萊德系統 (R) 2014 Q2 法說會逐字稿

Good morning, and welcome to Ryder System, Incorporated second quarter 2014 earnings release conference call.

All lines are in a listen-only mode until after the presentation. As a reminder, if you're using a headset or speaker phone, please pick up your handset before asking your question. Today's call is being recorded. If you have any objections, please disconnect at this time.

I would like to introduce Mr. Bob Brunn, Vice President Corporate Strategy and Investor Relations for Ryder. Mr. Brunn, you may begin.

Thanks very much. Good morning, and welcome to Ryder's second quarter 2014 earnings conference call.

I'd like to remind you are that during this presentation, you'll hear some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances.

Actual results may differ materially from these expectations due to changes in economic, business, competitive, market, political and regulatory factors. More detailed information about these factors is contained in this morning's earnings release and in Ryder's filings with the Securities and Exchange Commission.

Presenting on today's call are Robert Sanchez, Chairman and Chief Executive Officer, and Art Garcia, Executive Vice President and Chief Financial Officer. Additionally, Dennis Cooke, President of Global Fleet Management Solutions, and John Williford, President of Global Supply Chain Solutions are on the call today and available for questions following the presentation.

With that, let me turn it over to Robert.

Good morning, everyone, and thanks for joining us.

This morning, we'll recap our second quarter 2014 results, review the asset management area, and discuss the current outlook for our business. Then I'll open up the call for questions. With that, let's turn to an overview of our second quarter results.

Comparable earnings per share from continuing operations were a record $1.44 for the second quarter of 2014, up from $1.25 in the prior year. This reflects an improvement of $0.19, or 15%. Second quarter comparable results for both years excludes non-operating pension costs.

We beat the second quarter forecast range of $1.35 to $1.40 by $0.04 to $0.09. Our outperformance was driven by better than expected used vehicle pricing and commercial rental performance. This was partially offset by lower supply chain results.

Operating revenue, which excludes FMS fuel and all subcontracted transportation revenue, was up by 6% to a record $1.39 billion for the second quarter. We saw revenue growth in both segments and in all major product lines.

Page 5 includes some additional financials for the second quarter. The average number of diluted shares outstanding for the quarter increased by 1.1 million shares, to 53 million. This reflects the pause of our anti-dilutive share repurchase program last year.

In December of 2013, we announced a new 2 million share anti-dilutive repurchase program and started buying under the program in early February. During the second quarter, we bought 464,000 shares at an average price of $84.06.

Our second quarter 2014 tax rate was 36.9%, which includes the impact of non-operating pension costs. Excluding this item, the comparable tax rate is 37.1% above the prior year of 36%. The increased rate reflects the impact of nondeductible foreign operating losses, resulting in a higher than expected tax rate.

Page 6 highlights key financial statistics on a year-to-date basis. Operating revenue was up 5%, or $2.7 -- to $2.7 billion. Comparable EPS from continuing operations were $2.36, up 15% from $2.06 in the prior year.

The spread between adjusted return on capital and cost of capital narrowed to 90 basis points, down from 110 basis points in the prior year, driven primarily by lower leverage. On a full-year basis, we expect the spread to widen to 100 basis points, which is higher than our previous forecast of 90 basis points. The forecast improvement is driven primarily by higher projected earnings.

I'll now turn to page 7 and discuss some key trends we saw in the business segments during the quarter. Fleet management solutions operating revenue, which excludes fuel, grew by 6%, driven mainly by growth in commercial rental and full-service lease. This is the highest organic revenue growth rate we've seen in FMS in a decade.

Full-service lease revenue increased by 5% due to higher rate -- due to a higher rate on replacement vehicles, reflecting the higher cost of new engine technology, and the growth in the lease fleet. On a year-over-year basis, the lease fleet increased by 2,700 vehicles, including the planned reduction of 800 low margin trailers in the UK. Excluding the UK trailer impact, the lease fleet grew by 3,500 units year-over-year.

Sequentially from the first quarter, the lease fleet was relatively unchanged. This is in line with our second quarter expectation and reflects variability in the timing of lease sales activity.

Following strong new sales in the second quarter we're increasing our outlook for full-year lease fleet growth, excluding UK trailers, to 2,500 vehicles, above our prior forecast of 2,000. This forecast reflects our current view and of course could change based on customer activity during the last half of the year.

Miles driven per vehicle, per day on the US lease power units were up 1% compared to the prior year and have returned to normal historical levels. The average age of our lease fleet began to decline in June of 2012, as a result of higher replacement activity. It continued to improve this quarter and was down by one month sequentially or five months since the second quarter of last year.

Contract maintenance revenue increased 2%, primarily reflecting the implementation of a significant new customer contract signed earlier in the year. Our contract maintenance fleet grew by 2,400 vehicles from the prior year. Contract-related maintenance increased by 9% from the prior year.

On-demand maintenance continued to show solid growth, as we continued to see both strong new sales and increased activity with current customers for this service offering. During the quarter we serviced 6,500 vehicles under on-demand maintenance agreements, a 75% increase from the prior year.

Commercial rental revenue grew 13% driven by improved global pricing and higher demand in North America. The average rental fleet increased by 8% from the prior year and 4% sequentially. We've continued to redeploy surplus and off-lease vehicles into rental in order to meet strong market demand.

Rental utilization on power units was 78.3%, below the prior year of 80.5%, but at a strong absolute level. The decline in utilization for the quarter was due primarily to vehicles out of service, due to maintenance deferred from the first quarter. Global pricing on power units was up 5% for the quarter and in line with our expectations.

In used vehicle sales, we saw strong demand in pricing. I'll discuss those results separately in a few minutes.

Overall, FMS earnings increased due to significantly higher used vehicle sales results, strong commercial rental performance, and better full-service lease results. The earnings impact from used vehicle sales was driven by higher gains realized from increased used vehicle pricing.

