Ryder System Inc (R) Q3 2022 Earnings Call Transcript

Good morning and welcome to the Ryder System Third Quarter 2022 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, Senior Vice President, Investor Relations and Corporate Strategy for Ryder. Mr. Brunn, you may begin.

Thanks very much. Good morning and welcome to Ryder's third quarter 2022 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 economic, business, competitive, market, political, and regulatory factors. More detailed information about these factors and a reconciliation of each non-GAAP financial measure to the nearest GAAP measure is contained in this morning's earnings release, earnings call presentation, and in Ryder's filings with the Securities and Exchange Commission, which are all available on Ryder's website. Presenting on today's call are Robert Sanchez, Chairman and Chief Executive Officer; and John Diez, Executive Vice President and Chief Financial Officer. Additionally, Tom Haven, President of Global Fleet Management Solutions; and Steve Sensing, President of Global Supply Chain Solutions and Dedicated Transportation, 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. I'm very pleased with this quarter's record earnings, which reflects growth in all three business segments. I'm also excited to update you on the significant progress we continue to make on our strategy to increase core earnings and create long-term shareholder value. I'll begin the call by providing you with a strategic update. John will then take you through our third quarter results, which exceeded our expectations again this quarter. We'll then discuss our outlook and review how we position the business to deliver on our targets over the long term. Let's start on Slide 4. Secular trends, including recent supply chain disruptions and labor challenges, are continuing to drive companies to pursue long-term transportation and logistics outsourcing solutions. As a result of these trends and our initiatives, strong sales momentum has continued and we've realized record contractual sales activity year-to-date, which positions us well for future revenue growth. We're also pleased to report that the lease fleet in North America returned to growth this quarter despite ongoing OEM delivery delays. Our two recent supply chain acquisitions, Whiplash and Midwest Warehouse & Distribution System, continued to perform well and were accretive to earnings. These acquisitions support our strategy to accelerate growth in our asset-light supply chain business. Whiplash significantly grows our e-fulfillment network with scalable e-commerce and omni-channel fulfillment solutions, and Midwest expands our multi-client warehousing offering. During the quarter, we also acquired Baton, a tech start-up which we initially invested in through RyderVentures, our corporate venture capital fund. This acquisition is expected to enhance our product and technology development capabilities. We're excited about the value that this can create for Ryder customers as we build out a suite of products that focus on optimizing transportation and supply chain networks. We generated strong return on equity of 30% for the trailing 12 months, which is above our target and reflects our initiatives and strong market conditions in FMS. We successfully executed on our actions to return Supply Chain and Dedicated to their high single-digit earnings targets, resulting in segment earnings growth of approximately 190% and 150%, respectively. These significant increases in earnings primarily reflect pricing adjustments to address unusually high labor costs that began in mid-2021 and the benefits from profitable new business. We increased our full year 2022 return on equity forecast by one percentage point to 26% to 27% and also increased our full year 2022 comparable EPS forecast. These increases reflect higher results in used vehicle sales and rental. We completed our $300 million ASR in September, retiring 4 million shares at an average price of $74.7 and have existing Board authorization for a 2 million share discretionary program and a 2.5 million share anti-dilutive program. Our strong balance sheet continues to provide us with the capacity to pursue targeted acquisitions and investments as well as return capital to shareholders. We increased our full year 2022 free cash flow forecast by $50 million to $800 million to $900 million to reflect higher expected used vehicle proceeds. The cash flow forecast also includes deferred capital expenditures of approximately $200 million due to OEM delivery delays and $350 million in expected proceeds from the previously announced exit of our U.K. business. We continue to develop and implement customer-facing technologies to differentiate our services and drive profitable growth. As we've been doing for some time now, we would like to highlight one of those technologies on today's call. This quarter, we're highlighting RyderGuide, an innovative customer-facing platform that is bringing significant value to our FMS customers. RyderGuide is a proprietary platform that empowers fleet managers and drivers to engage with Ryder services in a fully digital way. We currently have more than 12,000 active users per month. We're seeing strong growth in usage with a 24% increase in active users compared to last year. RyderGuide is focused on delivering a completely digital end-to-end experience for servicing vehicles from pre-scheduling appointments, self-check-in upon arrival at the maintenance shop and tracking the real-time progress of vehicles through service completion, all within the RyderGuide platform. Bringing real-time and reliable visibility to our customers during two of the most critical customer touch points, namely the in-shop experience and the roadside service experience, has been a key area of focus for RyderGuide. For example, our new digital roadside experience allows drivers to pinpoint their exact location for faster and more reliable deployment of service and enables interactive real-time progress updates for drivers and fleet managers as we get our customers back on the road. We believe RyderGuide creates a new standard for best-in-class fleet management. Our ongoing investments in this technology, combined with our expertise in infrastructure, enables us to provide an industry-leading solution that makes it easier for customers to do business with Ryder. I'll turn the call over to John now to cover third quarter results.

