Earnings Call Transcript - URI Q4 2023

Operator, Operator

Good morning and welcome to the United Rentals Investor Conference call. Please be advised that this call is being recorded. Before we begin, please note that the company's press release, comments made on today's call, and responses to your questions contain forward-looking statements. The company's business and operations are subject to a variety of risks and uncertainties, many of which 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 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, 2023, as well as to subsequent filings with the SEC. You can access these filings on the Company's website at www.unitedrentals.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 and today's call include references to non-GAAP terms such as free cash flow, adjusted EPS, EBITDA, and adjusted EBITDA. Please refer to the back of the Company's recent investor presentations to see the reconciliation from each non-GAAP financial measure to the most comparable GAAP financial measure. Speaking today for United Rentals is Matt Flannery, President and Chief Executive Officer, and Ted Grace, Chief Financial Officer. I will now turn the call over to Mr. Flannery. Mr. Flannery, you may begin.

Matthew J. Flannery, CEO

Thank you, operator, and good morning, everyone. Thanks for joining our call. Our theme for 2023 was Raising the Bar, and today I'm very pleased to discuss our record fourth quarter, which capped a number of notable achievements by our team and enabled us to indeed raise the bar this past year with record revenue, earnings, and returns. The team did this by continuing to serve our customers with an unmatched commitment to operational excellence and a laser focus on safety, all while integrating Ahern, our second largest acquisition ever. Today, I'll start with a recap of our fourth quarter and full year 2023 results, followed by what's driving our optimism for 2024, and finally, our updated leverage and capital deployment strategies. So let's start with some of the highlights from the fourth quarter. Our total revenue grew by 13% year-over-year to $3.7 billion, a fourth quarter record. And within this, rental revenue grew by 13.5%. Fleet productivity increased by 2.4% on a pro forma basis. Adjusted EBITDA increased almost 10% to a fourth quarter record of over $1.8 billion, translating to a healthy margin of 48%. And adjusted EPS grew by 16% to $11.26. For the full year, rental CAPEX of $3.5 billion was in line with our guidance. And I'll add that with the supply chain largely recovered, we now expect a quarterly cadence of our CAPEX spend to be more closely matched to historical patterns. 2023 free cash flow exceeded $2.3 billion. We view our ability to generate strong free cash flow throughout the cycle as a hallmark of the company and a testament to both the profitability and flexibility of our business model. Moreover, and this may be the most important thing to convey, the durability of our free cash generation provides us tremendous flexibility to create long-term value for our shareholders. Now let's turn to customer activity. We continue to see broad-based demand across geographies, verticals, and customer segments. Industrial end markets saw healthy growth, led by industrial manufacturing and power. Within our construction markets, both infrastructure and non-res continued to show solid growth year-over-year, as our customers kicked off new projects across a diverse range of markets and these include battery plants, semiconductor-related jobs, power, infrastructure, as well as data centers. Geographically, we continue to see strength across the business, and specialty specifically delivered on another strong quarter, with rental revenue up 15% year-on-year, reflecting double-digit growth across all businesses. Furthermore, we opened 10 cold starts during the quarter, resulting in 49 for the full year. Finally, turning to capital allocation. In addition to the investments we made in 2023, we returned over $1.4 billion to our shareholders. Looking ahead, we expect 2024 to be another year of growth, led by large projects. This is supported by customer sentiment indicators, solid backlogs, and most importantly feedback from our field teams. And finally, and I'll be quick here because I don't want to steal too much of Ted's thunder, but I'm very pleased to announce our updated capital deployment and leverage strategies, which cover our plans to return nearly $2 billion of cash to shareholders this year, and a reduced leverage target of one and a half to two and a half times. This announcement reflects our work towards building an even stronger company and driving shareholder value. And what's more, this comes after fully funding growth. Finally, before I get to my concluding remarks, I want to share with you all that we hosted our Annual Management Meeting in Indianapolis earlier this month. This provided an opportunity for over 2,500 United Rentals leaders to gather and build momentum as we execute on our strategy. It also highlighted our incredible team, which is a real competitive differentiator for us, and offered an opportunity to remind ourselves of the culture we work so hard to strengthen and maintain. So it's no surprise when you see everyone in action, why the team continues to win accolades, including recently from the Wall Street Journal and Newsweek. In closing, I'll repeat what you've heard me say many times before that it is what continues to be relevant and true, we are building the best business to serve our customers. Our scale, go-to-market approach, technology, and one-stop shop offering across general rental and specialty are unmatched. Our team puts customers at the center of everything we do, giving me confidence that we're well-positioned to continue to outpace the industry and capitalize on the opportunities ahead of us. We expect 2024 to be another record year for our company, and longer term, we continue to march towards our 2028 aspirational goals that we shared with you last May at our Investor Day, and I'm so proud of all our teammates who will help us deliver these results. And with that, I'll hand the call over to Ted and then we'll take your questions. Ted, over to you.