Commercial rental performance benefited from stronger pricing and demand environments. Better lease results reflect vehicle residual value benefits and fleet growth. These benefits more than offset the impact from maintenance activity delayed from the first quarter.

Earnings before taxes in FMS increased 28%, reflecting better used vehicle pricing and leverage on revenue growth. FMS earnings as a percent of operating revenue were 12.5%, up 210 basis points from the prior year.

I'll turn now to supply chain solutions on page 8. Operating revenue grew 6% due to new business and higher volumes, with growth in all industry groups. New business primarily benefited dedicated, as well as our high tech and CPG industry verticals. We saw volume improvements in auto, industrial, and high tech.

Operating revenue from dedicated services increased 7%, reflecting continued strong sales activity. Dedicated revenue growth was partially offset by lost business in certain automotive accounts.

SCS earnings before taxes were down 7%. The decrease was driven primarily by higher than expected startup costs on a new international distribution management account. This impacted earnings by almost $4 million in the quarter. Earnings were also impacted, to a lesser degree, by shutdown costs related to a lost automotive business. These negative impacts were partially offset by new business and improved dedicated performance.

Segment earnings before taxes, as a percent of operating revenue were 5.6%, down 80 basis points from the prior year.

Page 9 shows the business segment view of the income statement, I just discussed and is included here for your reference.

Page 10 reflects our year-to-date business results by business segment. In the interest of time, I won't review these results in detail, but I'll jut highlight the bottom line results. Comparable year-to-date earnings from continuing operations were $125.7 million, up 17% from the prior year.

At this point, I'll turn the call over to our CFO, Art Garcia, to cover several items beginning with capital expenditures.

Thanks, Robert.

Turning to page 11, year-to-date gross capital expenditures were around $1.25 billion, up nearly $270 million from the prior year. This increase reflects planned investments in our commercial rental and lease fleets, as well as $40 million for the purchase of our headquarters facility during the second quarter.

We're raising our full-year forecast of gross capital spending by $150 million to $2.31 billion. The increase reflects additional rental capital of $100 million for targeted spending in certain vehicle classes, which are in high demand, as well as for replacement of some rental vehicles used to fulfill lease sales.

The forecast also includes $50 million of higher lease capital related to increased sales activity. We realize proceeds primarily from sales of revenue earning equipment of $277 million, up by $48 million, or 21% from the prior year. The increase reflects higher sales prices per vehicle across all channels.

Given strong used vehicle pricing trends, we're increasing our outlook for full-year sales proceeds to $530 million. We're also forecasting an increase of $25 million in our planned sale lease-back transaction, which should now total $125 million.

Year-to-date net capital expenditures increased by $220 million to $980 million. Full-year net capital expenditures are now forecast at $1.66 billion, up by $60 million from our prior forecast.

Turning to the next page, we generated cash from operating activities of approximately $540 million during the first half, down slightly from the prior year. This decrease was driven primarily by the timing of annual pension contributions and higher working capital needs, partially offset by higher cash-based earnings.

We generated $845 million of total cash year to date, slightly up from the prior year, primarily due to higher sales proceeds, which more than offset lower operating cash flow. Cash payments for capital expenditures increased by about $300 million to $1.26 billion year to date.

Company had negative free cash flow of $410 million year to date, below the prior year by about $300 million. This decrease was driven primarily by planned higher spending on rental and lease vehicles compared to the prior year, and was in line with our plan.

Our full-year outlook for free cash flow is unchanged at negative $300 million. Higher forecasted gross capital spending is expected to be offset by stronger used vehicle sales proceeds, an increase in the sale lease back transaction, and higher cash from operations.

Page 13 addresses our debt to equity position. Total obligations of $4.8 billion increased by about $520 million from year end 2013. Total obligations, as a percent to equity at the end of the quarter, were 245%, up from 226% at the end of 2013.

Leverage is just below the midpoint of our target range of 225% to 275%, and is expected to decline by year end. Equity at the end of the quarter was $1.97 billion, up by $68 million from year end 2013, as increased earnings more than offset share repurchases and dividends.

At this point, I'll hand the call back over to Robert to provide an asset management update.

Thanks, Art.

Page 15 summarizes key results from our asset management area. We continued to reduce used vehicle inventories, which are at the lowest levels in the past two years. Used vehicle inventory held for sale was 6,300 vehicles, significantly down from 9,600 units in the prior year, and 900 units below the first quarter. Used vehicle inventory is in our target range of 6,000 to 8,000 vehicles following higher levels for the past two years due to the lease replacement cycle.

Pricing from used vehicles was strong for both tractors and trucks. Compared to the second quarter of 2013, proceeds from vehicles sold were up 15% for tractors and 16% for trucks. From a sequential standpoint, tractor pricing was up 9% and truck pricing was up 4%.

Pricing benefited significantly, as we've shifted more of our sales to retail instead of wholesale, now that inventories are in our target range. In addition, retail pricing levels also improved versus the prior year, especially for tractors.

The number of lease vehicles that were extended beyond their original lease term increased versus last year by around 200 units, or 6%, but remained below the 2010, 2012 levels. Early termination of leased vehicles declined 11% and remained well below recessionary levels. Our average commercial rental fleet was up 8% versus the prior year and up 4% from the first quarter.

I'll turn now to page 18 to cover our outlook and forecast. Actually, page 17. Our stronger full-year earnings outlook reflects improvements in fleet management solutions, partially offset by lower supply chain results.

Strong performance in both used vehicle sales and rental has continued into early July and we expect these trends to continue throughout the second half. In rental, we increased capacity during the second quarter through redeployment of surplus vehicles.