Thanks, Robert. Total company results for the third quarter on Page 6. Operating revenue of $2.3 billion in the third quarter increased 18% from the prior year, reflecting revenue growth in all segments and the supply chain acquisitions. Comparable earnings per share from continuing operations were $4.45 in the third quarter, up from $2.55 in the prior year and reflected higher earnings in all three business segments. Return on equity, our primary financial metric, reached a record 30% for the trailing 12-month period, reflecting ongoing truck capacity constraints in the market as well as continued benefits from our initiatives to increase returns. Year-to-date free cash flow increased to $887 million from $829 million in the prior year, reflecting higher used vehicle sales proceeds, partially offset by higher planned capital expenditures. Year-to-date free cash flow in '22 includes $326 million from the sale of vehicles and properties in the U.K. part of the exit of business. Turning to FMS results on Page 7. Fleet Management Solutions operating revenue increased 4%, reflecting 16% higher rental revenue driven by higher pricing and demand. FMS operating revenue increased globally despite a 4% negative impact from the wind-down of the U.K. business. Rental pricing increased 7% primarily due to higher rates across all vehicle classes. Fleet Management realized pretax earnings of $265 million, up by $79 million from the prior year. $55 million of this improvement is from higher gains on used vehicles sold and lower depreciation expense impact related to prior residual value estimate changes. Improved rental performance also significantly contributed to increased FMS earnings. Rental utilization on the power fleet was strong at 83% on a larger fleet. FMS EBT as a percent of operating revenue was 20.4% in the third quarter and 20.3% for the trailing 12 months, both well above the segment's long-term target of low double digits. Excluding all used vehicle gains in the quarter, FMS EBT percent was still in the segment's low double-digit target range. Page 8 highlights used vehicle sales results for the quarter. Used vehicle market conditions remained strong, reflecting solid freight activity and tight vehicle availability due to continued OEM production constraints. Used vehicle sales proceeds in North America increased versus the prior year and remain above historical averages. On a sequential basis, as anticipated, used vehicle proceeds declined. Tractor proceeds decreased 22% and truck proceeds decreased 11%. During the quarter, we sold 7,500 used vehicles, of which 2,500 were related to the exit of our U.K. business. Excluding the U.K. exit-related sales, used vehicles sold were up approximately 300 vehicles versus the prior year and up 1,000 vehicles sequentially from the second quarter. Used vehicle inventory inclusive of the U.K. was 4,700 vehicles at quarter end, below our target range of 7,000 to 9,000 vehicles. The majority of the 1,100 U.K. used vehicles and inventory at the end of the third quarter were sold in the month of October. Although used vehicle pricing declined sequentially, it remains well above residual value estimates used for depreciation purposes. Turning to Supply Chain on Page 9. Operating revenue versus the prior year increased 49% due to the acquisitions and double-digit revenue growth in all industry verticals, reflecting new business volumes and pricing. Operating revenue excluding acquisitions was up 23%. SCS EBT increased 189%, primarily reflecting higher