Q3 2019 Earnings Call
Please standby.
Good morning, and welcome to the writer systems third quarter 2019 earnings release Conference call.
All lines are gonna 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 Brown, Vice President Investor Relations corporate strategy and product strategy for writer Mr. Brown you may begin.
Thanks, very much good morning, welcome to broader third quarter 2019 earnings conference call.
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 managements current expectations and are subject to uncertainties on 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 was contained in this morning's earnings release, and a 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 web sites and investors Dot rider Dot com.
Presenting on todays call or Robert Sanchez, Chairman, and Chief Executive Officer, Scott Parker, Executive Vice President and Chief Financial Officer.
Additionally, John D. as President of Global Fleet Management solutions, and Steve something President of global supply chain solutions and dedicated transportation solutions for on the call today available for questions. Following the presentation at this time I'll turn the call over to Robert Good morning, everyone and thanks for joining us.
I'm going to start by covering the actions that we took this quarter to lower accounting residual value estimates on vehicles in our fleet.
I'll start with some background on the used vehicle market provide an overview of the change and discuss why we believe this and other actions positions rider well for the future.
Well, then briefly recap our third quarter results and discuss our current outlook for the business.
With that let's begin with page four.
Our value proposition is strong and continues to be driven by long term outsourcing trends in the large transportation logistics markets.
As discussed in our press release today, we expect 2019 and 2020 earnings to be negatively impacted by the continued used vehicle downturn.
In the coming slide I'm going to discuss a change of residual value estimates we made as a result.
Market conditions and the associated increase in depreciation will see in the near term.
The effective this change in estimate however, lowers the likelihood in magnitude of negative earnings impact from used vehicle sales in future years.
We expect returns to organically improve as the depreciation impact from these changes lessons in each quarter going forward and as the majority of underperforming leases written prior to 2014 exit the fleet over the next 18 months or so.
We began to increase rates in our leases starting in 2014.
These leases.
Returns that are expected to be at or above our target will become an increasing part of our portfolio going forward.
We're strongly focused on accelerating initiatives.
To improve return on capital and all options are on the table in order to achieve this key objective.
I'll cover several of our Aro see improvement initiatives, including additional lease pricing actions cost reductions.
Improved execution in our used vehicle sales.
In addressing lower performing accounts.
Our new CFO , Scott Parker is helping in this regard by providing a fresh view of our business model and helping to identify opportunities for improvement.
Additionally, our new President of Fms, John D. is it's also identifying returned enhancement opportunities leveraging has proven finance and operations execution experience.
Turning to page five.
This Georgia. This chart illustrates riders used classy tractor sales prices for.
Original cost over the past 20 years.
As you can see the used vehicle market is cyclical and is driven by changes in supply and demand.
Technology and other factors.
As noted on the chart there was a steep increase in tractor pricing during 2012 in 2015.
Driven by a lack of supply in the market and a change in engine technology.
Following the mid 2015 peak tractor proceeds declined sharply through 2017 to below our accounting residuals supply entered the market in the freight environment slowed.
They used truck your market showed signs of stabilization and improvement during 2018 and early 19.
Based on these trends, we had previously anticipated that market prices and the accounting residual values used for depreciation were moving towards a line.
Thereby reducing the likelihood of losses at the time to sale or the need for additional dupree accelerated depreciation in future years.
Turning to page six as we discussed on the second quarter call. This trend began to change in June when we started seeing saw a softening market conditions for used tractors.
You Stryker conditions continue to worsen in the third quarter. We now expect this downward trend to continue in the near term.
This triggered a review and the lowering of residual value estimates on powered vehicles, which is intended to reflect this downturn and our lowered outlook.
But those that you are less familiar with this area page seven highlight some relevant aspects of how we handle residual value estimates and depreciation.
We really view residual value estimates and the expected useful lives of vehicles at least annually.
Changes in these items may impact our financials in several ways.
First we estimate residual values for vehicles initially at the inception of a lease and then adjust those values over the duration of the lease as needed.
On a number of factors to reflect our long term view of used vehicle sales prices.
This determines the vehicle depreciation which has taken on a straight line basis when the vehicles in operation.
We refer to this as policy depreciation.
Second.
As vehicles approach the end of their useful life. If the market value was expected to be below book value. We may recorded additional depreciation to better align these values within just a patient in anticipation of the upcoming sale.
This adjustment if needed is based on our near term view of market values.
We refer to this has accelerated depreciation.
Finally, when a vehicle is no longer used in operation is moved to our used vehicle sales center.
We recorded a downward adjustment to vehicle to the vehicles value if its expected market value is below its estimated residual value.
At that time.
We do not recorded an upward adjustment if the market value is above the estimated residual value instead those vehicles would see a gain recorded at the time of sale, we refer to this as valuation adjustments.
For your reference the appendix up to this presentation includes some additional detail regarding the company's residual value in depreciation policy.
Page eight no tell these items will be impacted by our new estimates of residual values.
As a reminder, we last adjusted residual values on January 1st in accordance with our standard annual review.
Effective July Onest, we further lowered our long term view of residual values for vehicle is expected to be sold starting in late 2021 to reflect more recent multiyear market trends and our outlook.
This view now excludes the peak pricing year of 2015.
Our view of residual values also now incorporates our expectation for a near term used vehicle downturn.
This revision to our view of long term residual residuals will be reflected as a policy depreciation impact.
We also lowered our near term view of residual values for vehicles expected to be sold through late 2021.
Yes, the made it residuals on these vehicles have been lowered to below policy depreciation levels to reflect our expectations for a continued near term vehicle downturn and increased wholesaling activity.
Revisions to our view of near term residuals are reflected as accelerated depreciation.
The largest impact of these rigid residual estimate changes is for class eight truck.
We also lowered truck residuals, although to a lesser extent to align with market conditions, we saw in the quarter in our revised outlook.
Page nine illustrates the level of our new residual value estimate on tractors for policy depreciation purposes, as compared to historical sales prices.