William Ted Grace, CFO

Thanks, Matt. And good morning, everyone. I'm going to start my comments by adding some more color on our record fourth quarter results before pivoting toward 2024 guidance, which points to another strong year for the company. One quick reminder before I jump into the numbers, as usual, the figures I'll be discussing are as reported, except where I call them out as pro forma, which is to say the prior period is adjusted to include Ahern's standalone results. So with that said, let's get into the numbers. Fourth quarter rental revenue was a record $3.12 billion, that's a year-over-year increase of $372 million, or 13.5% supported by diverse strength across our end markets and our strong positioning on large projects. Within rental revenue, OER increased by $313 million or 13.9%. An increase in our average fleet size contributed 15.1%, while as reported fleet productivity added 0.3%, partially offset by assumed fleet inflation of 1.5%. Also within rental, ancillary revenues were higher by $61 million or 14.2%, which was consistent with rental revenue growth. I'll add that re-rent declined $2 million year-on-year. On a pro forma basis, which as you know is how we look at our results, rental revenue increased 7.6% year-on-year, with fleet productivity up 2.4%, reflecting a healthy rate environment that continues to be supported by good industry discipline. Turning to used results, fourth quarter proceeds increased better than 7% to $438 million as we continue to take advantage of a strong retail market to refresh our fleet at attractive returns by recovering roughly 62% of our original fleet cost. Our adjusted use margin was flat sequentially at 55.3%, while the year-over-year decline in margin reflected the ongoing normalization of the use market we have been talking about for the last several quarters. Moving to EBITDA, adjusted EBITDA for the quarter was a record of $1.81 billion, reflecting an increase of $162 million or 10%. The year-on-year dollar change includes a $197 million increase from rental. The year-on-year dollar change includes a $197 million increase from rental, within which OER contributed $195 million, while ancillary and re-rent added $2 million on a combined basis. Outside of rental, used sales were a headwind of about $10 million to adjusted EBITDA, while other non-rental lines of businesses were up $4 million. SG&A in the quarter increased $29 million due primarily to increases in variable costs. As a percentage of sales, however, SG&A declined about 100 basis points to 10.5% of total revenue. Looking at fourth quarter profitability, our adjusted EBITDA margin decreased 150 basis points year-on-year to 48.5% due largely to the combined impact of Ahern and used margins. When looked at pro forma, our EBITDA margin, excluding used, was down just 20 basis points, translating to flow-through of 46%, versus the 38% you can see on an as-reported basis. And finally, our adjusted earnings per share increased 16% to $11.26. Shifting to CAPEX, gross rental CAPEX was $430 million, reflecting a return to a more normalized seasonal cadence, supported by improvements in the supply chain. You can also see this in our net rental CAPEX, which declined $8 million. Turning to return on invested capital and free cash flow, ROIC increased 90 basis points year-on-year to 13.6%, exceeding our weighted average cost of capital by over 260 basis points. Free cash flow also remains a good story with the year coming in at just over $2.3 billion, translating to a free cash margin of 16.1%, even as we continue to fund significant organic growth. The business continues to generate very strong free cash flow on both an absolute and relative basis. As Matt said, this provides us with a lot of flexibility to drive shareholder value across the cycle, through both investment and growth, and the return of excess capital to our investors, more on this in a bit. Moving to the balance sheet, our net leverage ratio at the end of the quarter improved two-tenths of a turn sequentially to 1.6 times, while our total liquidity exceeded $3.3 billion at year's end. And as a reminder, we continue to have no long-term note maturities until 2027. Notably, all of this was after returning over $1.4 billion to shareholders in 2023. This included $1 billion through share repurchases and $406 million via dividends. Combined, this translated to the return of over $20 per share during the year. Now let's look forward and talk more about our 2024 guidance. Total revenues is expected in the range of $14.65 billion to $15.15 billion, implying full year growth of about 4% at midpoint. Within total revenue, I'll note that our used sales guidance is implied at roughly $1.5 billion, down mid-single-digits year-on-year on a percentage basis, which implies slightly better growth within our core rental revenue. Within used, I'll add that we expect to sell around $2.5 billion of original equipment cost, translating to a recovery rate of about 60% versus roughly 66% in 2023, but historical norms that are more in the 50% to 55% range. Our adjusted EBITDA range is $6.9 to $7.15 billion. At midpoint, excluding the impact of used, this implies flow-through in the 40s and flat adjusted EBITDA margins versus as reported flow-through of around 30% at approximately 70 basis points of year-on-year margin compression at the midpoint of guidance. On the fleet side, our gross CAPEX guidance is $3.4 billion to $3.7 billion with net CAPEX of $1.9 billion to $2.2 billion. And finally, we are guiding to another strong year of free cash flow in the range of $2 billion to $2.2 billion. Now, let's shift to our updated balance sheet and capital allocation strategy. First and foremost, we remain focused on funding growth where we can generate attractive returns, both organically and through acquisitions. Beyond that, our goal is to allocate excess free cash flow to drive shareholder value, and to this end, last night we announced several exciting things. First, consistent with the intentions we shared a year ago when we introduced our dividend, we are increasing our quarterly payment by 10% to $1.63 per share, or $6.52 per share annualized. I'll add that it remains our plan to consistently grow our dividend in line with long-term earnings. Second, we plan to repurchase $1.5 billion of common stock in 2024, an increase of $500 million versus what we bought in 2023. So, in total, we intend to return over $1.9 billion to shareholders this year, equating to almost $30 per share, or a return of capital yield of over 5% based on our current share price. Lastly, and importantly, we are able to do this while also lowering our targeted full cycle leverage range by half turn to 1.5 to 2.5 times. As a reminder, this reduction follows the similar half turn reduction we announced in mid-2019. As most of you know, this is something we've been working towards with the idea of building an even stronger company and critically driving shareholder value. What's more, this has all been achieved after fully funding growth. Just to provide some perspective, since 2019 when we introduced the first leg of our enhanced capital allocation strategy, our revenue has increased by more than 50%, our EBITDA has increased closer to 60%, and our earnings per share has grown more than 130%, while at the same time averaged leverage ratio has declined from 2.6 times at the end of 2019 to 1.6 times at the end of 2023. This combination of results has supported very strong shareholder value creation that our team is very proud of and remains very focused on sustaining. So with that, let me turn the call over to the operator for Q&A. Operator, please open the line.

Operator, Operator

Our first question will come from David Raso with Evercore ISI. Please go ahead.

