Ryder System, Inc. (R) Q3 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the Ryder System Third Quarter 2020 Earnings Release Conference Call [Operator Instructions]. Today's call is being recorded. If you have any objections, please disconnect at this time. I would now like to introduce Mr. Bob Brunn, Vice President, Investor Relations, Corporate Strategy and Product Strategy for Ryder. Mr. Brunn, you may begin.

Thanks very much. Good morning, and welcome to Ryder's third quarter 2020 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 measures 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 available on Ryder's Web site. Presenting on today's call are Robert Sanchez, Chairman and Chief Executive Officer and Scott Parker, Executive Vice President and Chief Financial Officer. Additionally, John Diez, President of Global Fleet Management Solutions and Steve Sensing, President of Global Supply Chain Solutions and Dedicated Transportation, are on the call today available for questions following the presentation. With that, I'll turn it over to Robert.

Good morning, everyone, and thanks for joining us. I'd like to start the call by thanking our employees, particularly our frontline associates, our truck drivers, our maintenance technicians, warehouse workers, and all essential Ryder personnel who have worked tirelessly on behalf of our customers to ensure the flow of goods and services throughout the economy. On our call this morning, we'll provide an overview of our third quarter results and an update on our outlook. We'll also review the progress we're making on actions to achieve our ROE targets over time. Following our prepared remarks, we'll open the call for questions. With that, let's turn to a brief overview of our third quarter results. Operating revenue of $1.8 billion in the third quarter was in line with the prior year as higher revenues in supply chain and lease were offset by lower revenues in rental and dedicated. Comparable earnings per share from continuing operations was $1.21 in the third quarter as compared to a loss of $1.49 in the prior year. Results reflect a year-over-year earnings benefit of $108 million from a declining depreciation expense impact related to prior residual value estimate changes and higher gains on sale of used vehicles. Higher supply chain earnings and improved lease performance also contributed to increased results. Page 5 includes some additional financial information for the third quarter. Comparable EBITDA for the quarter was $640 million, up 8% from the prior year, driven primarily by improved operating performance. Excluding pension costs and other items, the comparable tax rate was an expense of 17.9% in the quarter as compared to an expense of 7% in the prior year. Adjusted return on equity for the trailing 12-month period was a negative 4.4% as compared to a positive 5.3% in the prior year, reflecting lower earnings from depreciation expense related to prior residual value changes and impacts related to COVID-19. I'll now turn it over to Scott to discuss the key trends that we saw in each business and review overall capital spending, cash flow and leverage.