pricing and cost-recovery initiatives as well as profitable new business. The impact of automotive supply chain disruptions in the prior year and acquisitions also benefited earnings comparisons. SCS EBT as a percent of operating revenue was 7.7% in the quarter, returning to the segment's high single-digit target range. We expect SCS results to continue to benefit from pricing actions, profitable growth, and acquisitions going forward. Moving to Dedicated on Page 10. Operating revenue increased 17% due to higher pricing, increased volumes, and new business. Dedicated EBT increased 149% primarily due to pricing adjustments to address unusually high labor costs as well as new business. DTS EBT as a percent of operating revenue of 8.9% was in line with the segment's high single-digit target and up sequentially from the second quarter. We expect DTS to continue to benefit from pricing actions and profitable growth going forward. Turning to Slide 11. Year-to-date, lease capital spending of $1.3 billion was up year-over-year due to increased lease vehicle replacements for expiring lease contracts. Year-to-date, rental capital spending of $492 million declined versus prior year, reflecting lower planned investments. Our full year 2022 lease CapEx forecast is unchanged at $1.8 billion to $1.9 billion and reflects higher lease replacement and growth capital versus 2021. This forecast also reflects a $200 million reduction in capital expenditures due to the extended OEM vehicle delivery delays that is expected to defer CapEx from 2022 into 2023. In North America, we continue to expect the lease fleet to be up by approximately 2,000 vehicles by year-end, and we're pleased to see the lease fleet return to growth in the third quarter, up by 300 vehicles versus prior year. With the majority of expected lease fleet growth occurring towards the end of 2022, the associated revenue and earnings will primarily benefit next year. Our full year 2022 rental CapEx forecast remains at $500 million, below the prior year with our ending fleet expected to grow by 2% or 700 vehicles. We expect the average rental fleet to be up by 9% or 3,600 vehicles on a full year basis. Gross capital expenditures are expected to be between $2.6 billion to $2.7 billion. We expect proceeds from the sale of used vehicles of approximately $1.2 billion. This number includes $350 million in proceeds related to the exit of our U.K. FMS business and higher proceeds from the sale of used vehicles versus the prior year. Full year net capital expenditures are expected to be between $1.4 billion and $1.5 billion. Turning to Slide 12. We increased our 2022 free cash flow forecast by $50 million to $800 million to $900 million range to reflect higher expected sales proceeds. The forecast also reflects $350 million in expected proceeds from the U.K. exit and $200 million in deferred lease capital expenditures. Our balance sheet leverage is 210% at the end of the third quarter and is below our 250% to 300% target range. We expect leverage to remain below our target range for the balance of the year, providing capacity for targeted acquisitions and share repurchases. We increased our 2022 ROE forecast to a range of 26% to 27%, up from our prior forecast of 25% to 26%. ROE is expected to benefit from continued strength in FMS as well as realizing higher SCS and DTS returns in the second half. I'll turn the call back over to Robert to provide an update on our plans to drive higher core earnings over the cycle and our increased 2022 EPS forecast.