Given the further strengthening and demand we've seen, we now also plan to add a modest number of new vehicles in the second half. Our full-year average rental fleet is now planned to grow by 5% up from the prior forecast of 4%. The year end fleet will grow by 4%. Our outlook for rental pricing is unchanged, with a 5% increase for the full year.

We continue to expect improvement in our full-service lease results, largely reflecting the benefits of higher residual values and the growth in our lease fleet. We had strong lease sales performance in the second quarter and as a result, we've increased our expectation for full-year fleet growth to around 2,500 vehicles. This outlook reflects our current view and, of course, could change based on customer activity in the second half.

We continue to make progress on our maintenance initiatives and are pleased with the continued decline in our lease fleet age. In contract maintenance, we saw nice revenue in fleet growth this quarter as a result of a large deal signed earlier in the year.

We're also encouraged by the strong market interest in our new products, including on-demand maintenance and natural gas vehicles. While currently a small part of our business, these products can become a meaningful part of our growth rate.

We now expect this year's FMS operating margin to approach pre-recessionary levels of 12%, ahead of our earlier expectations. Part of this is due to strong used vehicle pricing, which doesn't impact revenue, but benefits earnings. Looking ahead, we believe there's further upside to FMS margins, driven by stronger residual values, fleet growth, and other items.

In supply chain, higher than planned startup costs on an international account and to a lesser extent, lost automotive business, including shutdown costs, negatively impacted results in the quarter.

Although we expect the impact of the startup is mostly behind us, SCS performance in the third quarter will continue to be adversely impacted by lost business, as well as sales and marketing and technology investments.

Year-over-year results starting in the fourth quarter are expected to improve due to new business signed over the last few quarters, and a smaller impact from lost business.

Based on our outlook, we're increasing our full-year comparable EPS forecast to a range of $5.50 to $5.60. This is up from the most recent forecast we provided in April of $5.40 to $5.55, and up from the original forecast range in February of $5.30 to $5.45. The newer forecast represents a year-over-year increase of 13% to 15%. Our third quarter comparable EPS forecast is $1.58 to $1.63 versus the prior year of $1.46.

Before we turn to Q&A, I want to mention that we're launching a national brand ad campaign on Friday, designed to raise awareness with senior decision makers about Ryder and the benefits of services we offer.

This is the first time in 20 years that Ryder has undertaken a company-wide campaign like this. We're kicking off the campaign by ringing the closing bell at the NYSE on Friday and with a full-page ad in the Wall Street Journal. Keep your eyes out in select industry and general media for our new campaign, which is one of many initiatives we're undertaking to drive higher rates of outsourcing over time.

That concludes our prepared remarks this morning. At this time, I'll turn the call over to the operator to open up the line for questions. In order to give everyone an opportunity, I'd appreciate it if you'd keep your questions to two each, including any follow-up questions. If you'd like to get back in the queue, we would be happy to take as many questions as time permits.

(Operator Instructions)

The first question today is from Scott Group with Wolfe Research.

Thanks. Good morning, guys.

Hi, Scott.

Wanted to ask first about the rental fleet. You guys are growing that a little bit more, even though I think you mentioned that utilization was down, so wanted to understand the rationale there and how comfortable are you growing the fleet? I know in the past it's created some issues. What are you seeing differently this time that gives you comfort to accelerate that growth?

Yes, I guess, Scott, I would start with we're in a very healthy rental environment right now. Utilization has been very high. The only reason utilization is down is really primarily due to the fact that we had some deferred maintenance from the first quarter because of the weather and it got pushed off into the second quarter. So we had more of those rental vehicles in the shop being maintained and not available to be rented.

So we're seeing a very healthy rental environment. It actually is impacting even some of our lease customers who expect us to have rental vehicles available. We're making a modest increase in the rental fleet in order to meet that demand. So we feel pretty comfortable where we're at.

I think we've also, as you know over the last several years, have implemented other ways of adjusting the fleet, including redeploying units from lease, which we've been doing a lot of this year. This is just on the margin some additional units to help us meet the increased demand.

Yes, Scott, it's also targeted, as I said, at certain vehicle classes. So it's not a broad-based increase across our fleet. It's going to be the classes where we've been seeing the most demand and we see the opportunity to rent those units.

Okay. That makes sense. Then just in terms of leasing fleet, getting some questions on why was it down slightly sequentially from the first quarter, but you're still raising the full-year expectations?

Is that just a timing issue? And then in terms of that 2,500 for the year, is that all based on sales momentum in the first half of the year? Are you assuming any additional sales momentum in the back half? I guess I'm just wondering if there's upside to that 2,500 number.

Well, let me start with the fleet being flat or slightly down this quarter. That is just a timing issue. Sales don't always come in exactly pro rata throughout the year. So you have some ins and outs and you also have business that goes away throughout the year.

So this was in line with what we expected for the quarter, even when we had the 2,000. The 2,500 is primarily due to what we've seen in the first half of the year. We had a very strong second quarter, lease sales quarter. An extremely strong June. It was the highest sales month we've had in the last decade. So that is really what's helping to drive that forecast for the full year.

Still some stuff can happen in the second half. Lead times now are just over three months. So clearly, after you get past this quarter, you're going to run out of time. So we probably still have a little bit more room that things can happen. But things can happen on the upside. Things can happen on the downside. So we think the 2,500 is a good balance of, in order to place a forecast.

Okay. Appreciate the color. Thanks.

Thank you. The next question is from John Barnes with RBC Capital Markets.

Good morning, guys. First, it looked like in the quarter that early terminations trended down again. What's your outlook for looking at your book of business on early terminations for the balance of the year? Should we continue to see that sequential decline?

Yes, they're at pretty low levels. I think you could expect to see that kind of at these lower levels. They really get to the point where they're not very material.

And a lot of that is really a reflection of economies improving some, because usually early terminations could be because of bankruptcies and things that go on -- on the customer side. So, I think it's safe to expect that to continue at these levels.