Thanks, Robert. Fleet Management Solutions’ operating revenue decreased by 3% due to a decline in rental revenue, partially offset by higher ChoiceLease revenue. Year-over-year rental revenue was down 16% in the third quarter, reflecting lower demand. We are encouraged by the sequential recovery in rental from the second quarter, which reflects increased freight activity, as well as benefits from our actions to downsize the fleet. Demand and utilization improved throughout the third quarter, with September utilization above prior year levels. Utilization of our powered fleet was 71% in the quarter, modestly below the prior year of 74% but up significantly from 56% in the second quarter. Our ending rental fleet size was down 21% compared to prior year and down 4% sequentially as we took timely actions to address lower COVID-related demand. ChoiceLease revenue increased 2%, primarily due to higher pricing on leased vehicles, reflecting our pricing initiatives. Higher lease pricing more than offset the impact of the lower active fleet due to reduced sales and renewal activity. Lower lease sales as well as our initiatives to redeploy rental vehicles to fulfill new lease contracts are expected to result in significantly lower capital expenditures and higher free cash flow in 2020. FMS realized pretax earnings was $16 million, which included $100 million of depreciation expense impact related to prior residual value estimate changes and gain on the sale of leased vehicles. This impact is lower than the prior year, resulting in a year-over-year earnings benefit of $108 million. Higher pricing on leased vehicles and lower maintenance costs, including benefits from our cost savings initiatives, also contributed to earnings improvement. These benefits were partially offset by lower rental results. FMS EBT as a percent of operating revenue was 1.4% for the quarter, below the company's long-term target of high single-digits, reflecting depreciation expense from prior residual value estimate changes and lower rental performance. Page 7 highlights global used vehicle sales results for the quarter. An improving freight environment contributed to the stabilization of used vehicle market conditions in the third quarter, resulting in record sales volume and higher sequential pricing. Used vehicle sales also resulted from the initiatives to increase retail sales capacity and online sales capabilities. We sold an all-time record 8,800 used vehicles during the quarter, up 66% versus the prior year and up 40% sequentially. Used vehicle inventories held for sale was 10,700 vehicles at quarter end, up from 7,300 the prior year but down 3,300 vehicles sequentially, reflecting this record sales activity. We expect used vehicle inventories to continue to decline and end the year within our target range of 7,000 to 9,000 vehicles. In addition to strong sales volume, it's very encouraging that used vehicle proceeds per unit increase sequentially. Globally, tractor proceeds were up 14% and truck proceeds were up 8%. In the US, tractor and truck proceeds were both up 9% sequentially. As you may recall, on the second quarter call we provided a sensitivity, noting that 30% price increase for tractors and 10% price increase for trucks in the US was needed by 2022 in order to maintain our current policy depreciation residual estimate. Although the 9% sequential pricing increase is not age or mix adjusted, it is generally indicative of the pricing improvements that occurred in the quarter, which brings us closer to the levels that don't require any additional policy residual value adjustments. Now turning to supply chain on Page 8. Operating revenues versus the prior year increased 9%, primarily due to new business, higher volumes and increased pricing. Higher volumes were partly due to increased automotive production support following recent shutdowns and COVID-related freight increases in CPG and Ryder Last Mile. SCS pretax earnings increased 67% due to new business, higher pricing and improved operating performance. SCS EBT as a percent of operating revenues was 11.8% for the quarter, above the company's long term target of high single digits. Moving to dedicated on Page 9. Operating revenue versus prior year was down 6%, reflecting nonrenewed business and lower volumes. DTS earnings before tax increased 34% due to a lower impact from prior residual value estimate changes for vehicles used by DTS, a onetime benefit from a customer contract termination and improved operating performance. DTS EBT as a percent of operating revenue was 10.6% for the quarter, above the company's long term target of high single digits. I'll turn now to Slide 10 and discuss capital expenditures, cash flow and leverage. Year-to-date gross capital expenditures were just under $800 million, down by more than $2.2 billion from the prior year. This decrease primarily reflects lower investments in leased and rental vehicles. Weaker economic conditions as well as our strategic initiatives are resulting in lower lease sales activity and reduced capital spending. Use of redeployed equipment to fulfill new lease contracts in 2020 has also lowered capital spending. We now expect full year 2020 gross capital expenditures of $1 billion to $1.1 billion, below our previous forecast of $1 billion to $1.3 billion. We are now forecasting full year 2020 free cash flow of $1.4 billion to $1.5 billion, up from negative $1.1 billion in 2019, reflecting the countercyclical cash flow nature of our business model and our strategic direction to limit growth capital in lease. Year-to-date proceeds from sales of $401 million were in line with prior years, which included a property sale. Excluding PP&E, proceeds solely from sales of these vehicles were up $37 million. Net capital expenditures decreased by over $2.2 billion to $364 million year-to-date. Turning to the next page. We generated just under $2.1 billion of total cash year-to-date, up 5% from the prior year, primarily due to working capital management. Free cash flow was positive $1.2 billion year-to-date, up by approximately $2.2 billion from the prior year, reflecting significantly lower capital spending. Debt-to-equity at the end of the third quarter increased from the prior year to 346%, reflecting a reduction to equity due to higher depreciation expense impacts related to prior residual value estimate changes, a higher than normal cash balance due to uncertain economic conditions and a pension equity charge. We expect to use free cash flow and excess cash to delever the balance sheet during the fourth quarter. The pension equity charge was taken in conjunction with a recent cost action to curtail certain future pension benefits. This action required the remeasurement of our US and Canadian pension assets and liabilities, a process that normally occurs at year-end. Due to the lower discount from last year, this remeasurement resulted in a reduction to equity of approximately $68 million net of tax. A higher than normal cash balance and the pension equity charge increased debt to equity by approximately 25 percentage points and 10 percentage points respectively. Debt to equity declined, however, sequentially from 377% in the second quarter. At this point, I'll turn the call over to Robert to discuss our fourth quarter outlook as well as provide an update on our actions to increase returns.