Yes summit no longer includes the freaks peak sales year.
2015, and incorporates our outlook for a continued market downturn in the near term.
The change in estimate estimated residuals policy depreciation for all powered vehicle types represents an 18% reduction from the prior estimate primarily driven by a reduction in tractors.
This impact will be recognized over the remaining life of the vehicles.
Yes summit used for accelerated depreciation, which is applied to vehicles to be sold through late 2021.
Is that even lower level.
The policy values shown here.
The next page detailed the impact by quarter.
And year of our change in residual estimates on both policy and accelerated depreciation.
As you can see negative impact is most significant in the third quarter of 29 team with declining impacts in each quarter thereafter.
A total of 177 million in additional depreciation was taken this quarter.
This includes 125 million of accelerated depreciation, reflecting our updated view of near term residuals and 52 million policy depreciation impact, reflecting our updated view of long term residuals.
Overall.
Change result in earlier recognition of depreciation in 2019 and 2020.
That would have been recognized in 2021 or later years under our historical estimation practice.
Based on the lower residual value estimates in our current market outlook going forward, we expect to reduce our need for valuation adjustments to markdown vehicles going into the used vehicle centers or for accelerated depreciation beyond the amounts projected through 2020.
Given the impact of this change we're further intensifying our focus on a number of areas to improve return on capital.
Let me provide you a few examples.
First we've taken lease pricing actions to improve returns.
As some of you will recall well before the current changing residual estimates for accounting purposes, we lowered the residuals, we were using for pricing purposes.
Beginning in late 2017, we increased lease rates in several stages on all powered vehicles by reducing residual value assumptions used for pricing purposes.
Tractor residuals used for pricing purposes are currently at historically low levels and we continue to pursue opportunities to further optimize pricing to drive higher returns going forward.
Page 12 provides insight into our expectations for improving lease performance overtime.
This is anticipated because the pricing actions, we've already taken are expected to manifest in higher portfolio returns as the portfolio turns over into more recent model years.
Leases signed prior to 2014 are now expected to result in returns below our target level for two reasons.
First they've been negatively impacted by maintenance costs.
On the early model years of the post 2010 emissions technology.
And then turned out to be higher than anticipated.
Second the vehicles as they come off lease are now.
Expected to be sold in a down market at below priced levels.
The negative BNL impact of these vehicles will largely and by 2020 as these vintages accounts with the majority of the accelerated depreciation now projected.
Leases signed between 2014 in 2017 are expected to yield returns at or above our target.
These leases are benefiting from better than price maintenance costs since we raised pricing related to maintenance cost several years ago.
And we're seeing positive results in that area.
Lisa side. After 2017 are expected to see returns above our target levels.
Addition to better than price maintenance performance. These leases are also benefiting from better overall cost performance and reduced residual value assumptions used for pricing purposes.
As a result of our pricing and cost actions. Since 2014, we expect the performance of our lease portfolio to organically improve over time as a portfolio turns over to more recent and higher returning vintage year.
In addition to these lease pricing actions, we're driving a number of other initiatives to improve return on capital as shown on page 13.
We're expanding our retail used vehicle network capacity in order to maximize price.
This includes expanding our.
Spending into new retail sales locations and increasing our inside sales team.
Additionally, this year, we're launching an upgrade it later this year, we're launching an upgraded used vehicle website, which will expand its capabilities and include facilitating a sales transaction and enhancing the user experience.
We're also exploring structural options to share residual value risk through partnerships and utilization of capital market alternatives.
We remain focused on our core but our cost structure and are encouraged by our cost savings initiatives.
That are ahead of plan that are on or ahead of plans.
Most of the most significant of these initiatives is the multiyear 75 million.
Dollar annual maintenance cost savings initiatives.
We announced earlier this year.
I'm pleased to update you that we're tracking ahead of the 20 million.
Benefit that we had projected for 2019 and expect total savings to exceed our original expectation.
Additionally, we're on track with our zero based budgeting cost savings for this year and anticipate additional savings opportunities in future years.
The team is focused on pruning lower return accounts in assets to drive higher return on capital overtime.
We're also looking to accelerate growth in the higher return supply chain and dedicated business.
I'll turn the call number now to Scott Recondense recap of our third quarter 20 night teen results.
Thanks, Robert turning to page 15 comparable earnings per share from continuing operations was a negative dollar 49 for the third quarter.
Down $3.16 from the prior year.
The loss included $3.01 of higher depreciation expense in noncash item related to the reduced vehicle residual value estimate.
Operating revenue, which exclude feel and subcontracted transportation revenue increased by 5% to a record $1.8 billion.
Page 16 includes additional financial information for the third quarter.
Comparable EBITDA was up 12% from the prior year.
Primarily reflecting the earnings contribution from our growing portfolio of contractual lease dedicated and supply chain business.
The average number of diluted shares outstanding for the quarter was 52.3 million down slightly from the prior year.
We began repurchasing shares under a two year 1.5 million share anti dilutive repurchase program in February 2018.
During the quarter you bought approximately 63000 shares at an average price of $51 in 13 cents.
Excluding pension costs and other items are comparable tax rate was negative 7%, reflecting the impact from residual value estimate changes.
The return on capital spread was negative 140 basis points are are we was 5.5%.
Putting impacts from the residual value estimate changes.
I'll now turn to page 17, and discuss key trends, we saw on each of the business segment.
Fleet management solutions operating revenue, which excludes fuel increased 7% organically with growth and growth in all product lines.
Choice lease revenue increased 9%, primarily due to fleet growth and to a lesser extent.
Higher rates on replacement vehicles.
The lease fleet increased by 2900 vehicles during the quarter and Ben and by 10900 year to date.
Reflecting outsourcing trends and ongoing sales and marketing initiatives.
This also includes a higher number of vehicles awaiting out service for sale due to the increase lease replacement activity this year.
