United Rentals Inc

NYSE:URI

Earnings Call Transcript 2020-Q3

[Operator]

Good morning, 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. 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. 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, 2019, 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 presentation 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 Jessica Graziano, Chief Financial Officer.

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

[Matt Flannery, President and Chief Executive Officer]

Thank you, operator, and good morning, everyone. Thanks for joining us. I'll start with some observations that will frame out our discussion about the quarter as well as our customers and our markets.

What we saw in the third quarter was a continuing recovery, albeit at a moderate pace. Our end markets are improving. And for the first quarter, since COVID hit, the trends were in line with normal seasonality. That said, volumes were still down year-over-year.

Near term, we have good visibility. Market activity looks positive, and customer sentiment is trending up. Longer term, we expect that future events, including a potential vaccine, are likely to have a significant impact on demand.

I'm pleased that we delivered strong results in this environment. We have our arms around the things we can control, and we're showing discipline and agility in our daily operations. You saw that in our numbers where we outperformed our own expectations for the third quarter, and we did it safely. It's a different world out there right now. And every time our employees interact with each other, or with customers, or a supplier, their behavior is guided by our safety protocols and those protocols help the team turn in another safe quarter, with a recordable rate below 1. And that was a hard-fought win, when you factor in the fires in California, or the storms in the Gulf, or just simply the daily challenges of COVID. So kudos to the team for their effort.

In a few minutes, Jess will take you through our results. But first, I'll touch on a few highlights. Number one is margin. Rental revenue was about 13% below third quarter last year, but we made the most of it by controlling our operating costs. And I give the team full credit for that, because it's their discipline in the field that helps preserve our margin.

And as volumes in the quarter went up, SG&A as a percent of revenue went down. So clearly, we're being vigilant with controlling our variable costs. Another highlight for the quarter is our free cash flow. We generated over $2 billion of free cash flow year-to-date through September and our ability to produce significant cash in a downturn is a key strength of our business model.

The return to normal seasonality isn't enough to offset the impact of the pandemic, but it's definitely in the right direction. And it gives us a good line of sight on the fourth quarter. And based on that current visibility and our third quarter performance, we've updated our 2020 full year guidance to reflect higher targets for revenue, EBITDA, CapEx and free cash flow.

Now looking at our operating environment, the recovery in North America has been fairly broad-based and customer sentiment continues to trend up. We see business confidence improving in our own customer surveys as well as many external indicators.

Used equipment sales are another helpful indicator of demand. Our third quarter revenue from used sales was essentially flat with last year and used pricing held up as well. So demand is holding steady. And in fact, we sold 35% more fleet through the retail channel in the quarter compared with third quarter last year. And that tells us that contractors are buying fleet they feel confident they can put to work.

We're also encouraged by the industry's discipline on supply, which you can see in available third-party data. And we applaud this because a disciplined approach will serve everyone's interest as the recovery gains steam.

In July, I noted that rental volumes in all of our geographic regions finished the second quarter above the trough for fleet on rent we saw in April. In the third quarter, we continued to gain ground, with rental revenue increasing sequentially in 15 of our 16 regions, and that one outlier region was essentially flat. The standout verticals so far have been the ones we've been talking about: power, biotech and pharmaceuticals, and we see solid activity from warehousing and distribution, data centers, hospitals and other facilities in the healthcare and technology sectors. And there were some verticals that were a little less pronounced, but still on a positive path. Food and beverage is an example of a vertical that's edged back to historical levels. And by contrast, as I'm sure you know, all segments of oil and gas remain depressed, led by upstream.

Looking specifically at construction, non-res markets, as a whole, showed mild improvement, while retail, hospitality and entertainment remained largely on pause. The individual verticals within non-res are still a mixed bag, but our core markets all have solid long-term fundamentals.

And there's also a broad range of new projects starting up across our operating landscape, and this was true in our second and third quarters, and we're seeing the same thing this quarter. And this activity spans multiple markets, including manufacturing, automotive and road and bridge work, as examples, as well as the other positive verticals I mentioned earlier. And the team is doing a great job of getting in the door with these projects at an early stage.

One side note worth mentioning is the possible shift to an on-shoring strategy by North American manufacturers. This year has highlighted the vulnerability of the supply chains, and on-shoring could be a way to reduce this risk. And if that trend pans out, it could benefit 2 areas where our company is often first call with customers, in industrial construction and plant maintenance.

Also, a word about our Specialty segment, which continues to be resilient overall. Our power and HVAC business, in particular, had another strong performance in the quarter. And all of our specialty offerings are poised to capture incremental demand, and we're continuing to make strategic investments in the growth of this segment.

Through September, we've opened a total of 13 new specialty locations, and we're on track with our plan for 15 openings for this year. And I want to take a minute to talk about how we look at strategic investments, because capital discipline is more critical now than it's ever been.