Thanks, Scott. Looking ahead to the fourth quarter, we anticipate supply chain and dedicated returns to moderate from the third quarter, reflecting seasonality and lower COVID-related activity. This seasonal decline includes the impact from holiday automotive production shutdowns, reduced activity with certain customers, as well as the timing of annual employee merit increases. For the full year, we expect EBT as a percent of operating revenue for both supply chain and dedicated to be within our long-term target range of high single-digits. As you've heard me say before, riders, drivers, technicians, warehouse workers and other essential personnel are critical to our success. Throughout this pandemic, these dedicated employees have continued to ensure the safe delivery of food, healthcare goods and other supplies on behalf of our customers. In appreciation for their efforts, we are awarding a special recognition and retention bonus to these non-bonusable employees. This investment will result in a onetime expense of approximately $30 million in the fourth quarter. These earnings headwinds are expected to be partially offset by the continued decline of depreciation expense impact from the prior residual value estimate changes and improved rental performance. Return improvement in rental are expected to accelerate in the fourth quarter due to higher demand and improved utilization. And lease we expect the fleet to continue to decline, however, pricing is expected to be higher, reflecting our pricing initiative. We are expecting record free cash flow of $1.4 billion to $1.5 billion in 2020, driven by lower capital expenditures. We are planning to resume anti-dilutive share repurchase activity in the fourth quarter, following a temporary pause of the program earlier this year as a result of economic uncertainty due to COVID. As a reminder, Page 15 highlights our primary long-term financial target of 15% ROE over the cycle. The segment operating revenue growth and pretax earnings goals we previously outlined and that are shown here are key components to achieving this target. As I mentioned before, reaching an adjusted ROE of 11% to match our cost of equity is only an interim target. Slide 16 highlights the key drivers for reaching our long term ROE target. As illustrated in the chart, we expect to make significant progress towards our target by moving past higher levels of depreciation impact related to prior residual value estimate changes. In addition, a cyclical improvement in rental demand and utilization is expected to provide additional earnings benefit. The remaining improvement needed to reach our ROE target is expected to come primarily from initiatives that include lease pricing increases, cost actions, including our multiyear maintenance cost savings initiative and accelerated growth in our supply chain and dedicated businesses. Declining depreciation impact and higher lease and supply chain results were key drivers to the improvement in adjusted ROE from a negative 9.8% in the second quarter, which is shown on the page, to a negative 4.4% in the third quarter. Turning to Slide 17. I'll share the progress we're making on the five key areas I just outlined. As expected, earnings benefited from a decline in depreciation expense impact from residual value changes. In addition, improving used vehicle market conditions contributed to the realization of gains on used vehicles sold in the third quarter. We continue to increase our retail used vehicle sales capacity through the combination of digital investments and physical locations. We recently launched a new website, which allows our users to access the site from any device. Our new site offers improved search capabilities to enable users to better find, research, engage and make purchasing decisions. The site also includes expanded inventory at additional locations that make it easier for customers to locate the best pre-owned vehicle nearest to them. We've opened seven new Ryder used vehicle sales centers so far in 2020 and plan to open two more by year end. In rental, we've aligned our fleet size with market conditions, and we're pleased to see utilization improve throughout the third quarter. October utilization to date is trending higher sequentially from September, and utilization for the fourth quarter is expected to be in line with the prior year. In FMS, results continue to benefit from our lease pricing initiatives. Revenue on new lease vehicles increased year-over-year by mid-single digits, reflecting these pricing actions. We're also beginning to leverage data analytics to further refine portfolio pricing optimization and capital allocation decisions. Turning to Page 18. We're on track to achieve our expected annual savings of $30 million in 2020 from our multiyear maintenance initiative, bringing program to date savings to over $50 million. In July, we implemented other cost actions that are expected to result in an estimated annual savings of $50 million. We also recently took cost actions to curtail future pension benefits for participants that were previously exempt when we froze our US and Canadian pension plans. This change is expected to result in savings of approximately $6 million in 2021. We've also taken various actions to support our strategic goals of accelerating growth in our higher return supply chain and dedicated businesses and are encouraged by the results so far. We saw a significant increase in sales leads and online traffic through ryder.com following the third quarter launch of our brand awareness campaign. The campaign highlighted Ryder's broad range of logistics capabilities, including e-commerce fulfillment, Last Mile delivery, warehousing and transportation, as well as our visibility technology solutions. We're encouraged by the continued profitable performance of Ryder Last Mile, which provides home delivery and white glove installation for everything from furniture to large appliances. Revenues increased by nearly 30% in the quarter, driven by new business as well as higher volumes. We realized the leverage in the Ryder Last Mile network and delivered returns well above our overall target for supply chain. Sales activity was strong as well. We recently launched the visibility in collaborative logistics platform RyderShare, is enabling customers to benefit from improvements in productivity, labor efficiency, on-time performance and customer service. We expect demand for RyderShare to continue to grow, driven in part by shippers expecting to increase their use of freight visibility software in a post-COVID environment. We're continuing to invest in our e-fulfillment capabilities. We've expanded the size of our Pennsylvania location and are implementing automation technology that will support the scalability of the operations. We believe these investments will position us well to leverage trends towards increased e-commerce activity and are encouraged by the strong sales activity for this offering. Although economic uncertainty remains, accelerating trends towards e-commerce fulfillment, final mile delivery of big and bulky goods and on-shoring and near-shoring of manufacturing operations, presents Ryder with a compelling opportunity that we're strongly positioned to capitalize on. That concludes our prepared remarks this morning. Before we go on to questions, please note that we expect to file our 10-Q later this week. We had a lot of material covered today, so please limit yourself to one question each. If you have additional questions, you're welcome to get back in the queue and we'll take as many as we can. At this time, I'll turn it over to the operator to open up the line for questions.