Thanks, John. Turning to Slide 13. At our Investor Day in June, we discussed Ryder's core earnings and the actions we've taken to deliver significantly higher core earnings relative to the prior cycle peak. We also reviewed the initiatives we have underway that we expect will drive core earnings even higher in the future. As a reminder, core earnings excludes outsized gains and rental results that have benefited earnings in this historically strong freight environment. In a more normalized market environment, we expect gains of approximately $75 million versus the estimated $375 million forecasted for 2022 and also expect rental utilization to return to the mid- to high 70s in line with historical averages. As such, we have incorporated these assumptions into our estimate for core earnings. The left side of the slide illustrates the actions we've taken since the prior cycle peak in 2018 to increase core earnings. A key driver of this profitable growth has been the profitable growth in Supply Chain and Dedicated, which has accelerated during this period. In FMS, our maintenance cost-savings initiative continues to generate significant benefit, and we expect to achieve our target $100 million in annualized savings this year. Our lease pricing initiative also continues to drive substantial value, and we expect to achieve an estimated annual benefit of approximately $65 million by the end of 2022 with more to come as the remaining lease portfolio is renewed at higher returns. The right side of the slide describes the actions underway that we expect will increase core earnings in the future. For the past several quarters, we have discussed the pricing and contractual adjustments the team has been implementing to address unusually high labor costs we began to see in mid-2021. As a result of these actions and consistent with our forecast, Supply Chain and Dedicated EBT percent returned to the high single-digit target this quarter. We expect the impact from these pricing actions to carry over into next year with this carryover effect expected to benefit results in the first half of 2023. Profitable new business is also benefiting Supply Chain and Dedicated margins. In FMS, approximately 55% of our lease portfolio has been renewed to date under our lease pricing initiative. An additional 20% has been contracted under the new pricing model and is expected to be in service over the next 12 months or so. We expect an incremental earnings benefit as the remaining portfolio has renewed at higher returns. This initiative is expected to be fully implemented by the end of 2025 with an estimated total annual benefit of $125 million upon completion. Profitable revenue growth is another key driver of higher core earnings. During the third quarter, Supply Chain and Dedicated had double-digit organic revenue growth driven by secular trends in our sales and marketing initiatives, including new products and capabilities. Our strong balance sheet provides us with the capacity to pursue targeted acquisitions and return capital to shareholders. We're pleased with the performance of our two recent supply chain acquisitions, which have contributed to core earnings. We also recently completed a $300 million accelerated share repurchase program. I'm proud of the team's execution on these key drivers of higher core earnings and fully expect these initiatives to generate incremental benefits in the future and position us for higher earnings and stronger free cash flow relative to prior cycles. Turning to Slide 14, we will review our current accounting residual value estimates compared to the historical used vehicle sales proceeds index. As many of you know, we reduced our accounting residuals by about 30% in 2019 and 2020 to manage the risks associated with used vehicle market volatility. The left side of the slide displays our historical truck proceeds, while the right side shows our historical tractor proceeds. Both charts illustrate where our accounting residuals stand in relation to historical and current sales proceeds. For trucks, the accounting residual estimates are at their lowest levels, and for tractors, they are at historically low levels. We have also factored in a downturn in the freight cycle, impacting roughly 15% of our tractors. As depicted in the chart, and as anticipated, used vehicle pricing has started to decrease from its peak, but our accounting residual value estimates remain significantly below current pricing levels. Used vehicle pricing would need to decrease by 35% from Q3 '22 levels to yield $75 million in annualized gains and by 42% to achieve zero annualized gains, assuming all else remains constant. Now moving to Page 15, we are raising our full year comparable EPS forecast to a range of $15.65 to $15.85, an increase from our previous forecast of $14.30 to $14.80, and above last year's figure of $9.58. We are also offering a fourth quarter comparable EPS forecast of $3.18 to $3.38, which is lower than last year's $3.52, reflecting an anticipated decline in used vehicle pricing. The current full year forecast is largely driven by used vehicle sales and rental performance. We expect that the traditionally robust used vehicle sales environment will decline in the near term. Rental market conditions have remained strong thus far in October and are projected to stay strong through the fourth quarter due to OEM production limitations. Our record contractual wins and acquisitions year-to-date in 2022 are supporting our revenue and earnings growth. The lease fleet growth in 2022 is anticipated to primarily enhance earnings in 2023 since this growth is occurring late in the year. Overall, we are satisfied with the favorable trends in outsourcing and the outcomes of our initiatives in sales, marketing, and new product development. We are confident that our ongoing efforts to boost returns and enhance core earnings will help us reach our long-term goals over time. That concludes our prepared remarks this morning. We plan to file our 10-Q this afternoon. Given the extensive material covered today, please limit your questions to one each. If you have more questions, feel free to rejoin the queue, and we will address as many as possible. I will now hand it over to the operator.