Approximately 40% of the lease fleet growth is coming from customers new to outsourcing as we continue to penetrate the non how source market.
Commercial rental revenue was up 2% driven by higher pricing.
Rental utilization was 74%.
Down from an unusually high 80.4% in the prior year, primarily reflecting lower tractor demand.
We work throughout the quarter and continue to work on adjusting our fleet size to meet current demand levels that are below our original expectations for the here.
Fms earnings before tax showed a loss of $109 million, primarily reflecting higher noncash depreciation expense of $177 million due to the impact of the residual value estimate changes.
As well as lower rental utilization.
Lease results benefited from fleet growth, while both lease and rental benefited from lower maintenance costs.
Turning to page 18.
Used vehicle results for the quarter were down due to lower pricing and increased wholesaling activity.
We saw 5300 used vehicles during the quarter up 29% versus the prior year and up 4% sequentially.
Used vehicle inventory held a 7300 vehicles at quarter end within our target range of seven to 9000 vehicles.
Inventory increased by 1100 vehicles compared to the prior year.
Selecting a greater number of units coming off lease this year as expected.
Used vehicle inventory decreased thousand vehicles sequentially.
Proceeds per vehicle sold were down 8% for tractors and down 10% for trucks compared to a year ago.
Sequentially tractor pricing was down 15% and truck pricing was down 2%.
Turning to supply chain on page 19.
Operating revenue decreased 2% driven by previously announced lost business, partially offset by higher pricing.
Earnings before tax rate down, 5% due to a $3.8 million impact from residual value estimate changes for vehicles used by it supply chain business.
The decline was partially offset by improved operating performance.
On page 20, our dedicated business grew strongly with operating revenue up 11% driven by new business.
Turning to increase due to revenue growth and improved operating performance.
Partially offset by a 7 million dollar impact from residual value estimate changes for vehicles used by Dts.
Turning to page 21 year to date Rocap gross capital expenditures totaled $3 billion.
700 million from the prior year.
This increase reflects higher planned investments to grow and refresh the contractual lease fleet, while rental capex decline.
Year to date proceeds from sales were up $111 million.
Including $43 million from a seller property in the second quarter.
Net capital expenditures increased by $591 million to 2.6 billion, reflecting our contractual lease growth.
Turning to the next page, we generated cash from operating activities of nearly $1.6 billion year to date.
Approximately 300 million or 25%.
Free cash flow was negative negative $965 million year to date.
Down from the prior year of negative 633 million.
Primarily reflecting increased capital spending to grow the lease fleet and normalized levels of lease and rental replacement spending.
Debt to equity increased to 313% due to capital spending any reduction in equity do they increased depreciation from the residual value estimate change.
Balance sheet leverage is above our target of 250% to 300% and is expected to increase to around 330% at year end, primarily due to the earnings impacts from the residual value estimate changes.
Leverage is anticipated to come down overtime as we move past in near term impacts of the residual value change.
So we do not expect the current above target leverage to limit our ability to support profitable growth in our contractual lease business.
At this point I'll hand, it back to Robert to cover the outlook. Thanks Scott.
Our fourth quarter comparably MPS forecast ranges from a loss of three cents to a profit of seven cents and includes a 95 cent impact from the change in residual value estimates.
The impact from a labor strike.
At a customer in our supply chain segment and weaker rental demand combined with elevated vehicle help servicing activity.
Overall, we continue to benefit from long term outsourcing trends and transportation and logistics as well as our sales and marketing initiatives. We expect strong full year sales and our contractual lease dedicated and supply chain businesses, although below last year's record levels.
Slowdown in our transactional commercial rental and used vehicle businesses that we experienced in the third quarter is expected to continue primarily driven by softer freight conditions.
Although the negative impact from our change in residual value estimates will continue to be significant in the fourth quarter. The severity of the impact will be less than in the third quarter and is anticipated to further decline each quarter going forward.
And supply chain revenue as forecasted decline through mid year 2020, reflecting previously announced lost business and then returned to target growth level in the second half of 2020 as new business sold ramps up.
Segment earnings in Q4 are expected to be negatively impacted by the recently ended labor strike at a large writer customer.
By the impact.
Residual value estimate changes on vehicles used in this segment.
These items are anticipated to be partially offset by improved operating performance.
Dedicated revenue growth is expected to decelerate in the fourth quarter to mid single digit levels. Following a record sales year in 2018.
The negative earnings impact from residual value estimate changes on vehicles used in this segment is expected to be largely offset by improving our improved operating performance.
On a full year basis revenue growth should be above target while earnings are expected to be within target.
In fleet management earnings from year to date lease fleet growth will be negatively impacted as we prepare.
For the sale of large number of vehicles coming off lease contracts.
In rental we're anticipating weaker demand to continue particularly for tractors and expect to rightsize the fleet to better align with market conditions by early next year.
Looking ahead to 2020, we expect lease fleet growth to moderate due to lower OEM production.
Clearing of vehicles waiting to be out serviced and our enhanced focus on return on capital opportunities.
Expected higher expected headwinds from used vehicle sales are largely reflected in the revised residual value estimates and related depreciation expense.
Overall, our work to downsize the rental fleet and move off lease vehicles through the out service process will pressure fourth quarter earnings. However, we believe these actions along with the changes in residual value adjustments we've made.
We will better position us for 2020 and beyond.
That concludes our prepared remarks, so operator, please open up the light for questions.
In order to give or take when an opportunity. Please limit yourself to one question each.
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.
And if you would like to ask a question. Please signal by pressing star one on your telephone keypad, if you're using his speakerphone. Please make sure. Your mute function is turned to allow your signal to reach our equipment.
Once again press star one to ask a question.
I'll pause for just the momentum not everyone an opportunity to signal for questions.
We'll take our first question from Ben High for with Baird. Please go ahead.
Hey, good morning, guys.
Hi, good morning, guys.
Robert kind of a thorough review here, but I guess.