And I've already mentioned that we're controlling our costs to benefit our margins, and we've reduced our full year CapEx significantly, but we haven't gone full stop on investing in the business. We're taking the long view. We're managing our capital to support our customers and to drive long-term returns for our investors. The ongoing expansion of our specialty network is one good example of that. And as you saw in our guidance, we allocated some CapEx for fleet to address targeted areas of demand.

Throughout all the disruption this year, we kept our eye on the big picture, and we're making sound decisions with the benefit of a robust balance sheet.

I'll sum it up by saying all the things we've been doing right this year, we're still doing right. And that's the plan, execute well under all market conditions. And with COVID, that means, first and foremost, protecting our people, serving our customers, running a tight shift and doing all of this without limiting our capacity for growth.

The strong third quarter results we reported show that the plan is working. And now we have higher expectations for the fourth quarter than we did 3 months ago, in large part because we have more visibility into the near term. And we'll see how that plays out as we move into 2021.

I'm going to close with some things that I could say with absolute certainty in what's been a very uncertain year. As I look around our company, I'm proud of the way our team has stayed together, and it's working safely. And I'm glad that our operations have been able to remain open to serve our customers, because communities rely on these projects. And I'm pleased that we continue to be responsive to all of our stakeholders. And finally, I'm confident that we have the right strategy in place to leverage our competitive advantages and convert our revenue into attractive returns.

Every economic environment, weak or strong, has its opportunities, and this one is no different. We know how to use our strengths to make the most of any market conditions, and we did that on the downside of this pandemic, and we'll do it on the upside as well.

So with that, I'll hand the call over to Jess, and then we'll take your questions. Jess, over to you.

[Jessica Graziano, Chief Financial Officer]

Thanks, Matt, and good morning, everyone. As Matt mentioned, we're pleased with our results in Q3, notably rental revenue that tracked to seasonal trends, as expected. And the cost management our team delivered across the business, which was better than expected. We've generated significant free cash flow to-date and continue to strengthen our balance sheet. And I'll speak to both in a bit, and also provide some comments on our updated guidance for the full year.

Let's start with rental revenue for the quarter. Rental revenue for the third quarter was $1.86 billion, which is down $286 million or 13.3% year-over-year. Within rental revenue, OER decreased $259 million or 14.1%. In that, a 4.6% drop in the average size of the fleet was an $84 million headwind to revenue. Inflation of 1.5% cost us another $27 million, and fleet productivity was down 8% or $148 million on lower volumes. I'll note that fleet productivity did improve by a healthy 560 basis points from Q2, which is mainly from better fleet absorption. Rounding out the decline in rental revenue for the quarter was $27 million in lower ancillary and re-rent revenues, or an 80 basis point headwind.

Let's move to used sales. Used sales revenue was basically flat year-over-year at $199 million. The retail market continues to be quite strong for us, and we sold significantly more fleet through this channel through Q3 last year, with OEC sold up 35%. Used margins in the quarter were healthy as well. Adjusted gross margin on used sales was 44.2% versus 46% in Q3 last year. That change reflects softer year-over-year pricing, partially offset by improved channel mix. Importantly, cash proceeds, as a percentage of original cost, was a robust 51.4% on fleet sold that was, on average, 7 years old.

Taking a look at EBITDA. Adjusted EBITDA for the quarter was $1.081 billion, down $126 million or 10.4% year-over-year. Here is the bridge on the dollar change. The impact from rental was a drag of $162 million, OER was a headwind of $168 million, offset by a combined $6 million of tailwind from ancillary and re-rent. Used sales were a headwind to EBITDA of $3 million, and other lines of business, together, were a drag of $6 million. Year-over-year, SG&A was a benefit to EBITDA in the quarter by $45 million, with the majority of that benefit coming from lower discretionary costs, including T&E and professional fees as well as lower bonus expense.

Our adjusted EBITDA margin was very strong, coming in at 49.4%, up 90 basis points year-over-year. This reflects our continued commitment to aggressively manage costs. It was also benefited by certain one-time items contributing about $20 million to the quarter, including an insurance gain resulting from a flood event settled in Q3. Adjusting for the non-recurring benefits, adjusted EBITDA margin was flat, despite a 12% decline in total revenue year-over-year.

Flow-through, as reported, was approximately 42%. Again, adjusting for those one-time benefits, the resulting flow-through of just under 49% evidenced the flexibility we have in our business model to respond quickly on costs. Through the third quarter, we continued to bring delivery and repair in-house to reduce the use of third-parties. As a result, our overtime increased versus Q2, but continued to be down versus Q3 last year. And we continue to avoid discretionary spend where possible, mostly in G&A.

A quick comment on adjusted EPS, which was $5.40, that compares with $5.96 in Q3 last year. The year-over-year decline is primarily due to lower net income from lower revenue.