David Raso, Analyst

Hi. Thank you. I wanted to look into the fleet growth that you appear to have planned for this year and also how to think about fleet productivity on top of that growth. With some carryover from 2023 and the roughly billion plus you look to add this year, right, the 3.5 billion plus gross minus the OEC you expect to sell, the 2.5, it looks like you're roughly say, 4% or 5% fleet growth you're looking for in 2024. So just given some of the demand concerns some people have out there, I'm just trying to calibrate how much of the fleet growth would you argue is earmarked for projects that are essentially lined up versus the natural, you have to take some assumptions into how you manage the fleet generally? And then on top of that, how should we think about fleet productivity with that type of fleet growth? Thank you.

Matthew J. Flannery, CEO

Sure, David. This is Matt. And when you think about that fleet growth, then you'd have to net out of it whatever inflation you had for the replacement. So when we think about the fleet overall, we're thinking about $2.5 billion of sales of original OEC, and maybe almost $3 billion to replace that, depending on what we buy and all that. So you're talking about a 550 of growth. Within that, we have cold starts that we are going to support in specialty. Again, we'll continue to invest in the business there. And then to your point, a lot of the major projects, some bolster up some of our products that we know we're going to be using on major projects and just general growth. So we also have some carry over to your point that we'll be able to utilize. So we feel really good about the positioning we have. And while we're talking about CAPEX, we expect it to be a little more normalized cadence from what you've seen in the last couple of years as our partners have repaired their supply chain, probably at about 90% level, almost all the way there. How that'll turn into fleet productivity, as you saw as we exited this year, we felt all along we needed to work through in 2023 the Ahern acquisition and some really tough comps some time from unusually high time utilizations during COVID. We've now leveled off at a strong level of time historically higher than we were pre-COVID in 2019 and we think we can continue that throughout 2024. We think there'll be a positive rate environment. We think the industry is showing good discipline. There's still demand in the markets that we serve, and we think that'll be a good guide in the fleet productivity and then mix maybe a little bit of drag off of that. Really only because if you think about the inflation of our cost that might be over the one and a half peg that we put out there, we know it's going to be higher than that, probably more in the two to three range. So when you net that out, we feel good about positive fleet productivity throughout 2024. We don't get into forecasting it but embedded in our guidance is that expectation.

David Raso, Analyst

Well, that's helpful. And then lastly free cash flow, a large majority last year return to shareholders, the guide for this year is a very large majority to shareholders. How should we think about the balance sheet usage, the M&A landscape, but also appreciating the lower target range, can you give us an update on the M&A thoughts? Thank you.

Matthew J. Flannery, CEO

Yeah, sure, I'll touch on the M&A and Ted can talk a little bit about capital allocation. None of this is at the expense of M&A. We're open for business. Obviously, we have a high bar, as always, but the pipeline remains robust. We're always looking at assets that we could be a better owner of, and specifically any new products that we can add to the system for our customers. So, I mean, if you just think about one turn, even with all the share repurchase and the up dividend and the lower leverage, I mean, one turn is still $7 billion worth of capacity. So, and that's before you add EBITDA for many potential acquisitions that you'd have in. So, this is not at the expense at all. It's opportunity we had to return cash to shareholders and as Ted said in his opening remarks, lower our leverage. Ted, I don't know if you had anything to add.

William Ted Grace, CFO

No, I think Matt touched on the key points, but certainly, we feel great about where we sit within the range currently just because it's tremendous flexibility, optionality, and puts us in a great position to, as we said, kind of return excess capital to investors to augment shareholder value. And that's always going to be our goal.

David Raso, Analyst

And lastly for me, the implied incremental margins, if you exclude the used activity year-over-year, still a bit lower than the 50 to 60 range we've spoken of historically. It looks like it's about 46%. Can you help us understand some of the inputs there that keep that incremental a little bit lower? That's it for me. Thank you.

William Ted Grace, CFO

Yeah, of course. And David, that's a fair observation. I think ex-used we'd be looking for flow through in the 40s and call it flat margins. The key thing to think about here is we are getting to a point of modestly slower growth than what we've experienced the last several years. I think we were up 23% last year, we're up 20% the year before that, and 14% the year before that. So if you think about the nature of fixed cost absorption, obviously when you're talking about double-digit growth, that really kind of supports pretty good absorption in those environments. As you kind of get to this year, which we view more as a transition year and you're looking at mid-single-digit core growth. And still, it's a somewhat inflationary environment. It obviously creates new dynamics that you didn't have in the prior three years. At the same time, you heard Matt talk about kind of the optimism we have on a multi-year outlook. We think it's critical to make key investments in the business, things like cold starts and specialty. We'll be targeting 50 plus this year. Those are great long-term investments. At the margin, do they kind of weigh on incrementals? They do. I don't think that's a surprise to anybody. And there are other investments we want to continue to make core to the business. Think about areas like technology, that's long been an area, whether you want to talk about aspects of telematics, you want to talk about different aspects of performance optimization, and those are areas where we continue to be very focused. And in the current environment, which again is this modestly slower environment, we don't want to forego those investments that have very strong ROIs to hit respectfully kind of an arbitrary target, if you will, a flow through of some number. So we're going to continue investing in the business because we feel really good about our outlook. So Matt, I don't know what else.

Matthew J. Flannery, CEO

Absolutely. You can imagine we have these conversations internally. So we feel good about where we are.

David Raso, Analyst

Thank you.

Matthew J. Flannery, CEO

Thank you, David.

Operator, Operator

Our next question will come from Rob Wertheimer with Melius Research. Please go ahead.

Robert Wertheimer, Analyst

Thanks and good morning, everybody. I had a couple more questions on how you're thinking about the new leverage range and capital allocation. You've been on a multi-year, maybe five-plus years of deleveraging and in the recent past, you had sort of dipped below your old range as you are on that journey, and I think everybody understood that. Now that you've kind of reset the range, should we expect the 1.5% to be more of a floor or would you go below it, will you kind of hang out and maybe this is too much, but we hang at the low end of the range and say, the upside for acquisitions, as Matt mentioned, that's a ton of capacity? And then last question, I'll just ask them all at once, is this year, I don't think it would take a whole ton of upside to get you right down to that 1.5% and so if you do go past it, I mean, do you use the excess cash for share buybacks, I know there was a potential to add fleet, just generally, how you think about working within that capital allocation range? Thank you.