[Operator Instructions] We'll take our first question from David Ross with Stifel.

So I want to focus on the Supply Chain Solutions segment, first of all, Last Mile has obviously been a good area of growth for you guys and has benefited this year on the volume side. Wanted to get commentary around Last Mile pricing? Because it's been an area due to the fragmentation of the business where pricing really wasn't good enough historically to allow for decent returns in that business. And then that ties in a little bit to the margin on SCS, and you're maintaining the long-term target of high single-digits. But is the 10% theoretically sustainable on the margin side? So kind of two parts to that, one on the Last Mile pricing and two on the SCS margins.

Let me just give you a little bit of an overview, and then I'll hand it over to Steve. First, around the Ryder Last Mile. We made this acquisition a few years ago of MXD, and it was really -- the reason we did that acquisition was because, obviously, we wanted to get into this Last Mile delivery service. And we also really like the model that MXD had, which was in this environment, I think, very efficient and competitive and was a model that was giving good returns. As you might imagine, we're very pleased with the results of that acquisition and especially now in this post-COVID world, where we saw a big increase in demand for this type of service. The profitability of that business really increased pretty significantly, certainly in this quarter. But as we mentioned on the last quarter, we now expect that business to be in line with our supply chain earnings targets, which, as I know in the marketplace, I think, would probably be best in class. So one thing is the pricing. I think the pricing is competitive in that business. But what we find is that with this model, we can be competitive and get good returns for our shareholders. As far as the sustainability of the profitability that we saw in supply chain, I'll let Steve comment on that. But I think we did have some onetime pickups in the quarter with auto production really coming back as strongly as it did. There were no shutdowns during the summer, which we normally have, so we had extra volume there. And then we also did see other COVID-related increases, volume increases, which the question is, how sustainable would those be going forward. So Steve, you want to add to that?

So David, back on the last mile piece. I think as Robert said, I think the pricing in the market is kind of stabilized. It shows really in our top line growth in Last Mile. We had a good portion of our growth was related to volume. We had double-digit new sales in the Last Mile product. I think from a profitability perspective, as I said on the last couple of calls, it is about the continued density in the market. I think we've got a really great operating team that is optimizing our route utilization much better over the last couple of quarters. We do think that is sustainable. But as we continue to -- we got to continue to expand our network and gain further density. So I think your next question was around SCS. I think Robert hit it on the head. Typically, it's best to look at our business on a full year run rate or trailing 12 months. Q2 and Q3 typically our best-performing quarters. A little bit more color on Q3. And auto this quarter, we had fewer plant shutdowns than we typically would in a Q3. We worked more Saturdays this quarter. And we expect to see some plant shutdown in Q4 for retooling and new model conversion as we look at the balance of the year. So hopefully, that answered your -- most of the questions.

