Robert S. Brunn - Ryder System, Inc. Robert E. Sanchez - Ryder System, Inc. Art A. Garcia - Ryder System, Inc. Dennis C. Cooke - Ryder System, Inc. John J. Diez - Ryder System, Inc. J. Steven Sensing - Ryder System, Inc..

Justin Long - Stephens, Inc. Kevin Sterling - Seaport Global Securities Scott H. Group - Wolfe Research LLC Benjamin J. Hartford - Robert W. Baird & Co., Inc. David G. Ross - Stifel, Nicolaus & Co., Inc. Todd C. Fowler - KeyBanc Capital Markets, Inc. Casey S. Deak - Wells Fargo Securities LLC Brian P.

Ossenbeck - JPMorgan Securities LLC Matthew Reustle - Goldman Sachs & Co. LLC.

Good morning, and welcome to the Ryder System Second Quarter 2018 Earnings Release Conference Call. All lines are in a listen-only mode until after the presentation. Today's call is being recorded. If you have any objections, please disconnect at this time. I would now like to introduce Mr.

Bob Brunn, Vice President, Investor Relations, Corporate Strategy and Product Strategy (sic) [Vice President-Investor Relations & Corporate Strategy] for Ryder. Mr. Brunn, you may now begin..

Thanks very much. Good morning and welcome to Ryder's second quarter 2018 earnings conference call. I'd like to remind you 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 economics, 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. This conference call also includes certain non-GAAP financial measures.

You'll find reconciliations of each non-GAAP measure to the nearest GAAP measure in the written presentation accompanying this call which is available on our website at investors.ryder.com. 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; John Diez, President of Dedicated Transportation Solutions; and Steve Sensing, 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 2018 results, discuss the current outlook for our business, and highlight progress on some of our strategic initiatives. Then we'll open 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 $1.42 for the second quarter 2018, up 42%, or $0.42 from the prior year, reflecting strong operating performance and a lower federal tax rate from tax reform. This was above the upper end of our forecast range of $1.20 to $1.30.

Better than expected performance was driven by strong results in our Supply Chain, rental, and Dedicated businesses. SCS earnings benefited from higher volumes and stronger operating results. In FMS, rental demand and utilization were robust and used vehicle results were also somewhat better than expected.

Earnings in DTS reflect better than expected insurance and operating performance. Pre-tax earnings grew by over 20% with increases in all business segments reflecting revenue growth, benefits from cost reduction, and improved used vehicle results.

Sales activity remained robust as we continued the momentum from record 2017 sales and through mid-2018 delivered record sales again, driven by ChoiceLease and Dedicated. We're pleased with our overall double-digit revenue growth benefiting from a strong freight environment and new outsourcing wins.

We also continue to make progress on strategic initiatives that leveraged disruptive trends in transportation to drive longer-term revenue and earnings growth. We saw better than expected volumes from MXD, the e-fulfillment and last-mile service provider we acquired in early April.

We were also pleased to grow our FMS fleet and customer base in the Baltimore area following our tuck-in acquisition of Metro Truck & Tractor Leasing in mid-June.

Second quarter 2018 comparable results exclude a $0.52 charge from tax reform and other tax adjustments, as well as a net charge of $0.08 for restructuring, non-operating pension, and acquisition related cost. Last year's comparable earnings exclude $0.07 of non-operating pension costs and restructuring credits of $0.04.

Operating revenue, which excludes fuel and subcontracted transportation revenue increased by 11% to a record $1.6 billion for the second quarter and was higher in all segments. Both total revenue and operating revenue increased due to new business and higher volumes. Page 5 includes additional financial information for the second quarter.

I'd like to highlight that beginning this quarter we are reporting comparable EBITDA, a commonly used metric to highlight cash generation of our business prior to reinvestments. The calculation of our EBITDA is included in the appendix for your reference.

For the second quarter of 2018, comparable EBITDA was $506 million, up 11% from the prior year, primarily reflecting growth in our contractual businesses and strong rental performance. The average number of diluted shares outstanding for the quarter decreased to 52.6 million shares from 52.9 million last year.

We began repurchasing shares under a new two-year 1.5 million share anti-dilutive repurchase program in February 2018. During the quarter, we bought approximately 62,000 shares at an average price of $68.16.

Excluding pension costs and other items, the comparable tax rate was 27.2% for the second quarter of 2018, significantly lower than the prior year's rate of 37.4%, reflecting a lower federal tax rate from U.S. tax reform. Page 6 highlights key financial statistics on a year-to-date basis. Operating revenue increased 9% to $3.2 billion.

Comparable EPS from continuing operations were $2.33, up 27% from last year. Comparable EBITDA was $960 million, up 8% from last year. The return on capital spread was a positive 10 basis points, up from a negative 10 basis point spread in the prior year.

ROC spread has been impacted by lower used vehicle sales results and related depreciation due to the significant multi-year downturn in the used vehicle market. I'll turn now to page 7 and discuss key trends that we saw in the business during the quarter.

Fleet Management Solutions operating revenue, which excludes fuel, increased 8% from the prior year, driven by growth in all product lines. ChoiceLease increased 6% due to fleet growth and higher rates on replacement vehicles, reflecting their higher cost. The lease fleet increased organically by 3100 vehicles since year-end 2017.

ChoiceLease sales activity remains very robust with sales through mid-2018 exceeding our previous record for sales in any full year. We continue to effectively penetrate the non-outsourced market with around a third of our recent fleet growth coming from customers new to outsourcing.

