curiosity, but with more national account customers, more larger customers, more specialty, more being intertwined with all these customers, do you feel like the visibility into your business has improved with these changes? Just more curious than anything. I would say, overall, we feel good about the visibility into our business. I would say some of the metrics in this call, right? We're talking about it here. Let's be frank about it today. There's a way for us to maybe help everybody through how the impacts of all these acquisitions, different product offerings, different customer base, broader customer base. I think we've got a and Mike foreshadowed, maybe we could do this at Investor Day, try to bring this all together and help everybody else see what it is that's changed and what should we be focused on, and then therefore, you guys should be focused on. I think there's an opportunity there. But as far as for us, what this really does is we think just makes us a bigger, more important partner to the customers that we serve by being a broader solution for them. That's why, as well as profitable growth, which is why we do it. Right. No, I totally agree. Thanks, guys. Thanks. Thank you. Thank you. Our next question comes from the line of Chad Dillard from Deutsche Bank. Your question please. Hi, good morning, guys. Morning. Can you give a little bit of color on the level of quoting activity that you are seeing? And maybe you can compare what you are seeing right now to the same time last year, just to get some perspective. Chad, could you ask that again? I am sorry, we did not hear the question very clearly. Oh, sure. Yeah. Can you give some color on the level of quoting activity that you are seeing? And perhaps you can compare what you are seeing right now to the same time last year. Yeah. I extrapolate quoting activity to demand, right? Not just the RFPs and the handful of quotes that are more formal than what we go out and do every day. And we would say the activity is strong, robust. And from a year-over-year perspective, if you wanted to extrapolate our volume into activity, you would have to say it is, on a pro forma basis, 10% higher. But we do not necessarily look at it from a quote over quote, year over year. What has changed is where we are participating. So I would say we are getting more focused on certain verticals. I mentioned infrastructure in my opening remarks, but we are probably getting more than just product aligned, geographic alignment, but now vertical alignment. And we are seeing opportunities to get further penetration in some verticals, and we think that is what has helped driving our growth. I hope that is helpful, too. We just don't use that terminology of quoting on a year-over-year basis. Sure. That's definitely helpful. How big of an opportunity do you see with the BakerCorp acquisition to reprice some contracts? Maybe a similar question for BlueLine, but I don't know if it's too early to really provide color on that. It's certainly too early to ask on BlueLine. As far as Baker, we see the opportunity here into broader solutions, package solutions, not necessarily individual pricing on a transactional basis. We see this as broadening a fluid solution sale as opposed to three bids and a buy type work. Great. Thank you very much. Thank you. Thank you. Our next question comes from the line of Kathryn Thompson from Thompson Research Group. Your question please. Morning. Good morning. Good morning. This is Steven Ramsey on for Kathryn. I guess just thinking about Europe, early days there, I know, but as you kind of look ahead on Europe, do you think it will be more of a specialty-focused region? Or do you see kind of over time, there being a Gen Rent presence there? Then just any learnings so far now that you've got it under your umbrella? Well, this is Mike. Obviously, relatively to the Baker acquisition, it was relatively a small piece. We're very much in a learning stage. It would be premature to say anything else above and beyond that as far as how we would think about it. We do see the opportunity for Baker in Europe to continue to grow at very nice returns, and that's where our main focus will be. But clearly, we're probably looking at sometime in the first quarter, towards the mid to tail end of first quarter, at least the first half of the year, beginning that fully integrated with our operating system. Again, it's too early to tell, but we're still focused really in North America. It's still the biggest market for us. Yeah. I would just add, Steven, that we are encouraged by the level of talent we did acquire there, and how we can leverage that to learn faster than we would have without that is probably the opportunity. Excellent. Then thinking about specialty cold starts for next year, obviously a bigger amount this year than what we thought going in. Does bringing in BlueLine change the need to have cold starts and instead you just add on the capabilities for specialty to the BlueLine real estate? We'll make that decision. We haven't really decided on it. Regardless of where we house it and how we resource it from a real estate perspective. We're planning on about another 25 cold starts next year in specialty. You bring out a great opportunity that we've utilized in past integrations. Sometimes we get to use some of the real estate that we get from an acquisition because they have extra capacity, and sometimes we just have to go out and find real