We'll take our first question from Jordan Alliger with Goldman Sachs. Please go ahead.

Curious, now that you have your margins on Supply Chain and Dedicated to the ranges that you'd like to see them or your targeted range, can you maybe talk a little bit about the stickiness of those margins should the economy continue to falter or turn down a little bit? Thank you.

Yes. Listen, that's a good question. On the Supply Chain side, as you know, and Dedicated, these are contractual businesses where we have long-term contracts with our customers. So even when there's some volatility in the market, really the margins hold up very well, if you look historically. The one area that we've had some challenges in the past has been around automotive. But I would tell you with the backlog of automotive production that still exists, I would expect, certainly in the near term, that volume to still be pretty strong as we go well into 2023. So, I guess, to answer your question, I expect them to really hold up pretty well even during a slowdown.

We'll take our next question from Scott Group with Wolfe Research. Please go ahead.

So used prices started to fall, but earnings 3Q to 2Q were pretty flat. But now you've got a pretty big drop in the guidance from 3Q to 4Q. So maybe just help explain what's driving 3Q to 4Q? And then is anything changing with that $950 million of normalized earnings if we're raising guidance for this year, does the $950 million come up in your mind?

Yes. No, the $950 million for this year stays the same. It would go up for next year. But this year, really, the beat in the quarter was primarily used trucks and rental. But if you look at the sequential decline in earnings from Q3 to Q4, I'll tell you used trucks, is the biggest driver. Used trucks and rental is more than half of that decline. Then there's also Europe. As we get out of Europe, as you know, we're getting towards the tail end of that. So right now, we've got more cost there than we have the revenue coming in. So, that's a headwind in Q4. And then the rest is really just seasonal declines, I would call it, that are there. But the vast majority of that is used vehicles and a little bit of rental.

Robert, I'm not sure if there's much you can share, but we previously discussed the HG Vora situation. There was also some conversation about Apollo recently. Can you update us on where we stand with all of this, if possible?

Yes. Scott, as a matter of policy, we don't comment on rumors and speculation. As you know, on the HG Vora letter, we determined that the price was not indicative of the value of the Company. And that's really all I have to say on that.

We'll take our next question from Allison Poliniak with Wells Fargo. Please go ahead.

I want to revisit the discussion on RyderGuide. It appears to be a clear efficiency opportunity for Ryder. Although it's still in the early stages, can we consider its impact on a transactional basis in terms of the productivity or efficiencies that might be achieved over time? Any insights on that?

Yes, we are really excited about this development because it is something we've been working on for some time. We have received a lot of feedback from customers and are making improvements based on that input. This will make it easier for customers to engage with Ryder and strengthen those relationships. Now, let me pass it over to Tommy to provide further insights on how this will enhance our efficiency and benefit our customers. Tom, I believe you're muted.

Sorry, turned the wrong device off. Sorry about that. So, I'll just make a comment about the efficiency question. And Robert mentioned one of the recent functionalities that we just put out around the ability to track a breakdown. And if you think about our process previously, during a breakdown event, we track that event via phone calls and to multiple stakeholders within our customer base, which wasn't efficient at all and wasn't a great experience. This now delivering a completely digital experience, kind of eliminates all of those phone calls and back-office functions and gives the customer a much better experience with visibility to what's going on in the event. We view that as a moment of truth for our customers when they're broken down. So, we see it two ways: big benefit for the customer in terms of visibility; and certainly, from an efficiency standpoint in the back office at Ryder, we think will help us as well.

We'll take our next question from Brian Ossenbeck with JPMorgan. Please proceed.

Just wanted to ask more broadly about pipeline for contracts in SCS and Dedicated, where that stands right now? Obviously, there's a lot of uncertainty in the broader marketplace. There's probably a bit of catch-up given all the constraints on OEM equipment and labor and the like. But rates are going up, as you mentioned, to kind of cover some of those costs. Where does that all stand? Maybe you can comment a little bit more on the competition. Because I feel like from time to time, we get some of these competitive contracts that go one way or the other. Are you seeing any of that right now as the demand outlook starts to soften a bit?

Yes, Brian, I also want to mention that our ChoiceLease sales are performing well. We have signed lease agreements that will extend into the third quarter of next year, so much of that business is secured and waiting for trucks to arrive. On the Supply Chain and Dedicated side, as we noted during the call, we’ve achieved record contractual sales year-to-date in those areas, creating a robust pipeline. Now, I’ll pass it over to Steve to provide more insights on the pipeline.

Yes. Brian, as Robert said, I think we had historical pipelines both year-over-year and sequentially this quarter versus Q3. So we're not seeing any softening there. Deal size is up in both Dedicated and Supply Chain, so not seeing any softness right there. I think one key call-out is all industry verticals within Supply Chain grew in the double-digit level. So, team is really hitting it on all cylinders right now.

Okay. I have a follow-up for John. What does this mean for capital expenditures and free cash flow next year as you experience a bit more growth while waiting for the trucks to arrive? Do you expect it to be a flat free cash flow year next year? What are your initial thoughts on that considering the visibility you already have regarding some of this demand?

Yes. Brian, obviously, the visibility we have, especially on the FMS side, we do expect, as we laid out, $200 million of the CapEx to spill into 2023. So we do expect higher levels of CapEx going into next year, if you think about the lease replacement and growth activity that's happening in FMS. And what we have said previously, although we haven't really given any guidance for next year yet, we have kind of signaled towards a flattish free cash flow environment for next year, but it's still a little bit early to call that. So that's the direction we have.