Beginning this year, we're also seeing growth from customers expanding their fleets due to the strong freight environment, which is a dynamic that we haven't seen in many years.

Given our strong sales year-to-date, we're increasing our full-year forecast for lease fleet growth by another 1000 vehicles to 8500 units, which would be a new record for the company.

ChoiceLease results in the second quarter benefited from fleet growth, reflecting recent record sales, although this was offset by higher depreciation due to residual value changes and higher maintenance costs on certain older model year vehicles. Miles driven per vehicle per day on U.S.

lease power units increased by 1% versus the prior year and continue to run at normal historical levels. SelectCare revenue increased by 7%. The average SelectCare full-service and preventative fleets grew by 3800 vehicles from the prior year, reflecting new customer wins.

Commercial rental revenue was up 17% year-over-year, driven by higher demand and pricing. Global rental demand was up 13%, reflecting a strong freight environment. Global pricing was up 3%. Rental utilization on power units was 79.4%, up by 380 basis points on a 9% larger average fleet.

Used vehicle results for the quarter improved primarily reflecting higher inventory valuation adjustments in the prior year. I'll discuss those results separately in a few minutes. Overall, FMS earnings increased year-over-year, reflecting higher commercial rental and used vehicle sales results. Earnings before tax in FMS increased 7%.

FMS earnings as a percent of operating revenue were 6.7%, down 10 basis points from the prior year. I'll turn now to Dedicated Transportation Solutions on page 8. Total revenue increased 21% and operating revenue was up 7% this quarter due to higher volumes and new business.

Secular trends that favor outsourcing, including a very challenging driver market and tight rate conditions contributed to continued record DTS sales results. Our sales team remains focused on upselling our lease customers to dedicated, which continues to represent a significant source of growth for this business.

In addition, we continue to see strong growth with dedicated services provided as part of a multi-service solution, which is reported in our Supply Chain segment. Dedicated operating revenue within our reported Supply Chain segment grew by 21% for the second quarter, and 15% year-to-date.

DTS earnings increased 25% this quarter due to revenue growth and improved operating performance. Segment earnings before tax as a percent of operating revenue were 8.6% this quarter, up 120 basis points from the prior year. I'll turn now to Supply Chain Solutions on page 9.

Total revenue grew 30%, and operating revenue grew 20% due to new business and higher volumes. Revenue growth also reflects our April 2 acquisition of MXD Group, a provider of e-fulfillment and last mile delivery services for the fast growing big and bulky e-commerce market.

Excluding the revenue from the acquisition, SCS total and operating revenue growth would have increased by 19% and 14% respectively. SCS earnings before tax were up 45% due to revenue growth, and improved operating performance.

In addition, during the quarter, we resolved issues with an underperforming customer account that we've discussed in recent quarters. We expect this account to perform profitably going forward. Segment earnings before tax as a percent of operating revenue were 8.8% in the quarter, up 150 basis points from the prior year.

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

Thanks, Robert. Turning to page 10, year-to-date gross capital expenditures totaled nearly $1.5 billion, up by around $560 million from the prior year. This increase primarily reflects higher planned investments to grow and refresh our lease and rental fleets.

We realized proceeds primarily from the sale of revenue earning equipment of around $200 million. Net capital expenditures increased by around $570 million to nearly $1.3 billion. We are raising our forecast for full year gross and net capital expenditures to reflect our increased ChoiceLease fleet growth forecast.

The new forecast for gross capital is $3.1 billion and our forecast for net capital is now $2.7 billion. Turning to the next page, we generated cash from operating activities of $820 million year-to-date, up 12%. The increase was driven primarily by higher cash-based earnings.

We generated around $1.1 billion of total cash year-to-date, up $90 million from the prior year, reflecting higher operating cash. Cash payments for capital expenditures increased by $565 million to just over $1.4 billion year-to-date.

Company's free cash flow was negative $359 million year-to-date versus the prior year of positive $115 million, reflecting increased net capital spending. Our full year forecast for free cash flow remains unchanged at negative $750 million, due to the timing of cash payments for the increase in gross vehicles.

Page 12 addresses our debt-to-equity position. Total debt of just under $6 billion increased by nearly $570 million from year-end 2017, primarily reflecting higher capital spending.

Debt-to-equity at the end of the second quarter increased 210% from 191% at the end of 2017, and reflects investments in fleet growth as well as our two recent acquisitions. Our balance sheet leverage is toward the low end of our target range of 200% to 250%. Our year-end forecast for balance sheet leverage remains unchanged at 210%.

Equity at the end of the quarter was just over $2.8 billion, in line with year-end 2017, as earnings were offset by foreign exchange and dividends. At this point, I'll hand the call back over to Robert to provide a used vehicle sales update..

Thanks, Art. Page 14 summarizes Q2 results for global used vehicle sales. Used vehicle inventory held for sale was 5,600 vehicles at the quarter end, below the low end of our target range of 6,000 to 8,000 vehicles.

Used vehicle inventory declined significantly year-over-year, reflecting last year's initiative to reduce our used vehicle exposure in a weak market environment. Prior year inventory excludes an elevated number of lease vehicles that were being prepared for sale. However, we no longer have an elevated level in 2018.

Including these vehicles in the prior year inventory provides a more relevant comparison and shows a year-over-year decrease of 2,800 vehicles. Sequentially, inventory declined by 400 vehicles. We sold 4,700 used vehicles during the quarter, up 9% from the prior year, and up 12% sequentially.

Proceeds per vehicle sold were up 5% for tractors, and up 9% for trucks compared to a year ago. This reflects a greater use of our retail sales channel, where we received better pricing. From a sequential standpoint, tractor pricing was down 4% and truck pricing was up 8%.