[Operator Instructions] We'll go to Stephanie Benjamin with Truist.

Just kind of following up on the used truck business, based on what you saw in 3Q and October. Has the used truck market actually improved faster than you expected? And if so, what are the main drivers of that improvement and really, in your view, the sustainability of these factors? Thanks.

The simple answer is yes, it did improve quicker than we expected. I'll let John give you some color as to some of the drivers that we're seeing in that in terms of the volume. As we mentioned in the release, we had record volume sales in the quarter along with increasing in pricing. So John, do you want to give them a little more color?

So Stephanie, what we continue to see is, we started seeing it at the tail end of Q2 and into Q3. The freight environment has really opened up activity on the retail UVS side. What we're seeing is owner operators coming into the market and looking for primarily tractors but also straight trucks as you continue to see the e-commerce space take off. You're seeing a lot of buyers that are coming in and gobbling up not just one but multiple assets at a time. We did see volume go up to record level, as you heard. We were up sequentially 40% in the quarter. I don't expect that to continue at these high levels as we start eating into our inventory, and our inventory is expected to be down sequentially from Q3 to Q4. But what I am pretty encouraged by is we're going to see good demand with the freight cycle moving forward. So I expect in the short term, I expect good pricing activity for both our trucks and tractor pieces and that I expect will carry us into 2021. So overall we're seeing good activity primarily driven by the freight cycle and then some of these e-commerce activities that are driving higher demand.

And moving on, we'll go to Scott Group with Wolfe.

So just a couple of follow-ups on the used side. Can you just remind us what the depreciation tailwind is for fourth quarter and then for next year, do you have any sense on a good run rate for gains on sales going forward? And then with the improvement in used prices, how close are prices today relative to that threshold where you won't need to cut residuals again? Thank you.

Let me turn it over to Scott for the -- he can give you the depreciation year-over-year, answer your depreciation year-over-year impact question, and then we can get into the used vehicle pricing.

What we have provided for last time was an expectation for the fourth quarter of 2020 to have depreciation of about $100 million, that is exclusive of any UVS gains, so we gave those numbers it was without UVS. A year ago, that number was $148. So on a sequential basis, we are expecting third quarter to come in at $115. With the UVS gains, we came in closer to $100. So that is the piece that we're not going to be providing guidance on the UVS for the fourth quarter, but at least that's where the accelerated and policy expectations are for the fourth quarter.

And then I think your second question was about how close we are to not having to make any more adjustments that the numbers that we had talked about last call, we need to improve 30% for tractors and we needed to improve 10% for trucks. One of the things that we mentioned on the call in the prepared remarks is that even though it's not a perfect correlation because we do make some adjustments for lead age and mix but sequentially, pricing was up 9% for both of those, so it kind of gives you directionally. We've certainly made some good progress in the quarter in terms of getting to those levels, we will no longer have to make any more adjustments. And again, we've got two years to get there so I think it's a pretty strong move in just one quarter.

And next, we'll go to Justin Long with Stephens.

So maybe to just follow-up on that question, Scott. In terms of 2021, has there been any update to the impact you expect to depreciation from residual value changes? And then looking at returns and the targets that you laid out. Robert, do you have any updated thoughts about when you could achieve that interim target and the longer-term target of a 15% ROE?

Yes, what we provided last quarter, so we have not updated that. It's still kind of where we are and we'll true that up as we go into 2021. But the expected depreciation policy and accelerated for 2021 was expected to be $270 million. And when we gave that number for 2020 that number was $520 million, but that was as of second quarter. So with the improvement that we've made in the third quarter, the 2020 number would be expected to be lower than what we had provided in second quarter.