Let's move to CapEx. For the quarter, rental CapEx declined 49% to $432 million, bringing our year-to-date spend to $785 million in gross rental CapEx. Year-to-date proceeds from sales of used equipment were $583 million, resulting in net CapEx of $202 million. That's 85% lower than net CapEx at September 30 last year, and reflects our continuing focus on capital discipline and fleet absorption given current rental volumes.

ROIC remains strong, coming in at 9.2% for the third quarter. Now that continues to meaningfully exceed our weighted average cost of capital, which currently runs about 7%. Year-over-year, ROIC was down 150 basis points, driven by the decline in revenue.

Turning to free cash flow, which, through the end of September, is a record for us. We have generated over $2 billion of free cash flow year-to-date, an increase of over $900 million year-over-year. With the majority of our cash flow dedicated to debt reduction this year, our balance sheet continues to be the strongest it's ever been. Net debt was down $1.5 billion to $9.9 billion at September 30. Leverage was 2.4 times, down from 2.6 times at the end of 2019.

Liquidity remains extremely strong. We finished the third quarter with over $3.4 billion in total liquidity. That's made up of ABL capacity of just under $3.1 billion and availability on our AR facility of $165 million. We also had $174 million in cash.

On October 15, we used the ABL to redeem our $750 million 4 5/8 senior notes due 2025. Our decision to do so included our views of continuing strength in liquidity, and extends our next maturity on long-term notes out to 2026. Total liquidity, as of yesterday, October 28, was over $2.8 billion, and we expect that to increase to the end of the year, consistent with our free cash flow guidance.

Speaking of guidance, I'll close with a few comments. We've tightened and raised the bottom of our total revenue range as our visibility increases, and we expect to see a normal seasonal trend in demand in Q4. We also expect used sales will remain solid. We've tightened our adjusted EBITDA range and have raised our expectations for the full year, in part from the strength of Q3's results. Our gross CapEx guidance of between $900 million and $950 million is higher than our prior guidance as we manage fleet mix in support of customer projects. And finally, our free cash flow update continues to signal the strength and resiliency of our business model as we plan to generate over $2.2 billion in free cash flow this year and, in turn, plan to use the majority of it to reduce our debt.

And with that, let's move on to your questions. Operator, would you please open the line?

[Operator]

[Operator Instructions]. Our first question comes from the line of Dave Raso from Evercore ISI. Your question please.

[Dave Raso, Evercore ISI]

Just trying to think about the fleet for next year. How should we think about the thought -- base case as of right now? How do you think about sizing the fleet versus the size of the fleet that you expect to end this year? And maybe remind us the mix between how you view replacement CapEx? And then related to that, what kind of used equipment sales would you look for?

[Matt Flannery, President and Chief Executive Officer]

Sure, Dave. This is Matt. So when we think about next year -- and timing is appropriate because we're in the middle of our planning process right now. But as we think about next year, we -- as a starting point, we expect to sell about the same amount of used equipment that we will this year. And then from there, we're going to look at demand and say, alright, do we replace all of that fleet? Hopefully, that answer is yes. And then if so, how much extra capacity do we have in our existing fleet to serve any incremental demand? And then depending on how robust the demand is, will be if we are going to end up in the growth CapEx.

Now the good news for us, timing-wise, is, as you saw this year, we can be very flexible to how much we can flex up or down depending on the demand environment, as you saw by us cutting over $1 billion this year when we really didn't get a peek into that challenge until mid-March. So we'll do the same thing this year. We'll take a look. And sometime in the spring, we'll have to start to make some decisions. But I think by then, we'll have a lot more clarity on what demand looks like. So that flexibility gives me a lot of -- gives us a lot of hope in that the environment will be there, but also the ability to react if it's not. So no bet yet on 2021, but if this healing of the macro continues, we feel -- we don't expect to not replace used fleet that we sell at a minimum. And then we'll see where the demand goes from there.

[Dave Raso, Evercore ISI]

And if that's the case, unless there's a radical change in what you get for used values versus the OEC of that equipment that's being sold, if your base case is not thinking about shrinking the size of the fleet, wouldn’t that speak to gross CapEx $1.6 billion or so? Because I think we've spoken in the past, roughly, that's a replacement type number anyway. So it sort of seems to triangulate to that sort of the base case. Is that just a fair assessment when we think of the size of the fleet?

[Matt Flannery, President and Chief Executive Officer]

I think that would be the right way to think about a base case. And then from there, it would be -- everything else would be demand-based. Now in an environment like this year, we didn't even replace all the used sales that we had, because we had extra capacity existing. So we took that opportunity to take the fleet down as you saw. But we're not anticipating that next year. And once again, we won't have to make those decisions until the spring, and we'll react to the demand environment.

[Operator]

Our next question comes from the line of Tim Thein from Citi. Your question please.