We'll take our next question from Todd Fowler with KeyBanc Capital Markets. Please go ahead.

John, following up on your comment, when you mention flattish free cash flow for next year, are you referring to being flat to the $800 million to $900 million guidance this year or something else? I would think with proceeds decreasing, yes, please continue.

Yes. So just to clarify, the flattish environment, we're talking kind of a break-even free cash flow when we say flattish there. So, we do expect used vehicle proceeds to come down, as you said, from the record levels we're enjoying this year. And then you're going to have some uptick in the CapEx spend level, which is going to compress that free cash flow number.

Right. We would expect next year to be back in a growth mode in lease, plus you've got the carryover of some of the CapEx from this year. So yes, I think a breakeven of around zero free cash flow is probably the best estimate right now.

Okay. That helps. And I apologize, that wasn't my original question, so I get another one, just to follow up to the response there. When you think about the lease fleet growth being back-end loaded and also the pricing initiatives on the lease side, and Robert, I think you gave some quantification for kind of the annual target. But is there a way to sensitize what the lease fleet growth that's already been booked in '22 and the contracted pricing actions could equate to as we get into '23? Kind of where are you starting off just with kind of already EPS contribution that you have visibility to from the lease signings and the contract pricing?

Yes. We're starting with a growth of 2,000 units in our fleet in the fourth quarter, and the benefits from that will carry into next year. We also anticipate further growth next year. Regarding our target lease fleet growth, we expect to be at or exceed the top end of that range next year due to delays in acquiring lease vehicles. Looking ahead to next year, the main factor driving improved earnings is an increase in core earnings. We expect our core earnings to rise from the $950 million we discussed today, primarily due to Supply Chain and Dedicated achieving target margins for the full year, whereas this year we'll only see half a year's impact. The share repurchase we conducted will also provide a benefit next year since it will not contribute for a full year. We're looking at growth in leases, Supply Chain, and Dedicated all contributing to higher core earnings. Additionally, the lease pricing initiative will play a role in this growth. There may be some offsets from overhead costs and strategic investments. Overall, we predict core earnings will surpass the $950 million figure. However, total earnings may decline due to the expectation that used vehicle prices will continue to drop next year, likely reaching their lowest point in the latter half of the year. We also foresee a slowdown in rental activity at some stage. Despite this, we have not yet observed a slowdown in rentals, as the demand for vehicles remains strong in the market.

We'll take our next question from Bert Subin with Stifel. Please go ahead.

So, we've talked a fair amount about Supply Chain, and the SCS story has been really positive for Ryder. But there's been an increase, I would say, in private equity and VC activity just across that arena. Can you talk about what you're seeing on the competitive landscape across SCS? And do you think the barriers to entry that you have there will remain in place?

Yes, to answer your question briefly, our capabilities create a significant barrier to entry in that business. It's a challenging sector, and we have spent many years developing and refining our skills, which is exactly what our customers seek. This level of expertise is not easily duplicated. Additionally, with the new technology we have implemented, our offering has become quite attractive and valuable. Steve, could you provide some further insights?

Yes. Robert, I'll just add to, Bert, the technology piece. The announcement of the acquisition of Baton is a key investment for us. You've seen us build out RyderShare over the years. That's a key differentiator in the marketplace. Our technology stack with Whiplash is a differentiator. We have RyderView 2.0 and Last Mile. So technology is a key differentiator. But at the end of the day, it comes down to the people. We've got great people, long tenure, and they deliver on the promise to the customer.

Just as a clarification question on a previous comment earlier about all of the industry verticals. You guys had talked about autos being a tailwind coming to your end, and I guess it's starting to show that with double digits. Is there a runway for that to stay sort of the strongest segment as you go into '23, no matter really what happens?

Yes, we believe so because of what we're observing with our customers and the ongoing backlog in production required to meet the current replacement demand in the industry. Therefore, we anticipate the auto business will remain strong at least through the first half of the year as that demand is fulfilled. Historically, prior to COVID, the auto industry in the U.S. produced between 15 million to 17 million vehicles annually, showing relative stability aside from the Great Recession and the disruptions caused by COVID. Going forward, I expect we will return to that pattern. Additionally, as we shift towards more electric vehicles, Ryder will continue to play a crucial role in the logistics of that assembly process.