Okay. And then can you refresh our memory as to how much longer do you have to kind of grind through this Hill Hire trailer issue? And when will that eventually go away in terms of the retirement of that equipment?

It still has probably a few years left because these are long-lived pieces of equipment. But when you say grind, it's really -- it's a grind because we talk about fleet count. Operationally, the margin impact is not very significant and I would say trailers, even the revenue is not as significant.

We still probably got a couple years left of it where we're going to see, we're going to continue to de-fleet some of those units. Again, remember, these are vehicles that came with an acquisition. They were written down by the company that we acquired them from, so they were profitable. They had some profitability when we bought them.

But when it came time to renewal, we never expected that we would be renewing too many of them and that's kind of what we're seeing. Again, grind because we're going to have to talk about them on fleet count, but I wouldn't worry too much in terms of earnings and revenue impact.

Okay. Thanks for your time.

Thank you. The next question is from David Ross with Stifel.

Yes, good morning.

Good morning, David.

On the rental side, how much of that strong demand that you saw in the second quarter and I guess continuing into the third quarter is coming from existing customers. And how much is what I would call the pure renters, who are looking for capacity? And any other color you could add to kind of where that demand's coming from?

I'll let Dennis give you a little bit more color on that. But I think what we've seen in the last -- I would say this. Remember, this started early 2013. We started to see rental really strengthen since the beginning of 2013.

And I would say what we see is a continuation of that trend, in an environment where the economy seems to be picking up a little bit. People are running out and they are renting trucks. Some of those are lease customers. Some of them are not. So we're really seeing it on both ends, with maybe a little bit more on the pure side than on the lease side.

But I would tell you, it's an indication of some economic activity and we see that now really continuing to move in the right direction and continue to strengthen. So, Dennis?

David, this is Dennis. We saw pure rental up double digit in revenue, but we also saw lease support up strong also. And that's really reflective of I think a couple of things. One is strong sales that we're having seeing lease units getting ready to come in and providing support there.

And second, we're seeing a trend, which is interesting, and that is that a lot of these customers who maybe don't want to carry the same number of trucks that they have in the past for excess surge capacity, where they would meet it with trucks that they have in their fleet. They're finding those new trucks to be so expensive that they prefer to go with the rental route.

We're seeing demand come there also. So to answer your question, we're seeing double-digit growth with pure. We're also seeing strong lease support. And we're seeing this phenomena of customers who, in the past have carried excess units for surge capacity, who are now renting from us.

That's helpful. Thanks. And then just one note on the gain on vehicle sales. You talked about proceeds per unit were up 15%, 16%, but units sold were down about 9%.

So I'm trying to kind of get from where you were in gain on sales last year to this year. Seems like the gain on sales came up much more than it should have.

Gain on sale--

You're saying the total amount?

Yes, total amount's up 40% or so, but it doesn't seem, given what's going on in the proceeds per unit, number of units, that it would have been up that much. I just wanted to know if there's something else going on there?

No, it could be book value, but I would probably look more at sales proceeds. If you did the math around the sales proceeds, you see it kind of lines up the way you would expect. Proceeds are just the total dollars we're getting on the sale of the vehicles versus whatever the book value might be at any given time.

And remember, David, when you see proceeds going up like this, you're going to get the benefit ultimately in residuals and lease margin over time.

Thank you very much.

Okay.

Thank you. The next question is from Ben Hartford with Baird.

Good morning, guys. My line got dropped, so if this was covered, I apologize.

When you look at the greater than expected full service lease sales year to date, can you talk about the dynamics both in terms of your success penetrating the private fleet market versus the trend that you're seeing with existing customers?

Are you seeing more of the growth, more of the upside from traction from sales efforts with regard to private fleet conversions, or are you seeing growth, absolute unit growth with existing customers?

Yes, I would probably characterize it this way. Obviously, there's both, right? We're clearly in an environment now where you're seeing the OEMs are building more trucks. And they'll tell you that the vast majority of that is replacement. So the customer who has 10 trucks is still not asking for 11.

What we're getting is we're getting some more activity around customers that need trucks to replace trucks that they, that they -- that are maybe aged. And then we're getting -- we're making progress on some of these conversions. Again, we mentioned it on the script.

But a third of the adds that we had in the fleet count came from conversions. These are customers that were in ownership and are now doing lease.

So these initiatives that we've really been hammering around total cost of ownership, a tool that we put in the hands of our sales people that it really is having some nice success. Some of the sales and marketing efforts, and I talked about briefly, but this ad campaign that we're going to put out there is also to help drive that.

I think we're seeing that continue to play out, along with these macro trends that we've been talking about for a while. Those continue to be key drivers to customers who have to make decisions around the next vehicle that they're going to purchase or lease.

So I would tell you clearly, it's a healthier environment than it was a year ago, from an overall market. But we are certainly making some good progress in a good part of that contribution is from the efforts that we have around converting fleets from ownership to leasing.

Good, and maybe Art, to clarify the comment a moment ago about gains on sale. Should we assume this second quarter run rate through the balance of the year, based on what you're seeing from fundamental standpoint?

And then all things equal, as we look into 2015, net gains on sale should fall, but it would be offset by a lower depreciation expense as residuals presumably would be marked higher. Is that generally correct?

Yes, Ben, I would say if you think about the first half, we've had gains of about $60 odd million year to date. So we're forecasting that kind of range directionally in the second half. So it won't be as high as Q2, but it should be comparable to the first half.

And then to your point, as you look out into 2015, gains, you would think, would come down somewhat. But right now we haven't done all that work. But there will be some offset from around -- from around better values as we sit here today.

Okay. That's helpful. Thank you.

Ben, this is Robert. Another thing to keep in mind as it relates to used vehicle sales, clearly we're in a strong used vehicle market and environment.