[Tim Thein, Citigroup]

Matt, you started talking about the near-term visibility. I'm curious, maybe if you can just expand on that a bit as to -- as you speak to the branches, what -- can you help us in terms of just their overall visibility levels? And then potentially, how does that compare to, I don't know, this time last year? Is that -- any kind of benchmarks you can provide? Just to get a sense for, obviously, big question marks regarding as we work through this project pipeline, what's there to fill it up beyond that? So maybe just speak to what you hear from the branches with regards to project activity and just overall visibility would be great.

[Matt Flannery, President and Chief Executive Officer]

Sure, Tim. So as I mentioned in my opening remarks, we're hearing the same feedback that we're actually experiencing from our field leaders, and that is that activity continues to incrementally improve with normal seasonal patterns. So they're seeing that.

The visibility question, frankly, if they thought they had more visibility than through Q1, I would worry about it anyway, and they're not pretending to it. It all depends on how the macro environment responds to this winter. And I think we will have a much better take on that from January, but near term, their visibility is strong, which is why we've had the confidence to change our guidance.

And I think beyond that, we're going to take the time we have between now and January to get a better look at how the world, but more specifically for us, how the U.S. and Canada respond to COVID. And I'll say that we're hopeful, this healing that's going on in the macro environment that we're seeing through green shoots and new projects that we're seeing through outside oil and gas, most verticals and, to be fair, probably lodging and travel. Most verticals are showing some growth or are maintaining the growth that we've seen since the trough that we talked about in Q2. So they're encouraged, and I'd say cautiously optimistic is the best way to think about it.

[Tim Thein, Citigroup]

Okay. And maybe I'll sneak one more, and that was just on the operating costs. And as to what you've learned through this period this year in terms of, you talked earlier about cutting as it was a theme on the second quarter call in terms of some of the third-party costs and delivery and alike, how much of that, Matt, do you think you can extend presumably as volumes do improve. I guess, the question is how much of these cost benefits can be sustainable? And obviously, some of it were T&E and some of the discretionary things, presumably at some point, come back. But it's really around the kind of the longevity and the sustainability of some of these operating cost benefits that you've realized this year?

[Matt Flannery, President and Chief Executive Officer]

Yes. So I think that the term of necessity is mother of invention is appropriate here, right? So as we thought about how we really wanted to hold the team intact. So when we get on the other side of this COVID tunnel, as we've been calling it, to make sure we have the ability to respond. And we've been able to do that through the in-sourcing kind of that you referred to.

Just to give a data point, our headcount year-over-year is only down about 3%. And as you see, our margin -- I mean, our revenue volume for the quarter was down about 13%. And the reason we were able to do that, without having to sacrifice margin, is because we took some of our most expensive costs, like outside hauling, third-party repairs, and we in-sourced. So this way, we're keeping our people busy and, frankly, employed during a very difficult time. But to have capacity to be able to respond quickly as projects and markets continue to heal and grow. So that's something I think is silver lining through this COVID that we're going to utilize in the future.

We haven't put math to it, to what extent, because one of the variables there is how fast is the demand going to grow? And how can you keep up with it? So I think that's a key learning for us that this in-sourcing opportunity is a great way to not only have control of that variable, but to actually do it in a more efficient way.

As far as T&E and all that, we absolutely hope it comes back, because that means the world is healing and our people are out there with our customers and our employees. So that's less of an impact than the rental operating costs, as you can imagine. But we'd expect some of that to normalize. It might even increase a little bit here. So that's the way we're looking at the world right now.

[Operator]

Our next question comes from the line of Jerry Revich from Goldman Sachs. Your question please.

[Ashok Sivamohan, Goldman Sachs]

This is Ashok Sivamohan on for Jerry Revich. The 51% recovery rate in the utilization environment was a pleasant surprise. What would you attribute the strength in the used market to? And why did the used market recover ahead of industry utilization cycle?

[Jessica Graziano, Chief Financial Officer]

So this is Jessica. What I would say is a strength that we have here at United Rentals is that a large portion of our used sales are in a retail market that are essentially sales to our customers, right? And we continue to see strength through that retail channel. As a matter of fact, as I mentioned earlier, we had 35% more volume move through that channel this Q3 versus last. And so the strength of that is really indicative of our customers needing that equipment. And the continuing recovery that Matt also mentioned that we're seeing pretty broadly across the majority of our end markets. So the strength that we're seeing in used sales, I think, is directly attributable to that same recovery pace that we're seeing across the business.

[Operator]

Our next question comes from the line of Seth Weber from RBC Capital Markets. Your question please.