And it's fair to one question is as we think about slide 13, and the key areas of Oro see improvement.
The experience within SMS and the lease.
Portfolio issues in recent years.
And then item number five accelerating growth and the higher return businesses as you think about the next.
Michael the next several years how much of it is just.
Celebrating growth in that business as opposed to making a conscious effort to reduce exposure.
Within the Fms side.
And really shifting this business in a meaningful manner toward those higher return.
Segments in other words is just growth on the us CSD tier side that you see.
Or do you intend to reduce the size of this fms business going forward.
Yeah.
Thats a good question I look at the returns that we are seeing in the lease portfolio as you saw over the recent years.
Our pop are good returns and within the targets of what we're looking for so our goal is with this more with this new cost model at the cost model that we have to continued us to look for opportunities to sell business and grow that business. We think it's a good business to be and it's a good return business now having said that.
Part of this process going forward as we are looking to prune.
Accounts potentially that may be underperforming within each of those model years, which that in of itself will will slow growth down some.
As I look at OEM production for next year, that's going to be less certainly than this year. So that's going to Jimmy fewer at bats, or we're going to see some slowing there. So I think what you're going to have some natural.
Slowly of growth in the choice lease business.
And then our our goal is really to find ways to accelerate the growth in that other supply chain and dedicated business by allocating things like allocating more salespeople to it looking for.
Additional opportunities to really enhance the growth levels, we've seen there and improve the overall return to the company.
Thank you I'll get back into queue.
Okay.
And ladies and gentlemen, if you find that your question has been answered you may move yourself from the Q by pressing the Starkey followed by the digits.
We'll take our next question from Scott with Wolfe Research. Please go ahead.
Hey, Thanks morning, guys. So.
Can you can you say on how much of a further decline in used truck pricing you've assumed today I guess I'm trying to understand how how much more of a used truck hit can we face before we need to think potentially about additional policy were accelerated depreciation adjustments and then I.
I guess with that given I wonder what this means for losses on sales so you're sort of doing 70 million of losses. This year give or take what's a reasonable way to think about losses next year similar with this year.
Were smaller maybe with what you've done maybe we're not having losses on sales. This year I don't know how to think about losses, because I think thats separate from what you laid out in slide 10.
Yes, Scott on slide nine we showed you that we're overall, we brought a estimates down 18% across all powered vehicles, but obviously that's much more heavily weighted towards class eight took last night was bigger number.
And then for itself Thats for.
Policy depreciation for accelerated we went beyond that to to a lower number. So if you looked at slide nine you can see that below that acts you're now looking at pretty pretty historically low levels I want to give you exact numbers only because the market.
Conditions and things like that but I think what you're seeing as we've we've taken out.
Big bite at the Apple here at bringing those those residuals down to what we see well we expect really over the next.
18 months or so so.
As your second the second part of your question around gains and losses, yet see the change. We've made here, we expect will incorporate any losses going forward. So we wouldn't expect to see a lot of losses.
Or valuation adjustments in addition to what you're seeing here on accelerated and.
And policy depreciation.
So just some fair you're assuming for the accelerated piece for the next years, you're assuming some further drop in used truck pricing from current levels is that right.
Yes, yes, and we are but you're not where can it go ahead.
But you're not seeing how much many like is it 5% further from here is a 20% closer to one versus the others. Maybe you don't want to say the exact number for market purposes, but like I just want to get a sense like if you.
John .
Now for or not.
Got it if you look at slide slide nine where we had we kind of showed what our policy depreciation is.
Residual galliprant policy depreciation is relative to history, you can see it's actually below where Q3 ended so that gives you an idea of what we're expecting for going forward and where what we're using for accelerated as below that.
So we're we're you know anywhere in that range or it just store adequately low levels.
For prices as a percent of original cost.
Okay that makes sense aren't going to get back in Q.
Our next question will come from David Ross with Stifel. Please go ahead.
Yes, good morning, gentlemen.
Hey, David.
Yeah just.
Question again on the depreciation piece.
In the past, we've talked about not being able to accelerate more depreciation then trucks that are coming off.
Of their lease contract.
Being that their cash flows not impaired and so there is I guess, some accounting disconnect to where you weren't able to change the depreciation policy on the truck that's going to be sold in 2024.
It seems like.
Thats changed and so Thats what this policy depreciation is that you are able to take.
A onetime reset to the whole fleet.
No no no no David this is.
None of this is an impairment charge. These are changes in residual estimates betting that increase the depreciation so.
Celery depreciation number is basically what we're doing as we're taking it every vehicle that we think will be sold through late 2021.
And we are depreciating it to a new lower residual value over the remaining life of that vehicle. So obviously there is you are taking all of that adjustment in residual value over.
A year to year periods are very short period of time.
Policy is basically just saying for the rest of the vehicles that are going to come in after 2021 to be sold we're now seeing rather than waiting until over time, we get there were saying look we believe that the market next year is going to continue to be down. We really look we really created we really look out at what we think those.
Those vehicles will sell for in the future and we've made an adjustment to those residual values based on our on recent multiyear trends in our current outlook and that's that adjustments. So again, it's an adjustment to residual value, which increases depreciation for the remaining life for those vehicles. So it is not is not an impairment of any of those vehicles.
And then.
Really just related question is on the timing so what's.
The reason for a continued.
Change in depreciation both policy and accelerated through 2020, rather than having it all be reflected in Threeq you here.
Well the units have to David has to be amortized over the life of that remaining periods of those contracts. So that this is Dennis.
When you kind of set the new residual for each one of those assets. The numbers that were showing over the next couple of quarters first accelerated is to get those units coming off lease at that time down to the new level that we expect those residual to sell for.
The timing is based on the end of reserve end of term or end of life for those vehicles. So we're we're moving.
We are depreciating those vehicles to the new residual value over the remaining life and in some of those vehicles. The remaining life is two months one month some of it it's 18 months in some of it it's a little further but that's really what what is creating that the red bar. If you will the red part of the bar on on Slide 10, which is the accelerated depreciation.