Compared to peak prices realized in the second quarter of 2015, tractor proceeds were down 25%, and truck proceeds were down 11%. I'll turn now to page 15 to cover our outlook. We're raising our earnings forecast based on our earnings outperformance in the second quarter.

For the second half of the year, we expect continued strong year-over-year improvement in rental, Supply Chain and Dedicated moderately-better than our prior outlook. We're very pleased that the momentum from record lease sales in 2017 has continued into 2018.

Based on continued robust sales activity, we're increasing our organic fleet growth forecast to 8,500 units from the original forecast of 6,500. Given our recent sales, additional upside to this new fleet growth forecast is possible but is contingent on the timing of vehicle deliveries from manufacturers.

Although we continue to exceed our sales expectation in lease, we now anticipate that manufacturer production delays will impact the timing of vehicle deliveries. A portion of these deliveries are likely to be pushed back until later in the year, delaying the revenue and earnings benefit until 2019.

We're forecasting used vehicle pricing to remain generally consistent with recent trends. We anticipate continued strong used vehicle sales volumes with year-end inventory now projected to be at the low end of our target range, positioning us well for 2019.

We continue to expect pricing to benefit from a greater use of the retail sales channel versus the prior year. For the third quarter, we expect a slight sequential improvement in overall used vehicle sales results. In rental, we expect strong demand conditions to continue.

We now anticipate rental fleet growth of 9% for both the full year average and year-end fleet, with 3% price increase. Year-over-year utilization is expected to be up in the third quarter, although to a lesser extent than in the first half due to more challenging, prior year comparisons.

We anticipate double-digit revenue growth in both DTS and SCS for the balance of the year, including the benefits of the MXD acquisition in SCS. Strong earnings growth in DTS and SCS are also expected, driven by revenue growth and operational improvements implemented over the past year.

In SCS, we're in the process of exiting our small non-strategic Singapore operation. We expect this to be complete by mid-2019. For the balance of the year we expect year-over-year pre-tax earnings to be higher.

This reflects growth from contractual and rental revenue, as well as cost reductions, which will more than offset the impact of used vehicles sales, higher depreciation and increased maintenance expense on certain older model year vehicles. We expect FMS margin percent comparisons to inflect positive in the fourth quarter.

With our second quarter outperformance, and an unchanged outlook for the second half of the year, we're raising our full year comparable EPS forecast to a range of $5.62 to $5.82 versus our prior range of $5.45 to $5.70. Our third quarter comparable EPS forecast is $1.55 to $1.65, an increase of 17% to 24%, from $1.34 in the prior year.

The third quarter year-over-year forecast reflects a more challenging prior-year used vehicle comparison. Before we begin taking questions, I'd like to provide you a brief update on the progress that we're making on some of our strategic initiatives.

First, we continue to focus on driving long-term profitable growth and are very encouraged at the momentum from record sales in 2017 has continued into 2018, with record sales year-to-date driven by FMS and DTS.

In addition to benefiting from secular trends driving more outsourcing, we're realizing success from our initiatives to expand the size of our sales team, increase collaborative selling across the organization, and roll out new products. We're particularly pleased with what we expect will be our seventh consecutive year of organic lease fleet growth.

We have, for the second time this year, raised the full-year outlook for lease fleet growth and now expect organic lease fleet growth of 8,500 vehicles. We're pleased to expand our FMS fleet and customer base in the high-growth potential Baltimore area following our acquisition of Metro Truck & Tractor Leasing in mid-June.

Our investments in customer-facing technology continue to pay dividends and enhanced satisfaction with current customers and winning new prospects. During the quarter, we launched RyderGyde, a tool that allows customers to manage fleet activity on a streamlined digital platform.

We expect to continue to add additional capabilities to RyderGyde later this year and over time. In April we announced our acquisition of MXD Group, which we have rebranded as Ryder Last Mile. This strategic acquisition significantly expands our e-fulfillment network and adds new last mile capabilities for the e-commerce big and bulky goods market.

We were pleased with the better than expected volumes during the second quarter and are excited about the significant growth opportunities for this new business for Ryder. We are on track to achieve full-year cost savings expected from our zero-based budgeting process.

We continue to believe there are further opportunities to lower costs and drive efficiencies in the future. Lastly, we're proud to be named among America's Best Employers for the fourth straight year by Forbes Magazine.

Talent and culture is a key foundation for our long-term profitable growth strategy, so we're extremely pleased with this recognition in this area of our business. Slide 18 provides our expectation for 2018 result as compared to our longer-term financial targets as we updated earlier this year.

Our goal is to continue to move forward to move towards these three-year targets over time. All segments are expected to organically reach or exceed their operating revenue growth targets this year. FMS is forecast to beat the target while Dedicated should be on target.

Supply Chain is expected to be well above the target, which includes the MXD acquisition. Earnings before tax as a percent of operating revenue for FMS is expected to come in below the target this year, primarily due to the impact on the used vehicle sales and higher maintenance cost on certain older model year vehicles.

We expect these older model year vehicles to be mostly out of our operating fleet by mid-2019, benefiting maintenance costs after that time and to be largely sold by the end of 2019. Dedicated is forecast to come in just below their target EBT percent while SCS is expected to reach the target this year.

The return on capital spread is forecast to be 10 basis points this year, below our target of 100 basis points to 150 basis points. Again, this primarily reflects the impact from used vehicle sales and higher maintenance costs on certain older model year vehicles.