And I think what's important to keep in mind is that we are still entering a period where we expect overall inventory of used vehicles to continue to drop, right? Because our holding periods are six to seven years. Today, we are selling 2008s, 2008s, 2009s. As we get into next year, we're going to still have 2009s to sell and 2010s. So you really didn't get a pickup in new vehicles that were produced until 2011 really.

So I would expect used vehicle inventories to continue to tighten over the next couple of years. And that, that bodes well for the market and for the overall pricing environment. So, we'll have to see that all play out, but I think that we're in a robust market, but there's still some room to run here at these pricing levels.

And just to finalize that thought, so you benefit not only from healthy used pricing environment, but also I would imagine from just a leasing services perspective as well. It helps on both fronts within your business.

Absolutely, because certainly all this -- the other thing is all these -- this type of an environment bleeds into our, our residual value calculation.

So as we continue to see these healthy used vehicle pricing years come into that five-year average, our overall residuals that we're able to sustain both from an accounting standpoint, from a pricing standpoint, will also benefit, making our product more and more competitive.

Thank you.

Hey, Ben, it's Dennis. One final thing I would add is when you look at inventory levels down around 6,300, and as Robert said, you expect it to stay there, if not tighten more, we're obviously driving more retail activity as a result. So we'll keep pushing the proceeds up.

That's helpful. Thanks.

Thank you. The next question is from Todd Fowler with KeyBanc Capital Markets.

Great, thanks. Good morning. Congratulations on the quarter.

I guess, Robert, in the prepared remarks, you talked about the FMS margins on a full-year basis getting closer to 12% and kind of getting back to the pre-recession levels.

How do you think about the margin progression going forward? It sounds like that growth's going to be a component on top of that. But do you have an idea of what the cadence of margin improvement can be after you hit 12%? And what are some of the main factors that are going to be driving that?

Well, if you think about it, over the last several years we've been doing 70 to 80 basis points a year. And if you exclude some of the used vehicle sales performance this quarter, that's kind of the clip that we're at.

So I'd expect us to be able to continue to benefit from used vehicle sales performance over the next, certainly the next several quarters at least, if not beyond that. And then I'd expect us to continue to see margin improvement as we grow the top line and we're able to grow the fleet. Remember, we're targeting now 2,500 units in the full-service lease fleet.

We think there's opportunity to go if we crack the code, if you will, on this large non-outsourced market, we could get even well beyond that. So I would say just looking at historicals, you're looking at 70, 80 basis points and, again, the growth rate will dictate what else we can do beyond that.

Right. So, Todd, those are going to be the factors we talked about. Obviously, fleet growth is key. The new products on demand and the like. As well as continuing good residuals and then we got to look at the cost side of the equation also to manage that side of the business.

Okay. So if you see -- if you're able to see let's call it lease fleet growth somewhere in the single digits, the 2% to 3%, and those other variables are kind of held constant, 70 basis points give or take of margin point, is realistic?

Yes, I guess without laying out our 2015 guidance, I think over a longer period of time, yes. I think that those are reasonable.

Everything being equal.

Metrics.

Okay, good. That helps. And then just for a follow-up on kind of the question about the cadence of the lease growth this year. The 2,500 units, I guess is my math correct that you've done 500 organic units year to date, so you've got 2,000 in the back half of the year?

Is that 1,000 per quarter? And then the visibility on that, are those signed leases at this point that you have in place and you just haven't put the assets into service? Or is there other pieces that are factored into that?

Well, there's a few things, right? There are signed leases, yes. We got those. There could be some additional leases that we would expect in the third quarter that could impact -- that are going to impact that number. Now, those could end up being more than what we have in there or maybe less.

And also, what we don't have is lost business. We don't know what customers will be reducing their fleets in certain parts of the country and that could work against it. So there's still some unknowns there that could go on the upside or the downside. But right now, our best estimate is 2,500.

Okay, and is the math right, that it's 2,000 on the back half of the year?

Correct, yes.

Okay.

The math is right, 2,000.

Just lastly, this is just a comment. Any time you guys want to come to Cleveland and see LeBron James, you're more than welcome.

Wow, that hurts.

Wow.

That hurts.

Don't, wait. We're rebuilding. We're rebuilding without him.

Believe me, we've done that. We'll tell you how that ends.

Thank you. The next question is from Thomas Kim with Goldman Sachs.

Good morning, everyone. Want to just ask on the conversion rate from rental to leasing, how is the sort of pace compared to prior cycles? Is there any reason to think that the conversion rate should be any different from prior cycles?

Yes, actually that's a good point. It's something we've been trying to kind of figure out. This environment is different. I think you've had -- we've had an extended recovery period here and a muted recovery from the 2008 recession.

So the rental being sort of the spot or the place that companies go when there's more uncertainty, rental has taken a much longer road up in this recovery than we've ever seen. So it's hard to predict exactly what it's going to do. I think clearly, rental is still running very strong. And this is in an environment where the GDP has not really taken off.

So if -- I would expect if we get into periods where GDP starts to grow at 3%, maybe 3-plus, that's an environment where rentals should really strengthen, not weaken. Because customers are going to have demand for moving product that they won't be able to fill.

So I think the transition of when they decide to go to lease is going to be dictated on more and more on confidence in the economy. I think since the middle of last year, we started to see some improvement in that and lease sales really began to strengthen, as you know, middle of last year. So we continue to see that.

We continue to see that, but I wouldn't say it's at an accelerated clip. We'd look to see is over time, start to see GDP growing a little bit more robustly, confidence in the economy, and that's when you start to get then a larger scale of customers making that transition.

So, Dennis, do you want to add to that?

Yes, Robert. Thomas, I want to the make sure we get definitions right, because we use this term rental to lease in kind of two contexts.