Okay. Thank you.
Thank you David.
Our next question will come from Todd Fowler with Keybanc capital markets. Please go ahead.
Great Thanks, and good morning.
So thanks for all the additional deep good morning, thanks for the additional detail.
Really just want to make sure that that I'm understanding how you're presenting the information on slide 10.
So if I just look at what you're expecting for the first quarter of 2020.
<unk> million of policy impact an accelerated depreciation.
Is it right to think about that on an apples to apples basis for the first quarter of 19 that what you reported basically the $81 million EBIT Q1 19 would be close to zero under this new with using the new residuals that you've gotten place.
Let me make sure I understand you're saying the eight just let me explain the 80 million first the 80 million is for the fleet that we have today.
That is the that is how much incremental depreciation were going to have for those vehicles in the first quarter of 2020 versus versus where we are today, what we were depreciating I would say before that.
Okay. So maybe another way to ask at Robert then off of the 2020 per Scott if you want to jump in the 250 million that you're showing in slide 10, Thats 250 million or about $3.50 of higher depreciation.
That you'd be expecting in 2020 compared to where you'd be in 2019.
Yes, Thats correct.
On this but it's all paid these all these estimates are based on the portfolio as of the third quarter.
It does not have additional assets that will be coming on.
In regards to subsequent quarters in the fourth in fourth quarter in the first quarter.
Static pool as of the third quarter and that is correct. Okay understood. Yes, Scott that's why I wanted to ask a question about kind of first quarter kind of so for thinking about how you've laid this out what you're basically showing is.
As of today here is the higher depreciation and understanding that there's going to be other moving parts growth within certain parts of the businesses and pieces like that but basically what you're saying right. Now is into 2020 on a full year basis, there is 250 million or about $3.50 of additional depreciation coming.
Correct, yes, okay. Okay, I'll try respect that one I know that other people a lot of questions I'll jump back into line, but thank you again for the time.
Thanks.
Our next question will come from Matt Brooklier with Buckingham Research. Please go ahead.
Hey, Thanks, and good morning.
So.
Wanted to talk about commercial rental.
And your conviction level in terms of being able to right size that.
Obviously had a tougher used truck market, but.
If you could just walk us through maybe the timing around.
Reducing the fleet when do you think you get to your targeted level you know what are some of the challenges that you face.
In a market used truck market it seems.
Incrementally more challenging here thanks, Yeah remember.
Matt There's two things we do we do.
Move some vehicle so the used truck market and we also redeploy some vehicles into leases another.
Application, so I'll let.
John give you a little color on on the actions that were taken to get that rightsized by by early next year.
Yes, so Matt if you look going forward I think Q4, we certainly are looking to sequentially.
Reduce our commercial rental fleet.
Primarily around the tractor equal class, where we've seen the biggest declined and the man and that's in line with what we're seeing from a freight perspective as well as from a choice lease.
Sales activity activity levels. So we.
We expect to really take a good swipe at subtract your class in Q4 that activity will continue into Q1 and you should see in the.
Early part of 2020, we should be back to parity on some of the historical utilization levels loud. If if you look at utilization this year versus last just to remind you Q3 was unusually high last year and we continue to add sleep through Q4, So Q4.
Utilization levels from a comparative point of view or.
Are also being impacted by strong fourth quarter last year.
Okay. That's helpful get get back thank you.
All right. Thanks, Matt.
Well the next we'll go to Stephanie Benjamin with Suntrust. Please go ahead.
Hi, good afternoon, thanks to the question Hi.
Hi, I wanted to go back probably best to just reference slide probably slide nine but I wanted to think Faro I. Appreciate the extra color and also I think just the kind of more color on the impact going forward then what seems to be moralistic approach can you kind of walk through what happens is given to your point.
That it is a site on the cyclical business.
Say Lee start to see used truck pricing in frills I don't think anyone expects that to be anytime soon but as we look to the end of 2020 or 2021, how would that impact the expectations that you've now adjusted for today, just kind of high level I just want it makes I'm thinking about it correctly. Thanks sure. We are as I mentioned we.
Here, we are forecasting a downturn that would last.
Really through call it middle of 2021, so in a pretty pretty significant downturn so any.
Proven upon that would two things would have been one as you would start to see gains in the second thing is we would we would be able to slow down the accelerated depreciation and if it went up we eliminate the accelerated depreciation. So so obviously used truck pricing going up a lot of good things happen.
What we've tried to do here is really lay out our view of what we think.
It's going to happen over the next 18 to 24 month.
It becomes and better than we will will have opportunities to to get some improvement from that.
We do I also as a reminder, I do want to.
Make sure clear is that our policy. So the stuff beyond 2021, we are expecting an uplift, it's where that if you see where that X is on on page nine that's where we're expecting residual values to be out beyond 2021. So we expected to go down from where it is now over the next couple of.
Years, or the next year and a half and then over time to get back up to where that axes. Once it gets beyond that then you've got gains.
You'll have more gains and another good things that can happen.
Great. Thanks, so much.
Thank you Stephanie.
Our next question will come from Justin Long with Stephens, Inc. Please go ahead.
Thanks, and good morning.
So with all the adjustments to residuals I was wondering if you could comment on where you anticipate book value to shake out one all of these adjustments are completed and then Robert a lot of discussion around improving returns at what point do you think you'll get back.
Earning a positive spread above your cost of capital.
I'll take the first one so you look at the end of the third quarter, we end it.
About net $10.5 billion.
In regards to revenue earning equipment.
That that included the charge that we took in the third quarter. So if you kind of look out in the fourth quarter we.
Looking at about another hundred billion and that over the period of time.
2020 to 2025.
About another 500 million. So if you just look at the static book as a third quarter.
That would get you to somewhere between around $10 billion $9.9 billion to $10 billion for the static pool.
Assuming that the market plays out is Robert just went through.