We're focused on realizing operating leverage on our current maintenance facility network as we grow, lowering maintenance cost through fleet turnover and initiatives, improving used vehicle sales results, expanding our non-asset-based earnings, and continuing cost reduction opportunities to drive ROC to the target range.

Balance sheet leverage is forecast to be in the lower end of the target range, which provides room for capital to support growth and/or additional acquisitions in the near term. That concludes our prepared remarks this morning. At this time, I'll turn it over to the operator to open up the line for questions.

In order to give everyone an opportunity, please limit yourself to one or two questions each. If you have additional questions, you're welcome to get back into queue and we'll take as many calls as we can.

Operator?.

Thank you. Our first question comes from Justin Long with Stephens. Please go ahead..

Thanks, and good morning..

Good morning, Justin..

So maybe I'll start with one on rental. I'm curious if you could share how the rental business performed month to month throughout the quarter? And maybe an update on things thus far in July.

And then also, as we look at some of the truck orders and the strength on that front, more recently, what are you seeing in terms of the competitive landscape in rental and capacity additions? Is that something that we should be thinking about as a risk later this year and into 2019? Or are you not as concerned on that front?.

Let me let Dennis give – take you through the rental as it performed during the quarter..

Yeah, Justin. Just to give you a sense for power demand, we're looking at 13% increase year-over-year in April, 13% in May, 14% in June. In July it's looking even stronger than that..

So, I guess that was the first part of your question.

The second part is really about – you're asking about the competitive landscape in rental and the addition of more vehicles? Is that right?.

Correct.

And just what you're seeing in terms of the competitors adding capacity to that market?.

Yeah, well, there's clearly a shortage of rental vehicles right now. Shortage of vehicles in general. Shortage of rental vehicles. So, I think that all the competition is adding some. We're certainly taking – we've added as you saw, our fleet will be up 9% this year.

But certainly, measured in a lot of ways, if you look at our rental fleet, we're still below the level that we were in 2015. So, our plan is to just grow it over time, proportional to the growth in our lease and be able to keep that – the percent of revenue, if you will, in FMS that comes from rentals keep in that lower end of the 20% to 25%.

So, if you remember, we always say we want to keep rental between 20% and 25% of FMS's operating revenue. We were up in that 25% range in 2015. We're more down now at 20%, 21%. So, I would expect that's where we're going to end the year and be moving in that range.

Dennis?.

Yeah, Justin, I'll add just one other thing. Our lease fleet is up from the end of 2015, the second quarter this year by 9%. And our rental fleet is down 1%. So, when you look at that, we've really got to keep the rental fleet growing proportionally to the lease fleet as we go forward..

That's helpful. And maybe as my second question, I wanted to ask about ChoiceLease. And your commentary about delivery of some of those vehicles getting pushed into next year.

Could you help put some numbers around that? And just for modeling purposes, help us understand how many units were deferred to 2019? And at this point, given the strength in sales you've seen in that market, how much visibility do you have to growth in 2019 in ChoiceLease?.

Justin, it's Dennis. First, let's start with the lead times that we're seeing. So, for tractors normally you'd be looking at a three-month lead time. We're seeing about a seven-month lead time today. And with trucks, you normally see three-months and we're seeing about a four-month lead time driven by the body OEMs.

And what that's translated to is in Q2, we were 900 units below what we expected, in terms of deliveries. And, in Q3, we're expecting that to be another 900 units below what was expected. So, we start to catch up in the fourth quarter. But I can tell you, as we take heavy duty orders today, we're scheduling them out in January..

Right. So, I think that's an important point is that as we're selling, we had – and I don't know if you caught it during the prepared remarks, through the middle of the year, through the middle of 2018, Dennis's team, sales team has sold more than any other full year in terms of leases, ChoiceLease.

So, we had a record six months as compared to any other full year. Then at this point, sales are still extremely strong. And because of the lead times we're really selling into 2019 now. So, it's important to note that these are firm contracts, average life of six years. And the customers are obligated to take the leases.

So, this – we feel very good about the contractual growth, the lease growth as we're going into 2019. I mean we're already – this is unusual. We're already locking in revenue for 2019 and we're only in the middle of 2018..

Great. That's good to hear. Thanks for the time this morning and congrats on the quarter..

Thank you, Justin..

Thank you. We'll now take our next question from Kevin Sterling with Seaport Global Securities. Please go ahead..

Thank you. Good morning..

Good morning..

Good morning, Kevin..

Robert, you talked about your Dedicated growth, and we continue to hear growth across the board in that segment from other carriers.

Where is most of that coming from? Is it new customers? Existing customers? Probably a combination of both? Maybe you could add a little bit color around some of the growth you're seeing in Dedicated?.

Yeah, I'll let John give you a little more color. But it is really across the board. You're in an environment where there's just a capacity shortage and a driver shortage. The driver shortage is not likely to be cured any time soon.

So, it's really created a great environment for Dedicated, not only customers that are converting their private fleet, but I think customers that are going from truckload and freight to now wanting more of a dedicated private fleet.

So, John you want to add to that?.

Yeah, Kevin, two comments on that. Number one, we have seen continued progress with our lease customer base and upselling them to a Dedicated solution. If you look at the number of proposals in our pipeline today, more than half of our pipeline is still comprised of our lease activity upselling to Dedicated. So that's a big part of the story for us.

And then we are seeing broad based growth both from our existing customers as well as new opportunities that we're seeing. If you look at the industries, I think, the industrial sector sees tremendous growth and we're benefiting from that. On the retail side, we're winning new business.