[Seth Weber, RBC Capital Markets]

I just wanted to go back to the expense and cost question again. Really good job on the quarter here. But if I'm looking at the fourth quarter, it looks like margins are going to be down -- EBITDA margin is going to be down quite a bit year-over-year, kind of based on the midpoint of your guide. I'm just trying to tie a couple of these things together, where you're talking about some of the in-sourcing is a permanent change and stuff like that. But it looks like margins are going to be kind of down meaningfully year-to-year, even though they were just about flat year-over-year, if there's anything I'm missing there?

[Jessica Graziano, Chief Financial Officer]

Seth, so 2 things that I mentioned. So first, I know you've heard me say this before, but I think it's really important this quarter not to anchor to the midpoint. We've done a lot of work at possibilities of how the revenue could come in and what that means in terms of EBITDA and even some of the cost trends. And so I'll give that caution again about not anchoring to the midpoint.

The other thing that I'll mention is in the fourth quarter of last year, we had a tailwind in bonus expense. And so the impact that that's going to have on the fourth quarter this year, from a margin perspective, is going to be somewhere -- if I use midpoint revenue, it's going to be somewhere around 50 basis points to 70 basis points of drag. So that's going to play through Q4 as well.

[Seth Weber, RBC Capital Markets]

Sure. Okay. That's helpful. And then just a follow up on the specialty business. We've been hearing more. Just other national players have been talking more about getting bigger in the specialty space. Can you just kind of characterize what you're seeing in the specialty market as far as more competition or just asset valuations going up for M&A? Just kind of characterize what's happening in that market?

[Matt Flannery, President and Chief Executive Officer]

Sure, Seth. This is Matt. We're continuing to feel very strongly about our specialty business, the performance, as well the resiliency of the businesses have been doing great. They've been performing better than the business overall. All this was part of the strategy and expected.

We do hear a lot of people talking about getting into the specialty business, understand what that dynamic could cause. I'll tell you that we still are seeing positive trends in specialty. And I would say that the performance tells us there's either more penetration opportunity or the competition is not moving as quickly as maybe it may sound like. But either way, we're very pleased with what we're doing from a specialty perspective. And as you recall, last year, they had some transient issues with margins that we talked about. They're also doing this in a tough environment with improved margins.

[Operator]

Our next question comes from the line of Mig Dobre from Baird. Your question please.

[Mig Dobre, Baird]

If we can, I'd like to go back to the guidance. I'm just trying to understand the moving pieces here as well. Can you maybe comment on how you're thinking about equipment rental revenue specifically from a sequential standpoint, relative to used?

[Matt Flannery, President and Chief Executive Officer]

Yes. Is your question from a year-over-year comp perspective? Or what exactly you want to get at, Mig?

[Mig Dobre, Baird]

I'm trying to understand how you're thinking about revenue sequentially rather than year-over-year, right? I recognize that you commented on seasonality. But, obviously, there are a lot of moving pieces here as we're dealing with yet another big spike in infections and activity is choppy in some end markets like you called out. So I'm trying to understand, specifically here, are you thinking that this line item can be flat sequentially? Maybe a little bit down? How do you think about it?

[Matt Flannery, President and Chief Executive Officer]

So we would expect Q4, in any environment, over Q3 to be sequentially down. And you've heard us talk before. Once we get around mid-November, we start to see what we lovingly and I’m going to use that tongue in cheek called the turkey drop. So for the 30 years I've been in this business, I've never quite gotten comfortable with it. But we'll see a lot of fleet come off rent during that last half of the quarter. So therefore, we always expect sequentially that Q4 revenue will be lower than Q3 revenue by a little bit.

And when you look at our change to our guidance, we're actually overall for total rent revenue for the year and revenue for the year feeling better than we did a few months ago. So I would think that, that sequential dip is -- would be normal seasonality. And part of what we've been talking about is that normal seasonal trend.

Nothing out of the ordinary for us. As a matter of fact, if you think about the fact that we just raised CapEx, that's for specific projects that are coming out of the ground here in Q4 and specific opportunities. So that, in itself, we view as a positive sign that rent revenue will continue to trend with normal seasonal patterns.

[Mig Dobre, Baird]

Okay. I appreciate that. And then the follow up on the cost side, given the way you're kind of thinking about equipment rental revenue. As far as the cost of equipment rental sequentially, should that follow revenue as well? Or are there some inflationary items that can impact the fourth quarter?

[Matt Flannery, President and Chief Executive Officer]

I would say that’s just tactically right, as a lifelong operator. One of the interesting things of Q4 is when all that fleet comes off rent, you’re going to still have an enormous amount of activity, although you're not increasing your volumes of billable revenue. Because you're going to get all that fleet back and you're going to repair it when you get it back. So there are a little bit of cost disconnect in Q4 to that dynamic, but nothing out of the ordinary. Nothing that we haven't managed for years here, and nothing to call out specifically. But it is just think about it sequentially saying the cost would drop to the same level of revenue. It's usually not quite accurate in Q4, but nothing to call out, nothing out of the ordinary.