William Ted Grace, CFO

Thank you for the question, Rob. Our goal is to stay within that range. Similar to the previous range, the low end is not set in stone. We define our capital allocation plans for the year in January. Hypothetically, if EBITDA exceeds expectations and reaches around 1.4, we won't take action simply to remain within that boundary if it wasn't part of our original plan. We maintain strict discipline with these programs. That said, we intend to stay within the 1.5% to 2.5% range. It's important to remember that there is a cyclical element. Ideally, at peak times, we want to be at the lower end of that range, and at trough EBITDA, we aim for the upper end. Despite this, we have significant capacity to enhance earnings through acquisitions and other growth initiatives, including organic growth through M&A.

Robert Wertheimer, Analyst

Perfect, that answers that pretty cleanly. And then just one last on capital allocation on the dividend. You obviously took up the payments. Your earnings have been up more than by what you took it up and just to reiterate, if you would, your policy there. Will that over time just follow trend line earnings or how do you do that? And I'll stop there. Thank you.

William Ted Grace, CFO

Yes, so the idea, as we said a year ago was to grow it in line with long-term earnings. We don't want to get algorithmic, if you will. But certainly, we think that we've got the growth capacity and the cash flow growth capacity to support a growing dividend, which we recognize as an attractive aspect of the share profile. So what I would say is we look at companies that really benefited from dividends, call it that dividend aristocrat list. We've long said we aspire to be part of that group. That's the intent. So I don't want to kind of get too caught up in a formula of what dividend growth will look like, but our intent is absolutely to grow consistent with how we think about the long-term earnings power of the company. Matt, anything you'd add there?

Matthew J. Flannery, CEO

No. No. I think you said it right. Directionally, it will be aligned, but it won't be mathematically exact.

Robert Wertheimer, Analyst

Thank you.

Operator, Operator

Thank you. Our next question will come from Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich, Analyst

Yes, hi, good morning everyone. I'm wondering if you could just update us on how the Ahern integration is trending versus plan and within the guidance for 2024, what's the magnitude of margin uplift that's embedded from that in integration and on a separate note on GFN, now that we're halfway through the five-year plan for that asset, I'm wondering if you could just update us on where we are on the OEC and EBITDA growth plan that you folks laid out to double that business over five years when you made the acquisition?

Matthew J. Flannery, CEO

Sure, Jerry. Regarding the Ahern acquisition, the integration process is largely complete. We prioritized the people first, then moved on to the fleet and facilities. As mentioned in Q3, this was scheduled to be finalized by the end of 2023, and I'm happy to report that all that work has been completed. We will continue to see efficiencies in that business as some of the legacy Ahern facilities start to implement our processes and technology. It’s a gradual process. We expect further improvements in that area. However, when it comes to separate margin contributions, it’s all mixed into our current district and regional networks, but we are satisfied with the progress so far, particularly with the additional capacity we’ve gained. On the GFN front, I don’t believe we’ve been discussing that separately. Unless Ted has different insights, I can say that we have been ahead of our schedule right from the start. When we mentioned the goal of doubling that business in five years, we now anticipate reaching that milestone sooner than initially projected. Ted, have you provided any specific details about GFN?

William Ted Grace, CFO

No, we are ahead of target. The business has integrated exceptionally well with the rest of our operations. Regarding the margin uplift for Ahern in 2024 compared to 2023, now that we've completed the deal, we can confirm that we have achieved the targeted synergies. We allocated 18 months for this, but we reached a significant portion of our goal within just 12 months. Therefore, there isn't much additional benefit to carry over; any incremental advantage would be minimal because we realized the synergies quickly in 2023.

Jerry Revich, Analyst

So, then can I ask just one last one. The cold starts that you're planning were roughly 50, can you just give us a sense for mix between trends versus other lines of business just to help us get a feel and if that trajectory is any different from the mix within what you saw in 2023?

Matthew J. Flannery, CEO

Yes, it's quite broad. We have various maturity levels. You can envision reliable on-site business, the affordable sensation, and some additional products we are introducing to our Power HVAC team and mobile storage as major areas of focus. Interestingly, trench is still gaining traction, but it doesn't necessarily require geographic distribution growth for its penetration. As I mentioned earlier, all the specialty businesses and product lines experienced double-digit growth this quarter, which makes us very pleased with the ongoing opportunities for growth in specialty.

Jerry Revich, Analyst

Thank you very much.

Matthew J. Flannery, CEO

Thanks, Jerry.

Operator, Operator

Thank you. Our next question comes from Michael Feniger with Bank of America. Please go ahead.

Michael Feniger, Analyst

Yeah, thank you. Thanks for taking my question. Matt and Ted, if we look back at the last big downturn in construction, after rates were cut it took some time for nonresidential to really come back. Do you believe your portfolio of business mix and the environment is different now, if we see some easing of financial conditions, how do you see that kind of flowing through your business mix with MRO exposure, different verticals, versus maybe the path or is this a much more gradual longer recovery?

Matthew J. Flannery, CEO

So I'll start with, I don't pretend to be an economist, right, or an expert forecaster. But when we think about what the impacts could be of the Fed easing rates, we've seen slower growth in the local market business. We're very pleased that it's still growth. And as we said, pretty broad-based growth in Q4 as we exited the year but not double-digit growth opportunity out there. And that's why you see our guidance as it is. We feel while this transition of maybe that local market pipeline of business starting to be built out and funded, as interest rates lower that's our future growth. As we go forward we're very pleased, and we've been talking about for a while that the five tailwinds that we've been trumpeting throughout 2023 as a way to hedge against some of that slower growth in the local market have allowed us to come out with 2024 being a growth year. That's always been our thesis how it plays out, Michael. We're not experts in that, but we do talk to our customers. The majority of our customers surveyed in our customer confidence index continue to feel positive. So I don't want to paint a picture that there's negative growth or that we have problems in the local market. It's just not what it's been for the last couple of years, and we do think it will ramp back up once the Fed takes their actions. The pipeline will take a little while to fill, but we don't really have the ability to forecast how long.