First, we'll talk about an asset management move, where we take our rental fleet and you really look at it as used equipment. And we open that up to lease customers. So you may have a customer who's renting the unit and then you'll have a new lease customer where we'll take that rental unit and lease it to that new customer.

And that's an asset management play where we'll often times backfill that used piece of equipment in the rental fleet, when rental demand is strong. When it's not strong, we won't backfill it and we'll de-fleet the rental fleet. So it's a nice asset management move.

Then you've got the rental customer who's currently renting, who then decides to lease from us. And that in fact has increased year-over-year.

So rental to lease, with an asset management play, has been steady every month. It's pretty consistent in terms of our asset management moves. But the rental customers who then convert to lease has actually increased year-over-year.

That's really helpful. And then just can you comment on the tightness of the trucking market? And to what extent you could actually see maybe upside to the rental rate sort of guidance that you highlighted earlier in the year?

Well, the tightness of the transport market does help us I guess on rental and allows us to see some of that. But again, remember, lot of our customers are on the private fleet side in addition to the transport side.

But tightening there definitely helps private fleets and definitely helps Ryder. We implemented a price increase in rental, Dennis, when was it, end of -- beginning of the second quarter price increase?

Right, correct.

And as you see, that's being reflected in the pricing increase that we've seen. So we expect that to kind of -- there's still a little bit of bleeding that needs to happen. We think that's really going to hold throughout the balance of the year. If we see continued tightening, obviously there could be opportunities for more. But right now, that's sort of what we have in the forecast.

Thanks for the time.

Thank you. The next question is from John Mims with FBR Capital Markets.

Good morning, guys.

Good morning.

So most of my -- the fleet management questions have been answered. But so maybe one for Robert on supply side.

When you look at -- and I understand the startup costs that were in second quarter will bleed over into third quarter and you've got some lost automotive business. But when you look at the pipeline of new business in your division, what's sort of the general lead time on that pipeline?

I mean, is there enough potential new business wins in the third quarter that could offset the startup costs, or is it all any new business you bring in now will be accretive to maybe fourth quarter, but really 2015?

Hi, this is John Williford. First of all, we sold a record amount of new business in the first half and we have a very, very strong pipeline. So we are going to see strong growth eventually.

The lost automotive business we talked about, that came off in June. It was basically two automotive trucking accounts. That came off in June. That will be about a two to three-point headwind. But we have a lot of business coming on.

So you'll see the growth rate dip a little bit in the third quarter, then start to come back in the fourth quarter, and start to get, I would expect to be very strong into 2015. The lead time, it varies by the type of project. We've won a lot of projects in dedicated. It's a little shorter there.

And -- but we've also we're winning a lot of projects in CPG and high tech. And we really have a lot of new business scheduled to come on in the second half of the year, to the extent you'll start to really see the impact by Q4.

Okay. And is that really strong, is that kind of low double digits? Or how should we frame kind of once this has really ramped up in the beginning of 2015?

Well, it's hard to come out with a 2015 forecast right now.

Sure.

It's a little too early for that. But like I said, we've sold more -- last year, we sold a lot of new business. Now we've sold a lot more than that. So we feel very confident about that long-term prospects.

Okay. Stronger than what you've seen in the last few quarters.

Then Art, one for you, maybe just one and a half for you. The leverage ratio you said was going to trend down as the year runs on. Is there incentive or any leverage you can pull to kind of push that towards the higher end of your target range right now?

I would think in this current financing environment that you'd have an incentive to kind of lever up as much as you can in return and boost equity returns. But am I missing something on how fluid that is?

Well, it can move around, John, somewhat. Obviously, our target at the beginning of the year was to get around 230, I think it was. So as we sit here today, maybe a little bit higher than that. We've been buying back more shares than we thought when we entered the year.

Also, the number is subject to the vagaries of pension accounting, as you know. And so right now, pension is probably a negative. The discount rate has dropped 50, 60 basis points this year. So we would expect that could have some pressure on our target leverage, if you will. So right -- we're kind of trying to balance that with where we stand from a free cash flow perspective.

But the old high end of 275 is, given the pension, is not realistic?

Well with, it's still within our target range. I think as we sit here today, we're envisioning more in that 225 to 250 range, in the near term.

Okay, and then on the buyback, and then I'll give it back. But the stock up here near $90 looks like it will likely continue to trend higher.

Any thought on splitting the stock here? You're at all-time highs here, just from a liquidity standpoint, does it make sense to split the stock?

I think right now we're comfortable where we are. It's questionable what that really does longer term for us. We have very much an institutional base of investors, so may not see the value in that for us right now.

Great. Fair enough. Thanks so much.

Alright. Thanks, John.

Thank you. The next question is from Kevin Sterling with BB&T Capital Markets.

Thank you. Good morning, gentlemen.

Good morning, Kevin.

John, you talked a little bit about losing the auto business and the SCS pipeline being full and replacing it. That lost auto business, I think you mentioned two trucking customers.

Was it lower margin business and you guys kind of had maybe okay to see it walk away? Did it go to another mode and the business you're possibly replacing it with, would it be higher margin business? How should we think about that?

Yes, first of all, automotive-dedicated business has a little lower margin on average than our Ryder-dedicated business. These accounts were a little lower margin than average for auto dedicated, if you can follow all of that.

So they were lowish margin accounts that were each unique situations, totally had to do with price. We got to the end of the contract terms on them. They were rebid by, I would characterize as substitute competitors at much lower rates. And these are situations that I don't see repeating.

Anything can I guess happen in the future, but I don't see us having similar risks with other business anywhere in our pipeline.

Okay, great. Thank you. And you guys talked earlier about the increased capital spend on certain commercial rental vehicles.

Could you maybe elaborate a little bit more, what type of vehicles you're seeing the most strength, greatest demand? And then, are you seeing some of this strong commercial rental demand and this type of equipment spill over into lease?