[Mig Dobre, Baird]

Okay. Understood. And if I may one more. If we're looking at your fleet, the actual number of units came down maybe, call it, 30,000 through 2020. And I'm just curious, can you provide some perspective in terms of what the mix of these units were? I mean, was there maybe a little more concentration in earthmoving aerials? And anything that you'd call out here would be helpful.

[Matt Flannery, President and Chief Executive Officer]

Yes. I wouldn't say that the fleet profile has changed significantly overall. We continue to outspend our way in specialty products versus gen rent. But outside of that, the mix was in gen rent. It will vary a little bit depending on projects and needs, but nothing material that I would call out.

[Operator]

Our next question comes from the line of Steven Fisher from UBS. Your question please.

[Steven Fisher, UBS]

Just to clarify with the base case you talked to David Raso about reflects in terms of market activity year-over-year next year. Does that base case assume a modest decline in the market? Or flat or some modest growth? Or really it doesn't assume anything at all for the market? And just as a rule, place whatever you sell regardless of what the markets are? I just wanted to clarify that, please.

[Matt Flannery, President and Chief Executive Officer]

Sure. So the latter. To be clear, right, we'll use the replacement CapEx as a starting point, then that will flex to meet demand, right? Well, first full demand with existing capacity. Let's say, for example, in this year, that existing capacity we had was greater, we had more opportunity that told us that we didn't need to replace all that would be going one direction. The other direction is we fill any incremental demand that was beyond the existing fleet size, right, thinking about the starting point being keeping fleet constant.

Whatever gap we couldn't fill with existing capacity, existing fleet, we would then get incremental capital. So it's not a forecast usage tool. It's just to think about in a continually improving macro environment, your starting point, if we didn't need to shrink the fleet, would be to start at that replacement capital number. That's really what that has illustrated.

[Steven Fisher, UBS]

Got it. And then I wonder if you could just talk about the lessons learned in the post-election period in 2017? And how you manage the fleet? And I know macro environments are always a bit different. But curious, we're going to be coming up against another post-election period. There may be some optimism on infrastructure. Anything that you learned last time that you're trying to incorporate now and over the next few months as you kind of plan for what you may or may not need to do?

[Matt Flannery, President and Chief Executive Officer]

I would say, from a political perspective, outside of some type of infrastructure funding, which I think has bipartisan support, the issue there is how they're going to get funded. Outside of that, we're not -- we'll keep a very close eye on that as we have. We're not really watching that political environment from a macro perspective too much. We understand there may be winners and losers in certain sectors, but the impact on our business will be, we'll ship the assets to the winning verticals, and that's part of the resiliency of our model is that flexibility of very fungible assets.

Personally, I think how we get through the pandemic will have a much bigger impact on how fast the economy recovers than the political environment. But once again, we have the time to wait and see and react.

[Operator]

Our next question comes from the line of Chad Dillard from Bernstein. Your question please.

[Chad Dillard, Bernstein]

So it's probably fair to assume that we're going to see a shift in non-residential construction away from kind of the commercial side, probably more towards data centers, renewables, warehouses. Just trying to understand like just how your equipment needs change? If you could give some color on, from the classes of equipment, the mix between general versus specialty mix, that would be super helpful.

[Matt Flannery, President and Chief Executive Officer]

Yes. I would say that shift, right, within non-res would not be as pronounced there. Maybe you'll get a little bit heavier to some larger scissor products versus smaller electric scissors, maybe a move a little bit, of Reach Fork. And -- but these are businesses and end markets that we've been supporting for quite some time. And so I wouldn't view a huge profile change from our asset base.

As far as specialty, that's all about penetration. I would see infrastructure being a major area. I would see as turnarounds come back in refineries, that could be more opportunity for our specialty business as well as our gen rent. So I wouldn't say that shift within non-res as making a huge fleet profile change. I think more it would be industrial changes that would give us some maybe outweighted opportunity for our specialty products, because the industrial end markets tend to use the sole source broader fleet usage for us.

[Chad Dillard, Bernstein]

Got it. And then just in your industrial side of your business, can you talk about the pace of recovery that you're seeing right now? How far below normalized levels is that business kind of thinking specifically on the pet chems refining side?

[Matt Flannery, President and Chief Executive Officer]

Yes. Petrochem has really been a challenge this year, led by upstream. When you think about -- I believe that rig count for Q3 was down 73% for upstream. So that's been the biggest challenge within a challenging overall petrochem environment. The good news for us -- and our upstream business was down 56% in the quarter. The good news for us is it's kind of bottomed out. And it's about 2% of overall revenue. So we're not counting on or expecting any recovery there anytime soon. If it comes, we'll measure how quickly we'll react and how we'll react with really just specific key customers that have bigger value for us. I'm not chasing the oil rush. I don't think I see us doing that again.