And then if you look at the CPG accounts, we are seeing a healthy pipeline coming from that group as well..

Great. Robert, John, thank you for that color. And second question here, as we look at your lease growth, and I think you said maybe about a third of that is from customers new to the outsourced market.

But maybe – how much of that is from customers who were rental customers and are now converting to a longer-term lease product? Is there any way to measure that?.

Yeah. We don't really provide that stat, but I'd tell you, it is a feeder. Definitely rental is a feeder for our lease business. That's just always – it's an ongoing avenue to pick up new customers.

But I can tell you in this environment, the one source of growth that we're seeing that we hadn't seen in a long time is just existing customers needing larger fleets. Because primarily in the past, most of our growth was from new customers and new wins, either from competition or from new to outsourcing.

But we're actually seeing customers that are existing customers just say, I just need more trucks because I've got more need to move freight. So that's a very promising trend that we're seeing..

Can I just follow-up with that? You probably haven't seen that in a while with existing customers looking to expand their fleet, is that right? This is kind of – it sounds like it's relatively new what you're seeing in that growth?.

That's correct. We probably started seeing that late in last year. And that's really continued. I think some of it is just more freight moving, but another piece is, we are seeing more customers in this type of an environment saying I want to put more on my private fleet as opposed to waiting for a carrier or hoping that a carrier is going to pick up.

So that's also been a benefit I think across the board.

Dennis?.

Yeah, Kevin, I would just add to that, we're also seeing customers who are looking at outsourcing for the first time who will try our maintenance first. We're seeing increased interest for our asset light SelectCare product line.

And obviously, then once they get familiar with Ryder, we're selling them up into our lease product and then ultimately into Dedicated..

Got you. Okay. Well, that's great. I really appreciate all that insight. Thanks so much for your time today..

Thanks, Kevin..

Thank you. We'll now move onto our next question from Scott Group with Wolfe Research..

Hey, thanks. Good morning, guys..

Good morning, Scott..

So, wanted to start with the implied fourth quarter guidance. So, guess it implies higher earnings in the fourth quarter than the third quarter. I think, we've only seen – we had that last year, but I think last year was the only year we've seen that in the last 10 years.

So, what's – what are we assuming that gives us the better than normal third quarter to fourth quarter earnings ramp?.

I think, the key here is the ramp-up of contractual business, whether it's Dedicated, Supply Chain or lease. And if you think about it, if you were flat, we'd probably see more of what you normally see between the third and fourth.

But this contractual business is building on itself, right? So, as you get into the fourth quarter, you're now getting the growth from that piece of it in addition to the regular business – also obviously we expect rental will be strong in both the third and fourth quarter.

But ultimately if you just look at it sequentially, a lot of that is going to come from the contractual parts of the business..

Okay. That makes sense. And then wanted to ask about on the used side, do you have a view on why the proceeds were down sequentially? It felt like we were starting to see some more positive data points for the industry broadly.

And then any update in terms of sort of the initial view on the $30 million to $40 million of residual value and anything on accelerated depreciation for next year?.

Yeah, I would look at the sequential number more as flattish. I mean, it's really the mix of what we sold I think might have been a little different. We're – our view on it is, used vehicle market seems to have stabilized. We're hearing about the uptick on the newer used. We don't sell a lot of newer used.

So, the – it has not made it to – that uptick hasn't made it yet to the vintage of vehicles we're selling. As I mentioned on last quarter's call I would expect at some point that there's a trade down for that. But in the meantime, we're out selling as many of these vehicles as we can in the retail market.

There are buyers because we are moving the volume we need to move. We just haven't gotten the price uptick yet. But yeah, I would really read into this quarter as really being kind of stable market on the used truck side. And that's what we're forecasting for the balance of the year..

And then maybe, Art, if you had anything that – I think, last quarter, you said $30 million to $40 million residuals.

Same number to use? Any change there?.

Yeah, we talked last quarter, you remember, we said $30 million to $40 million around policy. That view hasn't changed. Obviously, on the accelerated depreciation side, we haven't made a final call there. I would just add that in the event that pricing kind of stays the same and that's our expectation, we would likely extend accelerated again.

So combined, we would look at that impact of policy and accelerated next year to be in that $40 million to $45 million range. So, a little bit higher than what it is this year.

The other piece is because we would need – we estimate about a 25%, 30% increase in pricing from these levels to eliminate the need for accelerated depreciation by July of 2019..

But I think, Scott, that's – it's important, I think, to reiterate kind of what we saw this quarter which is, look, even in an environment where the used vehicle market doesn't recover, with the growth that we're getting, and we're seeing in the contractual businesses, we are going be generating earnings growth in the business.

And really kind of trading gains, if you will, in used vehicle for growth from contractual business, which is good. It's what we want. So, we're certainly, you'll see this year, we'll be upwards of 10% pre-tax in earnings. Again, even with that headwind.

So, I would expect this even with continued headwinds next year, if we continue to have headwinds on the used truck side, to still be able to generate some nice earnings growth from – driven by the contractual parts of the business..

Okay that's actually a really good point.

Can I just ask one just quick follow-up on that? Your point about earnings growth continuing next year, is that dependent on continued positive rental growth? Or do you think as that sort of flattens out against tough comps, the growth in the contractual parts of the business are enough to grow earnings next year?.

Yeah, I would expect, as the rental market goes, I would expect some point next year rental to temper and to moderate. But would really be an offset – more than offset by the growth that we're going to get from contractual.

I mean, the amount of lease business that we are piling up in the back half of this year and into next year will start to generate revenue and earnings through 2019.