We'll take our next question from Brian Ossenbeck with JPMorgan. Please go ahead.

Yes. Just wanted to clarify one thing here. In terms of Baton, I know they had started off maybe working a little bit more on a, I think, final mile with delivery and sort of the drayage side and maybe talking about how they linked into autonomous, which I know you're also invested in. But I think they've pivoted from that since then. So maybe you can talk about exactly what you see in that industry. And then, I guess, separately, just one more on UVS. We've seen some divergence in some of the vintages they are getting a little bit stronger, some a little bit weaker. Does that have really any material impact on how you view the UVS market? Or is that just a little too early and the downward trend is still very much in place?

Let me address the first question, and then I'll pass it over to Steve to provide more details on Baton and what we're particularly enthusiastic about there. Regarding UVS, we're typically dealing with six- to seven-year-old vehicles, which is the age range we usually monitor. I can say that this segment is performing as we anticipated, especially on the tractor side. Trucks are actually holding up slightly better than we initially thought. Looking ahead to next year, those vintages are what we should focus on to understand the direction of our markets. Steve, would you like to share more insights on Baton?

Yes. Brian, I think the key for us is that we still are buying technology off the shelf. But to stay ahead of the competition, we really needed to develop technology in-house. Our key here is to eliminate friction, eliminate waste in our customer supply chain and in our operations. So yes, their base business was around more of a kind of a dray-type model. I think we can build on that, and they're going to be focused on transportation and supply chain optimization. So a great addition to the team, and we look forward to them really keeping us ahead of the competition as we move forward.

Our last question comes from Scott Group with Wolfe Research. Please go ahead.

Robert, can you walk us through the calculations on the sensitivity related to used pricing and gains that you mentioned in your prepared comments? Additionally, what are your thoughts on why the rental utilization is performing so much better in this freight environment and why that might continue, preventing us from returning to the mid-70s?

I'm sorry, Scott, can you repeat the second part of your question?

Yes. Rental utilization is performing well despite the freight environment. Is it possible that we won't return to the mid-70s, which you consider more normal?

I believe I can answer that part, and then I'll let John address the used vehicle aspect. On the rental utilization front, demand is clearly helping us achieve over 80 percent. Additionally, we've implemented internal process improvements to keep our rental trucks on the road and reduce the number that are out of service. These changes, made over the past couple of years, should help us maintain higher utilization levels. While it may not stay in the low 80s throughout the year, we believe achieving a level in the high 70s is feasible. I would say part of the decrease is due to market conditions, but we're also making efforts internally to keep our rental trucks operational. John, would you like to address the used truck question?

Yes. Scott, so what we laid out on Page 14 of the deck there, one of the commentaries you heard from us is we gave a sensitivity relative to the core earnings, which contemplates $75 million in annualized gains. So looking at where we're at in Q3, you would need to see a 35% drop across all vehicle classes to get to an annualized level of $75 million in gains. And then, we also provided to get to zero gains, you would need a 42% drop from where we sit in Q3. So, that was the sensitivity we gave relative to kind of where we're sitting today, which are at elevated levels. I would say right now, we're still at pre-pandemic highs. So, there's still quite a bit of distance before we get to that core earnings-level number.

Can I clarify? I'm not sure I fully understand. Please go ahead.

Yes. The delta could be that the additional depreciation that we set on those tractors that we have 50% of the fleet where we've already taken further depreciation down to trough levels on the tractor side. So that also helps to buoy that delta between the $75 million and the zero.

Yes. Just to help you with the sensitivities there, I would tell you, if you take our second quarter proceeds for North America and you annualize that, you're elevated above $900 million. You're in the mid-$900 level. And you apply seven points to that that gets you to roughly that $75 million that gets eroded in that sensitivity. So, that's the level that we're talking about, but that's a simplified math that I just did for you. But we could certainly follow up with you on that.

We'll take our next question from Justin Long, Stephens. Please go ahead.