Downstream is totally different ball of wax and they as well have been challenged, but we're very well positioned with these refineries. And I think as the world opens up again, and the need for their output increases, we're going to be poised -- very well poised for that to be a future opportunity. Whether that happens, at what period, in 2021 that happens? We don't have a position on yet. I can tell you that fourth quarter turnarounds and shutdowns have been delayed again as these people are really conserving cash and trying to do everything they can to control costs. But we'll be patient, and I would see that as an opportunity. But when you look at petrochem, overall, it's about 12% of our overall business and challenged right now.

Industrial, when you take that out, it's actually been flattish. It's been moderating. So it's been a better story once we take that petrochem headwind out of it. And I talked a little bit about the potential for offshoring, the potential for manufacturing opportunity here. And that's something we're keeping a close eye on, because that could be another leg of growth that we could look forward to kind of offset some of the challenges in the industrial end market.

[Operator]

Our next question comes from the line of Rob Wertheimer from Melius Research. Your question please.

[Rob Wertheimer, Melius Research]

Matt, I wanted to ask if I could, 1 short-term and 1 long-term question. In the short term, you've done a lot on downside flexibility in the cost structure and industry pricing, it’s held up according to the PPI and so forth. Based on prior downturns, when do you think you're kind of -- you can put the stamp on it and say, yes, this really has worked differently? Maybe price should have already collapsed and it hasn't so it's already there, maybe wait till spring, maybe longer. I'm just a little bit curious about how you feel about when that is sort of finally proven out?

My structural question, if I may is, amidst all this, should we expect that you’re continuing strategic activity? And if we look out 3 years, are you going to be in a couple of new specialty verticals? And is there any underlying progress on what you might be looking at there?

[Matt Flannery, President and Chief Executive Officer]

Sure, Rob. So on the first part of your question, that is a wildcard, right? This is where our lack of visibility of trying to time out when this dislocation, downturn, pandemic future term. When it ends? We really -- I think we really have to wait and see how we respond specifically in this winter and how things go up, and how the government, municipality, state and really, the population responds to it. So this is a bit different than any of the other downturns I've been in, in my career.

So I would say that that's still an open-ended question for us. But I think we've been seeing the signs of resiliency through this. And I think that whether it's the used sales volume holding up, whether it's that we're still seeing new projects start here in the fourth quarter as there's still a lot of concerns about when the broader economy is going to accelerate.

So we feel, I'll repeat, cautiously optimistic. We're seeing some good signs. They could all pause and go back. We don't know, but I think we're positioned as I talked about our flexibility for it either way. So there is no template, no boiler plate for pandemic-related downturn that I could pull out of the drawer. But at the same time, we are seeing activity pick up, which I view as a very positive sign.

From an M&A perspective, we continue to be focused on any M&A pipeline activity that we think makes sense for us strategically, and then it goes through the rigor. Well, does it make sense? Is the timing, right? And most importantly, does it make financial sense?

So admittedly, for the past 6 months, it hasn't been a large area of focus. But the pipeline still keeps working. Our M&A team, our business dev team will take inbound calls still keeps working. And we'll continue to do that with a lean towards anything that we can do to serve our customers with more products and services. To broaden that, as you heard me talk about that competitive moat to help do more -- solve more problems, we think, is just part of our whole value prop. So there would continue to be that lean to any new products that we can bring to market with our existing customers on our existing projects, is something we're focused on.

[Operator]

Our next question comes from the line of Scott Schneeberger from Oppenheimer. Your question please.

[Scott Schneeberger, Oppenheimer]

I guess, I'm curious on your fleet productivity metric. Could you just give us some high-level thoughts on cadence of that, inflection? And some of the considerations perhaps how you're seeing smaller competitors behave in this environment that we're in?

[Jessica Graziano, Chief Financial Officer]

Scott, hi, it's Jess. So yes, I mean, we're encouraged as we think about fleet productivity in an environment where this healing continues and the recovery -- this moderate recovery extends into 2021 that we've talked about fleet productivity getting better, right, and starting to turn, particularly in the back half of next year, right?

May come a little sooner, depending on how that recovery works through, but we are encouraged that, with a focus on continuing to have better absorption with each quarter that passes that, that fleet productivity is going to get better for us as 2021 goes on.

[Scott Schneeberger, Oppenheimer]

And then as a follow-up, just on the fleet aging, we're in that type of environment. Just curious, your comfort level of how high you can go on average? I know what is announcement by asset consideration. But also efficiency efforts and advancements you've made in repair and maintenance over the years, does that makes you comfortable in the demand at the moment?

[Matt Flannery, President and Chief Executive Officer]

Sure, Scott. So when we think about how much we sweated the fleet, I'll use the term that's been used frequently. The great news is because of the used sales volume that we've had this year and the ability to continue to get out what we call, RUL, rental useful life fleet, and manage this cradle to grave of these assets. We actually -- I think we’ve picked up on a year-over-year basis only about 5 months of fleet [agents].