And in addition to that, all the growth that we're seeing, the strong sales we're seeing in Dedicated and in Supply Chain, those are also – those businesses also have some lead time from when you sign the deal to when you actually get started.

So, a lot of revenue and earnings, I think, really hitting us in the back half of this year and into the beginning of next year, that really should bode well for 2019. Again, even with rental at some point tapering off some. We're certainly not counting on rental to be the driver of earnings for 2019..

Okay, very helpful. Thank you..

Thank you. We'll hear now from....

Actually – one of the things, Scott, I should mention. Let me just add to that. Two other things that we're going to be looking for is obviously continued benefits from our zero-based budgeting programs. So, continued cost control.

And then the last piece that we've been talking about the last few calls is the maintenance cost benefit that we're really expecting in the second half of next year. As you know, the 2012s have been the higher maintenance cost vehicles. Those are costing us $30 million this year in incremental maintenance costs.

Those vehicles will be out of the operating fleet by the middle of next year and we expect what's been a maintenance cost headwind over last several years to now become more of a tailwind starting in the second half of next year. So, again, all those things will help us on the earnings side..

Thank you..

Thank you. We'll hear now from Ben Hartford with Baird..

Hey, good morning. Maybe Robert and Art together just combining some of the comments that you've recently made. When you look toward that 10% to 12% FMS margin, Art, you made a comment about what you need to – or the likelihood of accelerated depreciation.

But to get toward the bottom end of that range, can you get there if used equipment prices continue to be relatively stable, but don't improve materially from here? And if so, what is the pathway to get toward the bottom end of that 10% to 12% FMS target?.

Yeah, Ben, it will be driven by the items we've been talking about, right, the continued contractual growth. The benefits of that helps leverage our maintenance network. That will be there. Focus on cost controls across the business will help FMS. And then obviously a stable rental environment. You kind of need all three of those.

We think with – either with kind of a flattish UVS environment you get to closer to the bottom end of the range. And then the maintenance costs that Robert just referred to should start to benefit us in 2019 and then even in 2020..

Okay.

And to be clear, I mean, obviously these are three-year targets that you introduced at the end of last year, you get to the bottom end of that range under the conditions that you had just said, in kind of 2020 that time period or is this something that might drag on a little bit longer simply because the UVS headwind is a little bit greater than expected?.

It could be. It could be in 2020 but it may drag on into 2021, if we see UVS continue to be kind of flat – flat environment..

That's helpful. And then Robert, we saw really strong growth from the ChoiceLease side.

But given some of the headwinds in recent years with some of the cyclical events, UVS specifically and the narrowing of the spread, is there any new thought given to the growth strategy within ChoiceLease? Perhaps metering it a little bit? And deploying resources and increasing focus on accelerating growth within the non-asset-based segments that you guys had talked about it in prepared remarks.

But just wondering if as you look out over the next few years and the drag that FMS has created here for that spread, if there's any renewed focus on accelerating the growth within DTS and SCS?.

Yeah, we clearly want to grow each of our contractual businesses. I think an important point to make is that in ChoiceLease what we've done on the pricing is we have lowered the residual – the expected sales proceeds at the end of that lease life.

So, we've lowered that residual to generally the current levels that we're seeing today, as opposed to using our normal rolling five-year average. So you can look at ChoiceLease today as being more de-risked than it has historically.

And I'm looking at it, and saying hey, at that level, at that – the de-risked ChoiceLease, I want to sell as much of it as I can. So we're going to continue to do that.

We are looking at different ways to accelerate growth in some of the – in addition to some of the other areas of the business whether it's Dedicated and Supply Chain or some of asset-light businesses in FMS. So, that's something that we're, as we look out to 2019 and 2020, we'll be able to talk a little bit more about how we might do that.

But again, primarily it'll be done organically, maybe just assigning some additional sales resources in those areas..

Okay. That's helpful. Thank you..

Thank you. We'll take our next question from David Ross with Stifel..

Yeah, good morning, gentlemen..

Hey, David..

Start off with a question on Dedicated for John. You've given the driver issues that you guys are probably having challenges seating those trucks just as your customers would be.

What is that leading to in terms of driver pay increases right now? And then how are the contracts set up in terms of pricing throughout the life of the contract so that you're able to cover any of these driver pay pressures we're seeing?.

Yeah, David, so we have seen some of the pressures ourselves. What I'll tell you there, the driver issues that we're seeing are pretty acute in certain parts of the market. In other parts of the market we haven't seen that level of impact where we've had to raise wages to be at margin levels.

Generally speaking, our drivers do receive a competitive wage and in many places they also enjoy great quality of life, which is a key component today to offer to our drivers.

So, from a contract perspective where we have had to raise wages significantly, and significantly I mean above inflation percentages, I will tell you we've had great support from our customers.

And what that looks like is we work with them, we educate them on the market conditions, and we've had a number of accounts where we've been able to pass along the wage increases this year.

So, I will tell you, so far in the first half of 2018 we haven't seen significant impact from the driver environment on the bottom line results because we've been able to work with our customers and get that done..

And then on the Supply Chain side, Steve, you are having conversations with your customers now about the tariffs and trade impact? And what is the level of concern or what are you hearing out there in terms of any impact from what's going on with the tariffs?.

Yeah, David, I think right now really kind of too early to tell is the general theme. We have not seen really any slowdown in the volumes, whether it be out of our operations in Mexico or Canada. So again, really too early to tell, but as you saw in the quarter, our volumes were a big part of our growth number..

Excellent. Thank you..