Well, first, let me just clarify. I think it was in the prepared remarks, but I want to make sure everybody got it. That of the $100 million that we're increasing, half of that is really to replace vehicles that went from the rental fleet, as Dennis articulated, went from the rental fleet into a lease customer.

So we're spending some additional money to replace those units that are now running with a contracted lease customer. The other half is really to increase the fleet size. And in terms of the types of vehicles, Dennis, the types of vehicles that we're adding to the rental fleet?

Yes, it's a combination of tractors and trucks. But I will say the tractor demand in particular has been high, but also trucks. As we look at it, earlier in the year we added to the tractor fleet. So to answer your question, Kevin, we're buying trucks, but again, the tractor demand has been high also.

Okay.

It's across the board.

Really across the board.

Okay, great. Thanks for your time this morning.

All right. Thank you, Kevin.

Thank you. The next question is from Jeff Kauffman with Buckingham Research.

Thank you. Hi, guys.

Hi, Jeff.

You know, LeBron plays in New York, too. Come up here and see him.

Two more questions. The stock was down a little earlier on the initial report this morning. It's come back nicely. And I think some of the disconnect is, if I take your comments about the 12% margin in FMS, in theory, that would add about $0.40 annualized to an earnings number.

And if I take John's view on some of these short-term headwinds and logistics, it would still imply earnings almost $0.20, $0.25 higher and yet the guidance is almost flattish. Given that the results were a little bit above what consensus was looking for.

I'm going to probably answer the question myself, but how do I bridge this gap in terms of reconciliation? Now, I know tax rate, if it goes up 100 basis points, that's $0.10 annualized. Tax rate's been running 37%. I know the beginning year guidance was kind of 35% to 36%. Can you help me reconcile the difference here?

Well, I'm not sure--

That's a lot of numbers --

I'm not sure I can reconcile all of those. Let me just reiterate sort of what we're looking at for the second half. We are looking at approaching 12%, full-year, approaching a 12% EBT for FMS, approaching. So you have that right.

In supply chain, as John articulated, in the third quarter we're going to see some headwinds from some lost business in automotive. And so that's going to hurt us year-over-year, the year-over-year comps. As we get into the fourth quarter, we expect that to subside with some of the new business coming on.

So clearly, still -- still some challenges for us versus what we had originally forecasted. But year-over-year comp should look much better. So that's -- the combination of those two things is what's really driving our, the full-year range that we gave.

So I'm not sure if you captured all the pluses and minuses in that, especially on the supply chain side, but that's really what makes up the guidance.

Okay. Should I be using a higher tax rate, just given what we've seen in the first half of the year on the nondeductible losses?

Our full-year tax rate I think starting the year was about 35.7%, I want to say. Right now, we're probably up a little bit. Some of it due to the international losses, but I think full-year, Jeff, we're looking at 36% tax rate.

So you probably want to think about it. We're typically higher in the first half, so we've been 37% the first half. Second half, we're looking in that 35% range.

All right. And second question, again, a thought question. The costs of new vehicles is materially higher than it was a cycle ago. I don't know whether it's 50%, 60%. It kind of depends on what you're buying. That's part of the reason the CapEx has been so high and the free cash flow hasn't really started yet.

You mentioned, okay, our spread is now 100 basis points and our rates are now up almost 3% on full-service lease vehicles. Is that enough to recapture the additional capital you have to outlay for new equipment?

Kind of how much after we deduct residual values over life are you using up? And kind of what type of return do you need to generate to recapture that higher equipment cost over the life of the trucks?

We -- remember, there's another thing in play here. Each year during the six-year lease of a vehicle, there's a CPI increase that's implemented that based on what's going on with CPI. So even though it's a 40% increase in net vehicle investment, the rate by the time it gets to the rest of its life already has built in some additional cost increases that are already being captured in the rate. So that's why you wouldn't expect, I'm going to see a 40% increase.

So the rates that we're seeing, as you might imagine, are appropriate for this type of an increase. Remember the way we do pricing, we run a discounted cash flow on every vehicle and we look at what we think our maintenance costs are going to be.

We build in a residual value. And we look for a positive return and the type of spread that you just articulated. So that's how the numbers fall out.

Okay, guys, thanks, and congratulations.

Thank you.

Thank you. The next question is from Justin Long with Stephens.

Thanks, and congrats on the quarter, guys.

Thank you, Justin.

Robert, I guess first question, I want to ask about the on-demand maintenance business. It seems to be getting a lot of traction. And I know it's a small piece of the pie today, but longer term, where do you envision that operation going?

Is there a longer term target you have in mind, whether it's a certain number of customers or revenue contribution that you're shooting for?

Yes, I'm glad somebody asked about that because there's a lot of exciting things going on there. I'll let Dennis expand on it.

But yes, we view this as a really important part of our growth story going forward. Still a small piece of the total business, but an important part of the growth story. And, again, we haven't really even officially rolled it out. We're still doing some work.

Dennis' team is doing some work behind the scenes to work on process and some technology changes we need to make to do this at a larger scale. We think we'll be done with that by the end of the year, maybe early next year and we'll be in a position to really roll it out more broadly.

But I'll let Dennis give you some of the updates on what we've seen so far this year.

Yes, Justin, I'll give you a number, just to give you a feeling for how it's going. We started the year with about 10 customers. And we told you -- we said about 20 customers by the end of the year. We're currently at 25 customers.

And we're focused on the larger customers who are looking for help with their outsourced maintenance. And when you look at the difficulties, I'll call it the complexities associated with the new truck technology, we can really help these customers out. And so as they're coming to us, what we're doing is making sure that we've got all of our processes set up to handle the transactional nature of this business.

And to your point, we're getting a lot of traction with it. We haven't launched it in a meaningful way, because we're waiting to make sure that we've got everything ready to go in terms of our internal processes where it's not this fixed, monthly dollar amount. It's a pay-by-the-drink nature in terms of the billing process and so forth.