Michael Feniger, Analyst

Right. Great. And Matt, just a follow-up. I mean you just delivered $2.3 billion of free cash flow in 2023. You're guiding another $2 billion in 2024. In a year that you're saying it's a transition year and you're still investing in the fleet, is it safe to say that the new baseline free cash flow level for URI going forward is this $2 billion marker. I mean 2024 is a transition year, 2025 you still see some growth. Like any reason why we shouldn't be thinking that maybe this $2 billion line is kind of a new baseline going forward?

William Ted Grace, CFO

So, I'm thinking through this, Mike only because we've never really kind of given that kind of guidance. So I want to think through and give you a more thoughtful answer. I mean you've heard us long saying we feel great about the cash generation characteristics of our business. We tend to frame things more as a function of normalized free cash margin, and I think certainly, if you were to apply that kind of construct to a reasonable outlook, again, I hesitate to kind of give you kind of numbers. But I think we feel comfortable that what you've seen us do historically in the recent history is something we can continue to sustain.

Matthew J. Flannery, CEO

Yes, I agree. Ted mentioned that he doesn’t want us to provide a five to ten-year future cash flow forecast, and I share that perspective. However, the way you're considering the evolution of the business and the changes we've experienced aligns with our previous discussions about generating positive free cash flow throughout the cycle. I believe we have demonstrated that capability. I understand and agree with Ted's view as well as the intent behind your question, but we will not be making long-term forecasts.

Michael Feniger, Analyst

Fair enough. Just one more question about your guidance on CAPEX disposal. How do you feel about the age of your fleet right now and where it will stand by the end of this year compared to your position before COVID? That would be helpful. Thanks, everyone.

Matthew J. Flannery, CEO

Yes, that’s a great question. We are feeling very positive about the age of our fleet. Currently, we are just over 52 months. However, when we take into account tanks, mobile storage, and some longer-lived assets included in the fleet, we find that our mix is back to pre-COVID levels. This indicates that we have returned to a healthy fleet age. While we still want to refresh and update some of our assets, overall, we are pleased with our current position in relation to the pre-COVID fleet age.

William Ted Grace, CFO

And that will improve further in 2024. The simplest way to understand this is that we will invest $3.5 billion in capital expenditures. Using simple assumptions, we can say that by midyear, we'll sell $2.5 billion of fleet that is approximately 90 months old on average. This suggests a mathematical implication for re-aging further down. To Matt's point, we are nominally at about 52 months, which is similar to pre-COVID levels in the upper 40s when accounting for acquisitions, and it will improve slightly. This demonstrates strength in our balance sheet and fleet, providing us with considerable flexibility.

Operator, Operator

Thank you. Our next question will come from Tim Thein with Citigroup. Please go ahead.

Timothy Thein, Analyst

Or Tim Thein, whichever. I like that one. Matt, regarding your comment about fleet productivity, when you introduced that concept, the aim was to outpace inflation. Do you think, even though you don't provide quarterly guidance, we should anticipate that figure to exceed inflation each quarter, or would that be overly ambitious given the challenges posed by seasonality and other factors?

Matthew J. Flannery, CEO

Our goal is to exceed the 1.5 target every quarter. Whether we achieve it or not, if you look at our pro forma from this past year, we actually did meet that goal. While we didn't achieve it at the reported level, we did from a pro forma perspective, which is how we manage the business. This is our aim moving forward, and we believe the market conditions are favorable for us to reach it.

Timothy Thein, Analyst

Got it. Okay. Ted, regarding the conversion from EBITDA to free cash flow, particularly about cash taxes, there's a proposed tax bill in Congress that might restore 100% bonus depreciation. I'm not sure of the implications if it doesn't go through, but how should we consider cash taxes for 2024 or 2025? And if it does go through, what potential implications do you foresee?

William Ted Grace, CFO

Yes, yes. So I'll take those in reverse order. If, and it's obviously a big if, but if that were to pass our understanding is it would actually even be retroactive. So in 2023, that would be worth certainly several hundred million dollars of incremental cash flow to us given the benefit it would have to our cash taxes. Taking the first part of the question, as you think about cash taxes going forward, you obviously see a significant step up in 2024 versus 2023. I think if you look at our investor presentation, the guidance is cash taxes of about $990 million. We paid about $500 million in 2023. So you see a $500 million step-up. That number is not at all representative of how to think about this on a go-forward basis. I would remind people, one of the benefits we had in 2023 from a cash tax perspective was the expensing of the Ahern fleet acquisition. So that was worth about $300 million of benefit. So apples-to-apples, you would say the step up 2024 versus 2023 is more like $200 million. And so as you think about that going forward, as you see this assuming you don't have that bill passed and we're stuck with this sunsetting provision within 2017 tax reform. You would see, depending on your assumptions on obviously, pretax income growth and CAPEX, you would see a gradual increase in our cash taxes that's there. But we think is obviously very manageable and something that has been known since the legislation was passed in 2017. So from a planning perspective, it's something that we've been aware of and obviously built into all of our expectations from a forecasting a capital allocation and balance sheet strategy perspective. Does that help, Tim? I'm happy to get to you if you want.