That our assumptions in our kind of estimates are.
Kind of what transpires that kind of where you would be if things get a little bit better than those those numbers would be adjusted.
Estimates would be updated accordingly, same would be as if things got worse than what we expected.
So I guess I guess, just an answer your question on Aro see both at when do we go positive and when do we get to our target.
Obviously got a lot of work to do still on on these are the see improvement initiatives, but assuming that the used truck market behave the way we've outlined here you're really looking at probably 2022, when we really have a lot of the depreciation behind us.
And the impact of these are most of these return on capital spread.
Actions are really starting to take effect I would expect us to start making very good progress, though in 2021.
As we get a lot of the accelerated depreciation behind us.
But again thinking about how do we get back to the targets that we we set out in that we want to get too.
It's probably more of a 2022 again.
I would shoot for positive spread in 2021, and then getting to the targets around 2022.
But again a lot I would tell you a lot of work needs to be done and we've got we've got a lot to do in terms of evaluating and executing on some of these initiatives.
Okay. That's helpful. Appreciate the time.
Thank you Justin.
Next we'll go to sign Ossenbeck with JP Morgan. Please go ahead.
Hey, guys. Good morning, Thanks for taking the question.
Maybe just for the longer term for Everything's talk about the idea of potentially off offloading are sharing some of the risk through their residuals sounds like you took a couple of big steps here too to bring down the value to where you think is is appropriate and maybe conservative but.
What do you think about this in the future is this something thats.
The.
Down at this point in time.
Or is it yet excuse me or is it something you're still exploring in early stages of.
Yes, right, it's something we're exploring.
Clearly working with our OEM partners over time and looking for ways to again, we're not looking at it we're not going to offload the entire residual risk on anyone but certainly being able to hedge some of that volatility I think is important for the model going forward. So we're looking at opportunities to work with the Oems also working into capital.
Markets and with some of the other some other industries have done and I'll, let Scott give you a little more color around that yes, Brian . So if you were working with our bankers, but thats.
You look at some of the other leasing markets there are.
Clearly different alternatives that can be used in financial products that can be used to.
Kind of spread or share risk. So we're currently looking at those and evaluating the cost benefit out of each one of those options and I think we'll be able to share more.
When we get into next year once we kind of finalize some of those evaluations.
Okay. So it sounds like the current outlook doesn't include any assumption of these these initiatives being being put into place or any of these new structures to to offset or mitigate some of the risk.
Correct. Yes. These are these are little longer term.
Okay. Thanks for clarifying.
Thanks, Brian .
We'll take our next question from Kevin Sterling with Seaport Global Securities. Please go ahead.
Thank you good morning, Robert Good morning, Scott Welcome Scott.
One of them Devon.
Robert if I can.
Kind of dig in you know the equipment Thats prior to 2014 were obviously it seems like the biggest issue is it.
If you go to us.
When you go to sell that equipment is that I guess assume this amendment probably would have go through the wholesale channel or would you epicel that equipment overseas. It seems to be that's kind of the biggest issue I would think wareham kind of whereas where values have declined the most.
Yes, no there are retail Kevin there's retail buyers from there is some also some have enough to go wholesale but clearly there are retail buyers for this equipment. The challenge for US I would tell you first and foremost is is really the the original pricing that we had said as we as we moved into this new technology may.
And as costs ended up coming in higher those and those years that it was with us.
Then we had originally.
Priced.
And now we happened to be in it in a down used truck market because it's not just these vehicles where that we're seeing pricing decline is really across the broader market. So there are retail buyers. These these.
Nick will still have like denim and there are secondary buyers, who will buy them and continue to run them, primarily probably lower mileage type of operations as most of our used trucks do but but I got to tell you. The most important part I think I want everybody to know is really our confidence around the leases that weve site since 2014.
Team. This isn't just a modeling exercise we were actually experiencing better than expected maintenance performance on these and even with the residuals that we have now forecasted which are significantly lower we're still looking at at or above our target returns on those so we feel very confident about.
That portfolio of leases, we want to continue to find it an improvement. So we're not done I think every year, we want to find ways to improve the return on that lease portfolio, but we feel very confident about.
The leases that we've signed since 2014 and the returns that were seeing.
Okay.
Gotcha.
Robert Thank you very much appreciate that it's all had thank you.
Thanks, Kevin.
Our next question will come from Barry Haimes with Sage asset management. Please go ahead.
Hi, Thanks, so much time again, just to make sure I'm understanding this correctly if.
If we go back to slide 10, and the Bar chart on the lower half.
Or you've laid out the year by year impact. So in effect. If we took those numbers and did a present value discount. It goes back to the precedence that would be the impairment in terms of less cash you will ultimately receive for disposing of those truck.
Based on assumptions have the right way to think about it.
Yes.
We will you when you're talking about this is all this is doing is we're not discounting back that piece, where we're setting the ultimate residual we expect to sell those vehicles.
And then depreciating to that new.
That new residual level.
And what's right I understand but.
Yes.
But so in effect here.
Bye bye bye those amount when you ultimately dispose of all those trucks.
You will have less cash than under the old assumptions.
Based on the net present value of of those amounts right I mean, you're spreading my thesis.
You're spreading out over time in terms of depreciation put the ultimate cash recovery from the vehicle.
The net present value sum total of those on the after that bar chart is that correct or not.
That's correct, so thats from an accounting perspective, but at the same point time as we showed on the kind of the model year perspective.
What was assumed regarding the return for that price residual.
It also has to be taken into consideration as you look at the book.
Kind of post some of those changes in in the in there.
As recent.
Model years.
Got it thanks very much very helpful presentation. Thanks for the slides I appreciate it.
Our next question will come from Scott Group with Wolfe Research.
Hey, Thanks again for the follow up so I want to go stick on slide 10, and just go back to Todd's question from earlier, because it sounded like you were saying 250 million of higher depreciation now in 20 versus 19 and is that right or are there.