I wanted to follow-up on some of the earlier use commentary. Robert, you mentioned used being one of the key drivers to upside in the quarter, but it's also one of the key drivers to sequential pressure in earnings from 3Q to 4Q. So could you share what you're assuming for the decline in used truck pricing as we go from third quarter to fourth quarter?

Yes. Truck and tractor pricing was down this quarter, with tractors down 22% and trucks down 11%. We anticipate that this trend will continue, possibly at a slightly slower pace. It's challenging to forecast this precisely from quarter to quarter, and we do not want to indicate exactly where the market is headed, as it will ultimately be determined by market dynamics. However, we do expect to see more declines at a double-digit rate.

Okay. Got it. That's helpful. And then getting your thoughts on 2023 just directionally was helpful. But I was wondering, if you could talk about the interest rate sensitivity moving into next year as well just given what we've seen with rates here recently.

John?

Yes. As we look ahead, we anticipate that rates will continue to rise in Q4. We expect to refinance just over $1 billion next year. This year, our free cash flow has been excellent, which has reduced our reliance on debt markets. Currently, if we were to enter the market, interest rates would be around 6% or more, indicating a significant increase in the interest rate environment. Fortunately, we only have over $1 billion due for refinancing next year.

Our last question comes from Jeff Kauffman with Vertical Research Partners. Please go ahead.

First of all, congratulations. It's just fantastic results. I kind of want to think bigger picture on what you're seeing between your Supply Chain business, and I know you mentioned rental fleet utilization still very strong on a larger fleet. So, we're not really seeing that economic canary in the coal mine, but the rest of the world seems to be nervous about happening. And I've got a lot of different industries and truckers that are saying, "Okay, things are slowing down." So what are you seeing in vehicle demand on the rental leasing side that different? Is this just hitting us later? Or are you seeing cracks in the dam? And then what are you seeing on the supply chain side? If I back out the acquisitive growth and I just kind of look at the organic growth, what's changing on the periphery?

On the rental side, there is still a shortage of vehicles in the marketplace, which we are benefiting from as the original equipment manufacturers work to address production delays. We've previously mentioned the positive impact of e-commerce on truck demand, indicating strong rental demand for trucks. On the supply chain side, there is significant interest from companies that have had to prioritize supply chain issues recently and are seeking assistance. This is contributing to organic growth in the mid to high 20s in a market that is favorable for companies looking to enhance their supply chain, including Ryder. Steve, could you provide more details?

Yes. Jeff, in the quarter, organic growth was 23%, again, just reiterating that we were double digit across all industry verticals. I think it's a couple of things. Our continued Ever better campaign, we pushed that again. This is the third year of that. We'll continue that in '23. It's getting our brand awareness out there, creating historical pipelines both on the Dedicated and Supply Chain side. And as Robert said before, it's a difficult business. And I think a lot of companies found that during 2020, 2021. And our ability to hire drivers, to hire warehouse workers, we've really invested in the recruiting side of the business, too. So, it's not an easy business. And then, I'll just close with the technology. We've got differentiated technology that our customers don't have and in some situations, our competition doesn't have either.

Thank you. And just one follow-up, if I can. Robert, I'm thinking back to the middle of the last decade when the rest of the world was slowing down and you guys were growing because your customers were demanding it. And then 1.5 years later, demand just evaporated. What feels different to you about what you're seeing right now? And kind of how do we manage growth to avoid that trap again this time around?

Yes. I believe that our contractual business, which accounts for about 90% of our revenue, will remain stable even during a slowdown. In our Supply Chain and Dedicated segments, customers will continue to need to transport their core products, and the same goes for leasing. Our purchases based on speculation are primarily related to rental. Over the past few years, while we've expanded our rental fleet, we've been careful not to overgrow it. We've also invested in trucks where we encounter less volatility compared to the tractor side. We're confident that these investments will endure through different economic cycles, and we've adjusted our management of the rental fleet to quickly shift trucks from rental to lease or dedicated applications. We are preparing for a potential slowdown and are analyzing various scenarios like many companies. We feel optimistic about our trajectory and believe that our core earnings will continue to grow even in a slowing economic environment, which will demonstrate our resilience.

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. Thanks, everyone. Thanks for the interest. Thanks for being on the call and the questions, and I look forward to seeing you over the next several months. Take care.

Ladies and gentlemen, that concludes today's conference. Thank you all for your participation.