Timothy Thein, Analyst

No, no, that's sufficient, thank you Ted. As we approach the conclusion of the call, I wanted to bring up something I noticed in the risk statement in the K. It mentioned that your activities in specialty are increasing, which introduces more risks to United. I'm curious if this indicates plans to expand further into specialty, or if it's just a legal requirement to include that disclaimer.

William Ted Grace, CFO

I think it's much more the latter. Yes, just more the latter. I mean there's nothing that's changed structurally.

Timothy Thein, Analyst

Okay, very good. Thank you.

William Ted Grace, CFO

Thanks Tim.

Operator, Operator

Thank you. Our next question comes from Steven Fisher with UBS. Please go ahead.

Steven Fisher, Analyst

Thanks, good morning. So it seems like you've put yourself in a pretty good position to make some of these long-term investments even while the growth is slowing. I'm wondering if you can just kind of quantify the investments you're making in 2024, either in dollar terms or what the impact on the flow-through is? And then are these going to be kind of ongoing investments through 2025 or is it more just sort of a one-time headwind in 2024?

William Ted Grace, CFO

I'll start by addressing that. It’s challenging to quantify the headwinds in isolation. One way to look at this is to consider the cost needed to move from $46 million to $50 million in EBITDA for example, which would be around $50 million. This amount is significantly less than 1% of our cash operating costs. This reflects the impact of cold starts, which are worthwhile investments. We don’t typically disclose the year one margin profile for cold starts, but it's not surprising that they initially drag on performance as we work to ramp up both revenue and efficiency. Regarding technology investments, we don't specify details, but it's understood that the costs involved are considerable. While they may not significantly affect a company with $15 billion in revenue, these are wise investments. If we consider initiatives in machine learning and optimization, and even aspects of AI, the fees associated with third-party partnerships can be high, yet we believe the returns justify these costs. While we expect this to be a short-term headwind in 2024, we will evaluate the situation in 2025 based on growth and our decisions regarding any further investments. Matt, would you like to add anything?

Matthew J. Flannery, CEO

Yes. No, I think well said. I think the real tone of why we make the conversation, there's a difference between 46% and 50% flow-through in a transition year, so to say, is not something that would cause us to have an austerity program, right. We're going to run the business as we run it continue to improve the systems that we have, the tools that we have and grow the footprint for future growth. That's really it. If we were in a different environment, we have the playbook, you guys saw a little bit of it during COVID. Then you'd run a different play, and we're nowhere near that world nor do we expect to be for a few years.

Steven Fisher, Analyst

Got it. That's very helpful. And then maybe if I could just dig into the manufacturing and industrial vertical a little bit. I know it's an area that you're still looking for some strength. Can you just talk about your sense for how that market is going to be different in 2024 versus 2023? Obviously, it was very strong in 2023. Kind of what are your field managers and customers telling you about how 2024 will look relative to 2023? Obviously, you still mentioned semiconductors and EVs, but just curious kind of how this year is going to be different than last year?

Matthew J. Flannery, CEO

Well, I think it will continue to be strong, and I think it will carry a good part of the growth this year, specifically a big part of the mega projects. When you're thinking about the plants we talked about and the onshoring of manufacturing. We saw it play through all the way in Q4, where that was our largest growing vertical that we track in Q4 in the industrial sector, it was industrial manufacturing. We haven't even really touched on LNG nor has it kicked off in a big way yet. That's yet another opportunity in the industrial space. So we feel really good about the industrial end markets. I mean outside of oil and gas and really the upstream which was down. You guys all probably see that in the rig count. That was down in Q4, and we expect to be down next year. Outside of that, we think it's going to continue to be another strong year in the industrial end markets.

Steven Fisher, Analyst

Terrific, thank you.

Matthew J. Flannery, CEO

Thanks Steve.

Operator, Operator

Thank you. Our next question comes from Seth Weber with Wells Fargo. Please go ahead.

Seth Weber, Analyst

Hey guys, good morning. Matt, I appreciate your comment about normalizing CAPEX. I wanted to explore that a bit more. Historically, first quarter CAPEX has been in the low double-digit percentages of the total. Is that still the number we should be considering? If so, that would indicate a decrease in the first quarter for gross CAPEX. Is that your perspective?

Matthew J. Flannery, CEO

Yes. As we have grown, it's fair to say that the first and fourth quarters need to be somewhat larger to accommodate the branches that process it and our partners that deliver it. We anticipate that the range will be around 15% to 20% for the first quarter, which I believe will still reflect a decline overall. However, it will be relatively stable. The key point is that we did not accumulate that load in the fourth quarter. Therefore, when considering the pattern, we see the range of 15% to 20% for the first and fourth quarters, with the fourth quarter being the more significant factor affecting the overall year. Additionally, about two thirds of our capital expenditure occurs in the middle quarters, which is an approximate way to consider it, even though we can't precisely forecast it.

William Ted Grace, CFO

So Seth, just to your question on the first quarter, if you go back to the strategy we had to implement last year, we took down certainly 20-plus percent of our full year CAPEX in the first quarter. I think it was 22%, 23%. It's about $800 million. So if you think the CAPEX is fractionally up this year, but you're going to have a smaller fraction. People should be thinking the CAPEX landed will be down because of the unusual actions we had to make in the fourth quarter of 2022 and the first quarter of 2023, given the supply chain challenges we faced.

Seth Weber, Analyst

Yes. That's exactly right. Okay. I appreciate that. And then maybe just can you dimensionalize some of this mega project commentary, kind of maybe just talk to where you think we are in that process, are these projects starting to move forward, and are you like seeing shovels and dirt on these projects? There's a lot of debate around this stuff, and just a lot of, I think, skepticism that some of these projects are going to go forward, and can you just talk to just sort of the rate of activity that you're seeing on those projects, maybe even touch on just sort of the competitive environment for United to win those projects or anything you can give to help us get comfortable that those projects are moving forward and will be an impact in 2024? Thanks.