So we're getting all that in place. And I think you're going to see from us, at the end of this year, beginning of next year, a more significant launch. And I think what's most exciting is once customers get a taste of what Ryder can do, what we're finding is that they're looking at, for example, buying fuel from us. They're looking at renting trucks from us.

Frankly, we're starting to see rental demand out of these customers. As they bring their unit in, they need to leave it for a period of time, they're renting trucks from us. And they're asking us to look at potentially doing what we call an on-site maintenance facility for them.

And ultimately, again, as they get a feel, we think it leads to a full-service lease relationship. So we're very excited and there's a lot of traction on the product line.

Okay. That's great. I appreciate it. That's helpful color.

Second question real quick, I know it's been a long call, but could you talk about the number of trucks in your full-service lease business that you feel like -- could make sense in a dedicated contract today?

Yes, we've historically talked about 15% of those vehicles are with customers that have a size that's more applicable to a dedicated. However, could go a little bit beyond that if we expand it to maybe fleets that might be a little smaller. But probably a good rule of thumb would be about 15% of the fleet.

Okay, great. I appreciate the time.

Alright, thank you.

Thank you. The next question is from Matt Brooklier with Longbow Research.

Hey, thanks, good morning. The maintenance that was deferred at FMS from 1Q into 2Q, how much of a headwind was that in terms of margin?

$2.5 million.

So about $0.03 for the quarter.

Okay. And you're caught up on maintenance at this point in time?

Generally we are. There's still a little bit trickling through, but we're generally done with that.

Got you. We've heard more from some of your competitors on the dedicated side regarding driver shortages and just in general across trucking.

But driver shortages hindering A, fleet growth and, B, also pushing up wages. I'm just curious to hear your commentary in terms of how driver shortages here may be impacting your dedicated operations.

I guess a couple points first. The fact that it's getting tougher is good, because more people are going to want to outsource it. So we view that challenge as a positive thing.

We do play in the same market that everybody else does for drivers, so certainly we feel some of that as we go out and recruit drivers. But we feel we're in a great position to do that because we've got a great recruiting network. And we're positioned very well with almost 6,000 commercial drivers that are our employees.

On the wage side, we're probably in a little bit of a different situation, probably more favorable, in that all of our contracts are dedicated. They're tied -- the driver wages tend to get adjusted in agreement with our contract and with our customer. So we don't necessarily just give out -- just give increases and get a squeeze on margin. Certainly over a longer period of time, that's usually passed through.

So I'll let John give you more color around it. But I think that's an important differentiator than you hear from some of the other competitors.

Yes, sure. Absolutely, there's been a structural driver shortage for some time. We expected it to get worse as the economy got stronger and as we got into the summer where there are more construction jobs. And it has gotten worse.

I think as Robert said, this is a good thing for us and it's driven some of this new business that I've talked about. You can't always be 100% sure why someone converts a private fleet, but we're seeing a lot more of it. And a lot of the customers we're talking to, both the new wins and the ones in our pipeline, are talking to us part, at least partly because they're having trouble with drivers.

We've seen our turnover rate tick up a little bit, but it's very low compared to the industry. And it's something we think we're very good at. There's historically been very little profit impact from this, as Robert points out, that we pass it on.

There is a little now, as it's ticked up and there's probably a little noise in our number, like maybe $1 million to $2 million a quarter from the higher turnover, where we replaced drivers with lease drivers who are a little more expensive. But that's something that it's in our numbers and its impact is dwarfed by the positive impact of growth.

Okay. So you -- it's fair to say you feel, given the current environment, relatively confident that you'll be able to keep your turn down, sorry, turnover down, be able to attract drivers? And this driver shortage situation shouldn't be a hindrance in terms of meaningfully growing the dedicated fleet from here?

Yes, the way I think of it, we have to be better at recruiting and retention than our private fleet potential customers and then our competitors.

And if we are, we're going to grow and add value. And so we do a lot of things that are focused on that, being better at recruiting and retention. And then the worse the driver shortage is, really the better for us.

Okay. Appreciate the color. Thanks.

Thank you. Our final question today is from Robert Reitzes with BroadArch Capital.

Yes, hi. Thanks for taking the call. I'll make it easy for you.

If you looking back a year ago and you saw, and you knew business was this good, would that be surprising to you, how good the business is a year ago when you were looking at business?

In other words, from your vantage point, do you think things are a lot better than you thought maybe six months ago to 12 months ago, or about as you predicted?

I think the short answer is things are better than what we would have expected a year ago. Certainly the activity around freight movement and rental has been better than what we expected.

Certainly, you look at the truck OEMs and manufacturers. They're exceeding what they had originally expected in terms of new trucks being built. So the environment in our industry in general is better than what I think any of us expect at the beginning of the year.

And then I would say in addition to that, I think I'm also very pleased with the progress that we're making on the strategic initiatives that we have around getting after these non-outsourced fleets and the non-outsourced supply chain activity, that we feel is really the long-term growth strategy that is going to get us where we need to be.

So, yes, the short answer is that, yes, the environment is better than what we had originally expected.

Thanks for the update.

Okay. Thank you, Robert.

Thank you. I would now like to turn the call over to Mr. Robert Sanchez for closing comments.

Well, great. Well, thank you. I think we're a few minutes past the top of the hour. I want to thank everybody for being on the call.

And I want to, again, remind you that we're going to be launching our new ad campaign on Friday. So be on the lookout for some Ryder ads in the Wall Street Journal, some commercials on the Golf Channel. So this is all part of our effort to get out to the C-suite and make sure people are aware of all the different services that we provide at Ryder and all the ways that we can help businesses grow.

So thanks for everything and have a safe day.

Thank you. This does conclude today's conference. Thank you for joining. You may disconnect at this time.