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Okay. I ended the absolute numbers. These are the outlook and offers lose if you looked at a 39 million less but if you look at the run rate by quarter that the $289 billion 20 is in the second half 2019, so on a run rate basis, you're really at less than half.
You get into 2020.
Because these are initiation is on an absolute numbers, okay depreciations, a tailwind now starting in 2020.
Correct depreciation from year over year over year over year, starting in 2020 every year going forward.
And then on slide 12, when you show in 2012, and 13 were below target and now were above target.
I guess, how do we get comfortable here because it feels like they used truck issues have been an issue for older trucks, you're not selling any 2015 trucks, yet so how do we know that you're actually earning above target.
On these trucks.
Well remember we have what we've done is we've lowered the residual assumption to in terms of this analysis, we've lowered the residual assumption to really.
Relatively low levels the levels that we've shown you on.
Slide nine so what we're saying is that even ask those lower residuals, we expect to be above our target returns again, primarily driven by the fact that.
Our maintenance experience has been significantly better and continues to be significantly better than what we price.
Okay. So that's certainly that would be nowhere, we know we know for effect, we're maintenance costs are covenants and at the end. This residual we've lowered the assumption and said even with those lowered assumptions, we're going to we're expecting.
Come in above our target level.
Okay and then just last thing quickly you talk about lower Capex next year any way to put some.
Numbers around that.
Yes look if you look if you look at next year clearly is a few things going on.
But.
As far as Capex, we're expecting theres going to be viewer, there's going be less capex on lease vehicles, just because there's fewer she will be lower OEM production. So I view that it's just fewer at bats provider. So that's going to drive some of it we're going to expect to continue to redeploy equipment you talked about rental additional units. So we'll be redeploy.
Equipment certainly in the first half of next year.
And then our and our ongoing initiatives to improve Aro see whether its pruning accounts or continue to raise price that's going to continue that's going to put a little bit of headwind on it also so I would expect less.
At least capital next year, so with that improved free cash flow levels.
Certainly well beyond where we where we where this year.
Okay. Thank you guys.
Thank you Scott.
We'll take another follow up on that broker with Buckingham Research. Please go ahead.
Thanks, Good morning, just a follow on to the free cash Capex question Im assuming that your spend on commercial rental trucks out will be lower as well.
Hi, yes.
And then this is relatively small in the Grand scheme of things, but could you talk to the impact of SCS from the the GM strike and then what are your expectations for you know.
Our net impact during fourth quarter.
Yeah, we had eight.
But an automotive customer we had a a strike that we dealt with started again tail end up through Q3 and has gone into Q4. Good news is that strike is done but it will impact we do expect it to impacts a Q4.
Enough can bring if it's certainly a contributor to why we're expecting supply chain.
Returns to be below our prior estimate for the fourth quarter. So.
Without giving exact it's a good portion of the of the decline that and obviously the the additional depreciation from the vehicles used and supply chain.
Okay. Thanks for the follow up question.
Alright, Thanks, Matt.
Take another follow up from Manhattan with Baird. Please go ahead.
Yes, thanks on the commercial rental side I know you mentioned that you expect us and some.
Stabilization in the front half of the year helped by a reduction in the fleet size, but what are you assuming from a demand perspective with regard to rental through next year.
Yeah, we still have as we haven't put the plan together, but I.
I would to I would expect on the Ondeck tractor side, we're going to see continued softness as as more vehicles have come into the into the market in the freight environment continues to be saw certainly the first half of the year, maybe picking up in the second half on the truck side I think you'll see certainly with some of the.
E Commerce activity, we would expect us to continue to see some growth.
There. So this is really more story about rightsizing our tractor.
In class eight fleet as we get into into 2020.
But I would also remind you.
We get into 2020 as you saw on slide 10, you're going to have a declining impact from our from the depreciation.
Changed in the residual value changes, we as as we go through the year, so that'll be that'll be a tailwind next year.
We will we will benefit from some of the lease fleet growth this year.
Certainly has a bit as the vintage vehicles from 12 and 13 begin to exit the fleet that should help us also.
We do expect.
Really.
Headed exceed our maintenance cost initiatives. So we're looking for continued success. There next year that could help the helped the story.
We've captured all the qbs headwinds in the depreciation changes that we may.
We're going to continue to leverage our zero based budgeting process.
To minimize overhead costs so.
That's that's a very important tool to have certainly in an environment.
The one that we're in and again, we're going to really sharpen the focus around some of the return on capital improvement opportunities that we have.
Including I would say.
Pruning of lower return accounts in assets in areas that really.
As may not help the topline as much but will help the bottom line and will help the return on capital story.
Okay. Good and then back to the pricing actions that you're taking.
To what extent you feel like you just kind of catching back up to either market levels or recouping price that you, perhaps sacrificed in recent years versus the industry as a whole being able to move price.
Can you provide any perspective in terms of where you think your pricing actions puts you over the past couple of years relative to the market.
Well if you have you if you consider the market to be the other leasing providers I think we don't we're all swimming in the same in the same ocean and and and we work to do that so I.
I think I think we're certainly we're expect weve, what we've done as we've taken the appropriate action, we think we need to take based on our costs and based on our learnings in the market and learning to the business ultimately that will dictate the amount of growth we get.
However, we I would tell you the most important part of the story is that versus ownership story doesn't really change because every thing we have felt around maintenance cost and everything we have felt the route lower residuals and lower used truck market any private owner of a truck is feeling so the value prop.
Versus ownership and the outsourcing story remains just as strong if not stronger than it was.
A year or two ago, because as we've talked to customers today or try to sell their 20 Twelves in 2000, thirteen's and are seeing the prices if they're getting in the marketplace.
This is a business that they may not want to be in anymore and it really creates a great opportunity for us. So certainly I see us remaining very competitive in the lease business.
And in the again versus ownership from a total cost of ownership standpoint. So.
As I said, you'll see some drop off in growth next year, I think as OEM production comes down and as we.