Matthew J. Flannery, CEO

Yes, certainly. First of all, we have no skepticism from our perspective. We have greater visibility into the large projects due to the planning involved, compared to the local market business. We feel very confident about our prospects regarding these large projects, and I believe that most of our peers who can participate feel similarly. You'll continue to hear that sentiment because these projects are currently ongoing, including some of the largest we have ever been involved with. We have resources allocated to them now and did in the latter half of 2023. This will provide a multiyear tailwind for us. For instance, discussions around electric vehicles have been prevalent, but there have been no cancellations in that area. One project was modified to a smaller scope, and another was paused due to environmental concerns but has since resumed. We're only seeing minor delays for unique reasons, without any cancellations in major projects. Additionally, as I previously mentioned, there is significant LNG work on the horizon. We believe the Infrastructure Bill is secure, regardless of the election outcomes, because it received full bipartisan support, which is crucial for the country. The Inflation Reduction Act, while open to debate, has a long-term impact that has not yet fully materialized. However, the positive trends we've been discussing are currently emerging in our business, and we anticipate this will continue for several years.

Seth Weber, Analyst

Okay. Can you provide any additional insights on the win rate or how successful you've been in securing these projects?

Matthew J. Flannery, CEO

No. We view that as competitive, and it's not something that we will discuss. All I can say is we've been the largest provider of equipment to national accounts and the people that do these type of jobs for many, many, many years, long before mega projects became a new term. So we feel good about our position.

Seth Weber, Analyst

Got it, okay, thanks guys. Appreciate it.

Operator, Operator

Thank you. Our next question comes from Nicole DeBlase with Deutsche Bank. Please go ahead.

Nicole DeBlase, Analyst

Yeah, thanks. Good morning guys. So a lot of ground has been covered here. I just wanted to ask one that I had left on used equipment sales. So another year of kind of higher than normal used equipment sales you guys are forecasting. I guess any thoughts on how long that elevated level of investment will last? And can you also talk about the expected mix of wholesale versus auction in 2024? Thank you.

William Ted Grace, CFO

Yes. While I'm not entirely sure how you view that data, we believe that the replacement sold by OEC aligns with our expectations from a Remaining Useful Life perspective. Although the figures are larger, they are based on a bigger foundation. The replacement cycle is influenced by our systematic approach to managing the fleet and returns. We can explore this further, but it's challenging to interpret your question accurately. We are optimistic about it. Regarding the channel mix, we anticipate returning to a normal distribution over time. Roughly, we expect about two-thirds to go through retail, around 20% to trade packages, low double digits to brokers, and mid-single digits to auctions. In 2023, the notable difference was our use of auctions to clear out Ahern inventory, particularly in the latter half, which impacted margins and recovery rates. Does that address your second question? Did I overlook anything?

Matthew J. Flannery, CEO

No, I would just add, Nicole, when considering the recovery rate as a percentage of OEC, you can see from our forecasts that this number is decreasing from historical highs but still above the mid-50s we previously discussed. We believe that as new equipment pricing continues to rise, it will provide some level of protection. Therefore, we don't anticipate returning all the way to the mid-50s, nor does this guidance suggest that. We believe it will stabilize somewhere between the low 70s, where it peaked, and the historical mid-50s.

William Ted Grace, CFO

It's never good to correct your boss, but more like 50 to 55.

Nicole DeBlase, Analyst

Thanks guys. I appreciate that.

Operator, Operator

Thank you. Our next question comes from Ken Newman with KeyBanc Capital Markets. Please go ahead.

Ken Newman, Analyst

Good morning everyone. Thank you for including me. My first question is about the forward visibility you mentioned from your customers. You've discussed the strong manufacturing activity, which had a remarkable 2023. As I consider your growth outlook for 2024, is it mainly influenced by the infrastructure and power sectors? It seems unlikely that we will see another year with several $10 billion-plus semiconductor fabrication projects. What factors are driving the growth in 2024?

William Ted Grace, CFO

Yes, I'll begin there. We've jokingly referred to the term mega projects, and it seems no one really knows what it actually means, as there are various definitions. I'm not focused on the specifics of what mega projects entail. We've discussed several sectors where we see opportunities for growth. Manufacturing clearly leads the list, and the power sector is also performing well. Additionally, when considering infrastructure elements, these may or may not be classified as mega projects. Sectors such as health care and education have shown strong momentum in 2023, and feedback from our field team and customers suggests this trend will continue into 2024. Some of these could be considered mega projects, but many simply represent significant areas where we have robust strategies that benefit us. Matt, do you have anything to add?

Matthew J. Flannery, CEO

You covered it. Well said.

Ken Newman, Analyst

Okay. No, that's helpful. And then, Matt, I think at the beginning of the call, you talked about optimism for rental rates maybe being a good guide for fleet productivity this year. I don't disagree with you, but I'm curious if you could just help us square us with that comment because, obviously, the guide is assuming supply chains are normalizing and used equipment sales were going to be a drag on margins this year. So where is the support for rates kind of staying here positive for the year?

Matthew J. Flannery, CEO

There are a few important points to consider. First, the growth environment is still present, which is essential. The industry has demonstrated discipline, which can be attributed to robust demand or the need created by rising equipment prices. Additionally, there is significantly more information available in this current cycle compared to previous ones. While some may compare this situation to pre-2009, the industry has evolved, and it is now more mature and better informed. For us, those who are known for making the best purchases in the industry, the rising prices indicate that it would be unreasonable or financially unfeasible for anyone to expect pricing to decline. All these factors contribute to our confidence in the outlook, as reflected in our daily business observations.

Ken Newman, Analyst

Yes, that makes sense. Appreciate it.

Operator, Operator

Thank you. Our next question comes from Scott Schneeberger with Oppenheimer. Please go ahead.