Thank you. We'll take our next question from Todd Fowler with KeyBanc Capital Markets..

Great. Thanks. Good morning. Robert, I just wanted to come back to your....

Good morning..

Good morning. I just wanted to come back to the comments around rental. When you talk about some moderations, some tapering into 2019, are you basically saying that your rental revenue could be down on a year-over-year basis? Or is it just saying that the utilization levels that you're seeing right now you may not be at that high-70% utilization.

And if you could also remind us how much of the rental business is more transactional versus contract and related to the leasing business, I think that would be helpful, too?.

Yeah, thanks, Todd. I guess as it relates to next year what we're – and again, I don't want to get into next year....

Yeah, understood. But I know that that's....

But I can tell you this, we're not – when I say moderate, we're just not expecting as big an uplift as we had this year. So, you're just not going to have – you may not have the same year-over-year increases you had this year.

But my point – the point I'm trying to make is that even as that may not be growing as much, or even if it was flat, the growth is really going to be coming from the contractual parts of the business. And that's going to be driving the earnings year-over-year. That's what I would expect that will happen. That's what we'll be counting on.

Based on just what we've seen so far this year, we're already pretty well-positioned to I think say that with some confidence. So, that's it. It's not that we're expecting it to (49:51).

If you look at truck utilization forecast for next year, I think we're still looking at a very healthy environment in terms of supply and demand of trucks, certainly through most of next year. So, I would expect that to still continue to be reflected in the environment, not only on the lease sale side but on the rental side.

And, Dennis, you want to give us some color on the customers and rental..

Yeah. Todd, to give you a sense, about 40% of our demand is for lease support and then about 60% is for customers who are – it's not lease support. So that's the rough mix..

Good. That helps on both fronts. And then Robert can you just talk maybe at a high level about the MXD acquisition? And I guess a couple of questions.

Just first from a seasonality standpoint, does that change the cadence of earnings where it's going to be something where we'd see more seasonal strength into the fourth quarter related to that business? And then if you could also talk a little bit about how that business maybe fits and feeds some of the other businesses.

Either does it contribute to rental or Dedicated or something along those lines? And then lastly margin profile versus the Supply Chain segment, I think that that could be helpful. Thanks..

Yeah. I guess, first of all, in terms of the seasonality, yeah, I think this business is more late third quarter, fourth quarter focused. I don't expect that to change the overall Supply Chain seasonality for a while. I think if it becomes a larger part, I would argue it could. But right now, I don't expect that for the next several years.

I think in terms of the profitability of the business, one of the things that we liked about this business is being run profitably. It's got reasonably strong returns. The synergies of this business are primarily around our being able to sell into this business with our existing sales force and the existing customer relationships that we have.

To put it in perspective, this group, or this organization had about three salespeople. And they used that to grow into the level that we talked about, to a couple hundred million. We had 600 salespeople, within Supply Chain we have 40.

So just leveraging that sales force and that capability to sell this service, we think can really bring some nice growth and nice earnings to the company. So those are the highlights. I'll hand it over to Steve. He can give you a little bit more detail around that. But we're really excited about it.

I think it's a part of the business that we expect to really continue to grow and really capitalize on what's a secular trend in this area..

Yeah, I'll just hit a couple of points here. We're three months into the integration. Everything is on track. No issues. Actually, slightly ahead of schedule. So that's very encouraging. I think the operating teams are gelling well from an integration standpoint, collaboration across the other verticals.

As Robert said, we've been through pretty extensive training with our sales team. We've had 40 salespeople as he mentioned across SCS and DTS to go out on site, understand the product offering, the value props, so very encouraged as we look forward. The pipeline in the last three months has doubled.

So, you're seeing their customers interested about our services that we had in SCS as a base. And then the SCS customer is very interested in last mile solution. So, the team is focused right now on that peak execution in late Q3 and Q4. And we're excited about the potential growth..

Great. Thanks for the color this morning..

Thank you, Todd..

Thank you. We'll now move onto our next question from Casey Deak with Wells Fargo..

All right, thank you. Good morning, gentlemen. I just had one question. I wanted to talk a little bit about the composition of your lease fleet and the contracts that you have. So, if you look back onto 2011 was really strong Class A outer (54:09) year.

And how many – like if we're to kind of look at what's coming available for renewal, how does that break out in the fleet and what we should expect here for the rest of the year? So, if I look at kind of your asset management update, it looks like renewals and redeployments are trending much lower than they have the past couple years.

And the used vehicle inventory is also at the low end or below your targeted range.

So, should we expect a large amount of vehicles either coming up for renewal or entering into the used vehicle market over the next six months?.

Yeah, let me answer that part, and then I'll let Dennis give you a little additional color. The simple answer around the number of vehicles coming up for renewal and hitting the used truck market in the next six months is – we expect that to be about the same. We expect to end the year at the bottom end of our target range.

So, we're going to be – we expect the volume coming in is a volume that we're able to handle going out. As we get into 2019, we should see some increase and we've got the capacity to be able to move those units. But yeah, we'll see more of an increase as we get into 2019..

Yeah. I would just add that as a rule of thumb, you've got about 16% of the fleet that's going to term out each year. And, obviously, with the growth that we've been seeing, six, seven years later, you're going to see them coming into the used market. So, you will see an increase that goes with the fleet growth that we've been seeing.

But again, about 16% or so of the fleet terms out..

Okay.

And that will – so what is, I guess, the appetite right now for, I guess, on the customer side, for those contracts that are terming out? Are those vehicles that are up for a renewal? Is the appetite to extend at this point or is it more to get a new vehicle and push for the better maintenance spend and the like?.