As we do some things around.
Pruning some accounts, but overall the value prop for leasing versus ownership is as strong if not stronger today than it was just a few years ago.
Thanks for talking.
Thanks Ben.
Our next follow up will come from just in line with Stephens Inc. Please go ahead.
Thanks for taking the follow up and I just wanted to put it at though around the residual.
Change GPS or is it a residual impact TPS I think you said this year and the full year guidance. It would have a negative impact of $3. A 95 cents as we look at your assumptions for 2020.
Where do we kind of shake out in terms of EPS impact, it's a little bit task because I guess, we don't have that first half of 19 numbers for policy and accelerated depreciation. So I just wanted to see if you could provide some more clarity on what you think that year over year tailwind in 2020 will look like.
Yes, I mean I'll, let these guys work through it but it's it's.
Certainly the 250 is the depreciation impact that we're expecting in 2020, so 250 million that translate from an EPS standpoint, that'll translates to about $3.58. We gotta look at what's going to what's going to happen exactly with tax rate in all but it's about three threed.
Our and 58 cents headwind versus this year.
It is almost $5.
Okay. That's helpful. So roughly a $1.50 of our year over year tailwind.
Roughly again those are very rough numbers.
As we refine the tax rate and all that for next year, you'll you'll be able to give you better numbers.
Okay, Great Thats, all I had I appreciate it.
All right.
Our next follow up will come from Brian Ossenbeck with JP Morgan. Please go ahead.
Hey, Thank you just a couple quick ones here, maybe one last point on on taxes any way to think about the normalized effective tax rate in past tax rate.
Excluding some of these these write downs that you're looking here.
You're talking about you just talking about that are kind of comparable tax rate.
Right right. If we wanted to look at operations ex the acceleration and the.
The policy impact.
What would you say is maybe a longer term.
Number to use both on the effective and on the cash tax side.
I think the if you kind of look at the comparable effective tax rate is probably would be in.
Pull off these items.
We were tracking before the the estimate change probably in the 20, 526% range.
So as you think going forward that's probably.
Probably.
Pretty good proxy.
And then the GAAP tax rate would would be really impacted.
Just.
From.
Other items that are kind of related to pension and some of the other things that are excluded from the comparable numbers I think thats a general range, probably if you use a 20, 526%.
Okay, and then cash cash taxes.
Lower than that because of the depreciation shields as we've seen correcting me correct, our cash cash taxes would be lower because of the.
Celery depreciation benefits, we get for buying equipment.
Okay. Thanks, Scott.
One last one for you Robert if you can just.
Confirming it sounds like I was going through.
Extensive process here with the update you summarized on slide 10, but I guess as mentioned earlier were accustomed to the usual yearend update with the five year, rolling average and and and that sort of mechanics. So.
Would you expect that based on what you've done today and analysis.
I hear you think that you're you would it be confident they were not going to see any additional adjustments at the end of at the end of the year based on where rates are are trending but you think there's enough.
No no cushion or enough of an impact reflected here.
We won't see.
Another adjustment either up or down.
In three months from now.
Well, Brian I could tell you that we've gone through a very extensive process over the last few months.
Really had a very granular level within the fleet and also looking at all the macro market.
Indicators that we have to try to.
Really come up with our best estimate of what this number is I feel very confident in that estimate right. Now obviously I don't have a crystal ball. So I can't tell you everything thats going to happen in the world.
Used trucks, but I feel I feel very confident in the estimates that we have here in the numbers that we put in front of you.
Okay. Thanks appreciate that.
Our next follow from David Ross with Stifel. Please go ahead.
Yes. Thank you.
Just a question about the hit that SCS and Dts took as a result of the increase in depreciation art I guess, our thought was that they were customers of Fms and Fms customers don't see any change in their cost or expenses and that would all be in Fms issues whats.
What's the issue with Dcs and SCS 'cause that's what they leased all the equipment from Fms, Yeah Dcs in SCS. Both are they are customers about a mess, but they have.
An equipment contribution that is given that has provided.
To each segment to really reflect the profits that are that are brought to rider.
For the business that they have so that does it is that does include it's almost it's almost a really showing you. What these operations would look like if they actually own the equipment.
So since since it's laid out that way when we changed depreciation for that equipment. It is impacting the margins above supply chain indicated it's important to note, though that is eliminated through eliminations. The earnings elimination line for total company. So.
Just wanted to make sure that you're not those aren't incremental to the to the depreciation changes that were reporting in Fms.
Okay and then.
As far as the free cash flow next year.
Talked a little bit about the decline in capex.
How quickly do you think you could get back within your target leverage range.
From a leverage standpoint.
Yes.
Yes look at that that's going to depend.
As.
We get this depreciation the accelerated depreciation behind us here in the next two years and you start till we start to grow the equity line, that's going to be a big driver certainly as we reduce capex that'll also be a driver so probably not in 2020 , maybe late 2020, as we get into 2021, but again lot of thanks.
Still that we've got to review.
But we certainly feel confident that we will be getting back in that range.
As we as we get passed this accelerated depreciation.
Period, and we start really growing growing earnings and growing equity again.
Okay. Thank you.
And there are no additional questions at this time I'd like to turn the call back over to Mr., Robert Sanchez for closing remarks.
Okay, well listen thank you everyone I, we ran a little late today, but given the.
The topics and the changes that we've we've made I wanted to make sure that we answered all your questions. We will be on the road here over the next few weeks. So certainly look forward to the season.
Many of you then and again. Thank you for your continued interest in rider. We're we're glad that we've got this out there clearly not.
Not glad about another used vehicle downturn, but I think.
What you're seeing now is is really our view of the short term and long term our updated view of the short term and long term used vehicle market and we think work. This will put us in a position now to be able to grow earnings from here and and really.
Then on the on the contractual growth that we've had over the last several years.
And ladies and gentlemen sounds like that does conclude today's conference. Thank you all for your participation.