estate. But we don't think either way real estate will be an inhibitor force. Great. Thank you. Thank you. Thank you. Our next question comes from the line of Scott Schneeberger from Oppenheimer. Your question, please. Hey, Scott. Hi, Scott. Thanks. Hey, good morning, everyone. In specialty, real strong growth in same-store sales, double digit. How sustainable is that? And then could you speak to volume versus price mix in there, what you have seen, what you would expect to see going forward, and how you think about managing that? We continue to see more growth opportunity in specialty. We haven't filled out the footprints, actually, of any individual one fully. So there's white space for every one of them. Some are a little further developed. Trench has been our longest-standing specialty business, so their network's a little more fully developed, but still have some white space. Others, Baker being the most recent example, have a ton of white space. So we think specialty will continue to be in growth mode for a while now. As far as pricing versus top-line revenue, their pricing on a year-over-year basis is very similar to what the overall company's pricing is. All right. Thanks. Following up on that, how implemented is Total Control across fluid solutions? Obviously, with Baker entering, is that something you are going to be aggressively pursuing? And how much of a differentiator can that be? Thanks. Some of our customers that we are already doing business with Baker, and we are on Total Control for us, have a very high expectation for us to do that quickly, and we are in the business of meeting those expectations. It absolutely needs to be integrated because the customers are counting on it. As far as will it be a further advantage to the value prop for the existing Baker customers that were not doing business with us, we believe so. Okay. Thanks, appreciate it. Bye. Thank you. Our next question comes from the line of Jerry Revich from Goldman Sachs. Your question, please. Jerry. Yes. Hi, good morning. Morning. Your ancillary revenue really accelerated this quarter. Can you just flesh that out a bit? Are you folks getting more success in pushing through transportation inflation than the past couple of quarters, or is that a strict pass-through? Can you comment on the contribution from the specialty business, in terms of contributing to that ancillary revenue performance this quarter and the sustainability of that? Hi, Jerry. You are right on point. I mean, the increase that we saw in ancillary, the biggest component of that is the delivery revenue that has grown as a result of our being able to recover the fuel increases that I think everyone is seeing across the business and across the industry. That is by far the biggest part of ancillary. As far as the breakdown of specialty in that number, it is pretty much the same for the specialty business as it would be for Gen Rent. Our being able to recover that delivery is pretty consistent, so I would not call out anything special for specialty in ancillary. I would just note again that the majority of the positive mix that we had for the quarter was definitely coming from the specialty business. Just a clarification, were you more successful in obtaining the recoveries this quarter than in the past couple of quarters? In other words, did the percentage of accounts that are willing to pay that increase for you folks? It is a very tangible thing to sell. All of our customers are dealing with the same issue, and freight increases, fuel increases. I would say we lagged a little bit in Q1, took a little time to catch up, and we talked about that on our Q1 call. Then we did a better job of recovering in Q2 and Q3. Right. My follow-up on utilization, Matt, you spoke about the storm comps. Can you just talk about that, how that continues into October? You folks had delivered fleet this third quarter, which impacted utilization, I think, a bit. Now that CapEx is slowing, should we expect utilization to be better than normal seasonality over the next couple of months? Can you Sure give us some context how you're thinking about it? Yeah, sure. When we look at our pro forma, which is how we always look at these metrics, whether it's rate or time, we were 0.4 positive in July, 0.2 in August, and then you saw 0.7 negative in September. That's when we had the huge ramp up last year due to Hurricane Harvey and, to a lesser degree, a little bit on Irma. We pegged that at about 50 bps of those 70 bps. We think that will continue in October just because of the comp issue, and then it'll start to moderate throughout November and then be gone by the end of the fourth quarter. As we go through Q4, we think that that comp compare issue will erode and we'll be back to par, let's say, by the end of the quarter. Okay, thanks. Thanks. Thank you. Thanks, Jerry. Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Mr. Kneeland for any further remarks. I want to thank everybody for joining us this morning. Our third quarter investor deck is online and available to download, along with our deck describing the BlueLine acquisition. Hopefully, we'll see you all at our Investor Day in December. If you have any questions or comments, please feel free to connect with Ted Grace, our head of IR, if you have any additional questions. Operator, you can end the call now and look forward to our next meeting. Thank you. Thank you. And thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.