Considering what we've gone through, that's less than we thought we would have, quite frankly. So we've always talked about that we'd have 12 months of headroom, at least in any particular Cat Class. We haven't even had to use half of that in what's been a very challenging year. So not that I want to speak this into anyone's future. If we had to wash, rinse and repeat 2020, again in '21, we'd be able to do it from a fleet age perspective without any meaningful increase in R&M. So that's the way we view that. We're very comfortable with that. And once again, it's important the way that we manage assets cradle to grave. The exit part of this is a big part of keeping that fleet age healthy and have the ability to get through any part of the cycle.

[Operator]

Our final question for today comes from the line of Courtney Yakavonis from Morgan Stanley. Your question please.

[Courtney Yakavonis, Morgan Stanley]

I was wondering if we could just go back to the in-sourcing discussion. It sounds like over time, it's been picking up this quarter. You haven't really reduced the head count at all. It's pretty almost flat year-over-year. Can you just help us understand how much more in-sourcing can you do without having to raise the headcount to do that? And if you can just help us quantify, at all, how much that opportunity could be? Maybe what you spent on third-party last year versus the increase over time to be this year? And then also, do you have any more systems in place that will help you manage that headcount maybe a little bit better? And why you haven't done it historically?

[Jessica Graziano, Chief Financial Officer]

Courtney, it's Jess. So the headcount actually has gone down. So on a year-over-year and even as we think about the headcount from, let's call it, the middle of March, when the pandemic started, we've had some natural attrition in the business where our headcount has declined. And we have leaned on that overtime that I mentioned did go up in the third quarter. We have leaned on that overtime not just to support that in-sourcing effort that we're doing with repair and delivery, but also to support just the fact that headcount is down across the branches.

So as we think about continuing to really manage through the opportunity of bringing that premium third-party cost in-house, it's a learning that we've had through the COVID period of having a better balance around how much full-time headcount do we want, how much overtime can we use as a flex for when seasonally the activity will peak and ebb and how we can continue to use third parties where we need to, but really focus instead on using our own capacity to be able to support the activity.

Now if we think about that from what's that worth financially, frankly, I don't think the business has normalized for enough of a period of time where we can put a number on that. But I can tell you as one of the primary learnings we've had from an operational perspective, there's definitely opportunity for us to continue to tweak how we use our inside labor to be able to support the business. I couldn't tell you right now exactly how much that’s worth, but it's definitely something that could drive productivity in the future.

[Matt Flannery, President and Chief Executive Officer]

Courtney, just for me to add on is, one interesting point you made, it sounds like me talking in a business review with the team in the field. When you talked about how can we have it manage the headcount earlier? I actually think we might have, what we're learning is we may have over-managed it. And using headcount as a proxy for cost, and what in-sourcing is [product]. So what I think the future opportunity is, is you can keep your heads heavier and get rid of higher per transaction cost through the outsourcing, which we used to look at as the opportunity for seasonal spikes. So these are some of the learnings that we'll be looking at. And Jess and the team will be will be turning through and great opportunity for the future.

[Courtney Yakavonis, Morgan Stanley]

That's helpful. And then just on the step-up, however slight it was in gross CapEx. Can you just share, was that largely just more replacement? Or was that more focused on specialty? And just any thoughts about the increase that you saw this year? Or was it really just because utilization trended better than you were expecting?

[Matt Flannery, President and Chief Executive Officer]

Yes. This was really a mix of both things that you had mentioned. Certainly, some specialty, and we have mentioned how power has had a real strong year. So certainly, some more capital than we had expected going there. But also even within our gen rent product lines, there are some categories that, as we sat here at peak season in October, we were tight on. And it's hard to believe when you think about that fleet productivity and volume still down year-over-year, but every dollar of CapEx is not created equal. There are some assets out there that we needed to go purchase to support some big customers on some projects coming out of the ground, and that's what that raise was about.

By definition, if you think about replacement CapEx being dollar for dollar, we won't replace all the fleet that we sold this year because our spend will be significantly less than the OEC value what we sold. So it really wouldn't be tied to replacement.

[Operator]

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Matthew Flannery for any further remarks.

[Matt Flannery, President and Chief Executive Officer]

Thank you, operator. And to everyone on the call, we appreciate your time. Thanks for joining. I'm glad we had, what we feel, is a positive story to tell. And our Q3 investor deck has the latest updates, including some key ESG data from our new corporate Responsibility Report that we released last week. So please take a look at that. And as always, if you have any questions, feel free to call Ted. So until we talk again in January, stay safe. Have a good holiday season, and look forward to talking to you soon.

Operator, you can end the call.

[Operator]

Thank you. And thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.