It's a mix. But I would say that when you look at the fuel economy that's out there and you look at some of the experience that we've had with the late model 2012s. When you look at those units in particular, customers do want to get out of them and get into some of the newer units.

Now when you start looking at some of the units that have been sold in the last few years, we'll see what their behavior is. But right now, yeah, there's interest in getting out of some of these units that are performing poorly..

Okay..

Let me mention one other thing, as it relates to the volumes for next year, we are expanding our retail capacity within the used truck sales organization. So, we've implemented an inside sales organization now.

So, as you think about those vehicles that are coming in, we're planning that out very well and really have the capacity to be able to move those in the retail market. Not have to rely as much in the wholesale market..

Okay. That's helpful. Thank you. I'll pass it back..

Okay..

Thank you. We'll now take our next question from Brian Ossenbeck with JPMorgan..

Hey, guys, good morning. Thanks for taking the questions..

Good morning, Brian..

So just one follow-up on what you're seeing on the new order deliveries? I'm assuming this happened in prior cycles where you see that get delayed.

How long do you think that needs to go on before you start to see some uptick in the type of used trucks pricing and volume that you sell, as people start to trade down? I understand it's already happening now. But it seems like if you're seeing the order time go out 2x on a new truck, it seems like that might be starting to accelerate here..

Yeah, that's a good question. It's just not an easy answer to that. Because, really, none of these cycles are the same. It's very difficult to kind of lay one over the other. I think this has been a very sharp increase in demand I think for new trucks and for freight. So, I think the behavior here could be a little differently.

I think what you're seeing now is customers who want to buy a new truck that can't because of the delayed deliveries of going and buying newer used trucks.

So that's raising the pricing on the newer used trucks, which as I mentioned last call, I would expect then the people who get priced out of that market because the prices get too high, then trade down to something a little bit older, and we start to see some price uplift there. So it's hard to tell when that's going to happen.

But you would expect it to be a logical progression here over the next couple quarters..

Okay. Appreciate the context..

Okay..

The other question was, just on the first half earnings generally coming at the high end or above expectations, but so far, just kind of bumped out the outperformance into guidance and not really raised the forward view at all.

So, here you've got some delayed growth in terms of the pipeline, but I was just wondering what would we need to see to get more positive on the second half of the year and actually carry forward some of the outperformance we see in the last couple quarters into the back half of this year?.

Yeah, look, I think the key – if you looked at how the way we laid it out in the press release, all parts of the business really outperforming including lease sales. The issue is more the delivery and the timing of when those vehicles hit the ground.

So if there's any – if we're able to accelerate some of that that will clearly be upside for the balance of the year, which we have not baked in. And obviously, things could always perform a little bit better. Rental can do a little bit better. We could get some uplift in our Dedicated or Supply Chain business.

Maintenance cost can always come in a little better. I mean, there's always some areas that can do better. But given the delays that we're expecting on the lease deliveries, we kind of view the balance of the year as maybe not having as much of the uplift capability as we saw in the second quarter.

Also, I would argue that we have built into the second half already, quite a bit of improvement, even from the beginning – the original forecast that we put out. So, that's really it.

It's really just – I would tell you the one single thing that could make that number better is just being able to pull in the delivery of some of these leases that we've already signed..

Okay. Great. Thanks for the details..

Okay..

Thank you. We'll take our next question from Matt Reustle with Goldman Sachs..

Hey. Thanks for taking the question. Just a follow-up on the Dedicated business and the driver shortage.

Do you think that's restricting any ability for you to take on Dedicated business? Or maybe extending the lead time in terms of that business and those contracts at all?.

Yeah, Matt, what I will tell you is we do expect that in certain markets it's going to have an impact.

There are a good number of markets where we haven't seen that be a headwind for us to launch new business but there are a few pockets out there that when we are faced with a new business activity, we work with the customer, set the expectations, and can prolong the launch of that new business without a doubt..

Yeah, I think the key though, Matt, is that if you step back is to cross our business, in general. The more complicated, the more difficult it becomes, the better it is for us, in general.

So, even in this case, it may be harder to get drivers for us, but it's really hard for somebody who doesn't do it for a living to get them, so I'll take that environment all day versus an environment where things are easier..

Yeah, absolutely. It seems like there's quite a few contractual opportunities that will extend into 2019 here and pent-up demand in a few areas..

Yep..

Just one more question on the ChoiceLease pricing. I just want to make sure I understood it properly.

I mean, in terms of your return hurdle, are you essentially pricing contracts higher with the assumption of a lower residual value? Is that the right way to think about that? And when did you implement that change in terms of the pricing?.

Yeah, just so you know, we've all – we've historically always done a five-year rolling average to determine our residual value, or our sales proceeds at the end of the lease term.

At the beginning of this year is when we switched it and said rather than just do a rolling five-year average, let's just bring it to – generally to where we're seeing sales today and we did that. It's primarily a Class A issue, so we did that really across the tractor business and the beginning of the year is when we started that..

Okay. Great. Thank you..

Okay..

Thank you. At this time there are no additional questions. I'd like to turn the call back over to Mr. Robert Sanchez for closing remarks..

Okay, thank you. I think we're just past the top of the hour, so I think we've got all the questions that we had in queue. So, thanks again for getting on the call and I know we've got a pretty active schedule. Bob's got us on the road. So, I'm sure I'll get a chance to see several of you. So, thank you. Have a great day..

Thank you. And that does conclude today's conference. Thank you all for your participation..