Scott Schneeberger, Analyst

Thanks everyone. Good morning. I have two questions. First, Matt, you mentioned your surveys. I believe you typically conduct surveys with your largest 300 customers. Do you also survey smaller customers? You mentioned some weakness being local. Could you compare and contrast those two categories? The second part of my demand question is about the Infrastructure Bill. Where do you see the funds flowing according to your customers? I know there are many projects underway, but are you seeing those funds in action?

Matthew J. Flannery, CEO

Yes, I'll talk to the customer set a little bit and let Ted give you some details on the survey and infrastructure. So when we talk about slowing local market business, it's what we see. When we segment our customers, we see that local markets that were growing double digits are growing mid- to low single digits in some places. So when we see that slowing, it's the reality of what we see. The survey is still positive overall, and Ted will get to that, but I didn't want that to be mistaken. And we just think we'll be putting more of our fleet towards the tailwinds and the major projects that we've been discussing that we had historically. Ted, do you want to touch on the survey?

William Ted Grace, CFO

Yes. The survey allows us to examine different customer segments, particularly national and strategic accounts, alongside total responses. The responses reflect a trailing three-week average of about 800 to 900, indicating a sizable survey sample that we believe accurately represents our customers' experiences. It's important to note that the strongest results, based on a diffusion index, come from larger customers, which supports our current discussions. However, this shouldn't lead to the conclusion that smaller accounts within the overall composite are performing poorly; they are still positive, though not as strongly so. A very small percentage of respondents continue to express a negative outlook, remaining within the low single-digit range. Overall, we're not observing any bearish signals from our customers' confidence. The feedback aligns with our expectations for 2024.

Scott Schneeberger, Analyst

Great, thanks. And then anything specific to Infrastructure Bill and funds flow guys?

William Ted Grace, CFO

So we've seen those awards, too. So it's been good to see a lot of those big awards made in 2023. If you look at the top 10 list that's on the White House website, very few of those have broken ground. You've obviously got an exceptionally large tunnel project between New York and New Jersey that I assume would be a 2024 event, maybe it's 2025. I suspect there's an awful lot of engineering there and permitting. But we've definitely seen anecdotally more dollars flow into that world in 2023, than in 2022. We said this. We really didn't see much in 2022, very late in the year we saw some. But across 2023 we started to see certainly road and highway projects where you could see that attribution to the IIJA. We saw a number of airports break ground. It wasn't just the big ones, but it was secondary and tertiary airports. You've heard us talk about that. You've seen some restoration projects in the Everglades and elsewhere that we've won. So again, it ends up being more anecdotal feedback from the team. There isn't some great summary or audit that the government has provided that we're aware of. But certainly gaining momentum.

Matthew J. Flannery, CEO

I'd agree. I'd say there's a lot more shovel ready to use your word work ahead, than there's been behind us certainly. So we're in the early innings of this. But I just want to remind everyone we've had growth, and even in the fourth quarter, we've had good growth in our infrastructure sector really for the past couple of years plus. And this is something we started focusing on as early as 2017 with the NEF acquisition for those who have been covering us for a while. So we feel good about this. And we think, to your point, in what Ted's comments, more room ahead of us on the infrastructure as far as shovel-ready active work over the next few years.

Scott Schneeberger, Analyst

Great, thanks guys. Good color. Appreciate that. For the follow-up, Ted, probably more for you. Just a summary of what we've heard on this call, your guidance for revenue, a little higher than the guidance for EBITDA growth. I think I heard hey, same level of cold starts on a little less revenue growth and a lot of technology investment. That's kind of my summary takeaway, but anything you'd add and is that accurate? Thanks.

William Ted Grace, CFO

The used piece is essential for understanding this, Scott, and I believe you do. We've discussed the expected normalization of the used market over the past few years, and you've started to see that in 2023 compared to 2022. A clear way to express this is through the recovery rate. In 2022, we recovered about $0.74 on the dollar for selling 90-month old equipment. Historically, we've seen recovery rates of about $0.50 to $0.55, which was influenced by an exceptionally unusual environment that everyone remembers. During that time, we made it clear that we did not expect those rates to be sustainable. It wouldn't be reasonable to buy an asset, earn 7.5 years of cash flow, and then sell it for just a 26% economic depreciation. Fast forward to 2023, and we recovered about $0.66 on the dollar, indicating some normalization. Looking ahead to 2024, we expect that number to approach $0.60, resulting in about $1.5 billion of proceeds from $2.5 billion of OEC sold. Although this is a decline from 2023, it remains significantly above historical norms. As a result, this will impact margins. Margins are still quite strong; throughout 2023, we averaged around 57%. If we compare this to pre-pandemic levels, which were typically in the upper 40s, it shows that we continue to maintain high margins. However, as we normalize the recovery rate, margins will be affected. For the sake of illustration, if we assume a direct relationship between the normalization of recovery and margins, you might project that if we reach low 50s adjusted used margin and apply that to revenue, it provides a way to gauge the EBITDA headwind we anticipate facing in 2024 as the used markets normalize. We've provided a framework to help you quantify this. Looking at those numbers, you can expect flat margins year-over-year excluding usage. Matt, do you have anything to add?

Matthew J. Flannery, CEO

Very thorough. We are good. Thanks.

Scott Schneeberger, Analyst

Great, thanks guys.

Operator, Operator

Thank you. And this does conclude our question-and-answer session. I will now turn the call back to Matt Flannery for any additional or closing remarks.

Matthew J. Flannery, CEO

Thank you, operator, and thanks to everyone on the call. We appreciate your time, and I'm glad you could join us today. And I'd just remind everyone, you can go to our site, our Q4 investor deck has the latest updates. And as always, Elizabeth is available to answer any of your questions. So stay safe, and I look forward to seeing you all in April. Operator, you can now end the call.

Operator, Operator

This does conclude today's call. We thank you for your participation. You may disconnect at any time.