And then, Justin, on the timing, I think, obviously, with all the uncertainty in the environment right now, it's hard to pin that down because remember the waterfall that we show on the earnings deck shows you that the two big drivers are the depreciation; the subsiding of the depreciation, higher depreciation impact from the residual value changes, that's a big contributor to us getting back and that stuff is happening already, so we're seeing that continue; the snapback of rental and really having rental come back to more normalized levels; and then the initiatives that we're taking around pricing and lease, around maintenance costs and around growing our supply chain in dedicated. So we're already seeing some of the benefits of that. But depending on how quickly the economy comes back, that will probably dictate how quickly we get there. We do still have, even as you go into next year, we're going to see, as Scott mentioned, a reduction in the impact of that depreciation from residual value changes, and we're going to get a tailwind from that. But we're still going to be carrying some pretty significant depreciation expense that I would call out a period. So as we get into 2022 is when that stuff really starts to lighten up some more and we get into an environment where you have less impact from that. So hopefully, that helps you.

And next we'll go to Todd Fowler with KeyBanc Capital Markets.

What a difference a quarter makes, I guess. Robert, I wanted to ask on the lease fleets, I kind of understand the trends here that we're seeing near term, but we're seeing truck orders pick up. And I think directionally, there's been some correlation with order activity and what you see on the lease fleet. As you look out into '21, how do you think about the thoughts around potentially growing the lease fleet versus some of the initiatives you're doing on the pricing side? And if you could tie in some CapEx comments, it sounds like that you're still expecting lower CapEx. Do you have kind of a baseline for CapEx as we think about '21 with how you're strategically thinking about the lease fleet?

Todd, it's still early in terms of understanding where the economy is going to go. But as you've seen orders pick up for OEMs, we are seeing some more activity on the lease side. But remember, we've said that we're going to moderate the growth of lease going forward. So what that means is that you shouldn't expect to see, even in a robust environment, us growing 10,000 units in a year. I think you're going to see a more moderate growth rate if there's a robust environment. But we are really focused on holding on our pricing initiatives and making sure that we're getting the returns that we need in that business in order to make those investments. So I'll let John give you a little bit more color on what we're seeing now in terms of lease sales and what we're seeing from the market.

So Todd, what we continue to see is, during the quarter, we saw sequentially from Q2 to Q3, better activity on lease sales. As you recall, in second quarter, we did see a number of customers that really had deferred decisions as they were evaluating their business conditions moving forward. When we stepped into Q3, we saw a better environment. I think that's reflected in some of the Class 8 numbers that you're seeing and hearing from the OEMs. We expect that freight cycle to move up as we get into Q4 because we are seeing momentum picking up for new vehicle orders on our side as well. With regards to next year, I think Robert hit it. I think it's still a little bit early for us to start signaling towards next year. But right now, what we'll continue to see is good momentum from very low levels that we saw in Q2, and we saw that pick up from Q2 to Q3.

So it's not that you are opposed to growth, it's maybe just more moderate growth than what we've seen in the last cycle. And then do you have any directional thoughts on CapEx at this point for '21?

No, not yet, Todd. I think -- remember, we said our long-term goal for FMS and lease is kind of a mid single digit top line growth. So if you think about it long term, it's that would be maybe 3,000 to 4,000 units a year over the cycle is what we're probably looking at. But no we don't have anything pinned down yet for next year.

And next, we'll hear from Brian Ossenbeck with JPMorgan.

Just I guess a couple of follow-ups on what we've talked about already. I know you're not giving guidance to used vehicle sales gains in the fourth quarter, but it seems like we should think that moderates a bit coming off the record level from here, obviously, pricing dependent. So I just want to make sure that was a reasonable expectation. And then just more on the pricing you just talked about, can you just give us some sense of how those initiatives are going in the market, how they've been received? If there's any competitive response as you look to maybe a segment some of the pricing opportunities, optimize the portfolio and hold the line on that mid single digit non renewal?

Yes. I guess your first question around used vehicle sales. I think the pricing has kind of been holding up in terms of used vehicles, so we saw a nice increase sequentially. So as we go into the fourth quarter, we don't have any indication right now that that's going to change. I would expect that to continue. Volumes, however, will be lower. I would expect as we -- our inventories are low. Our inventories were at pretty high levels going into the third quarter. They're coming down. And by the end of the third quarter, we should be within our target range. So I would expect we'll be selling fewer vehicles probably in this quarter than we did in the third, but still a pretty healthy level. And I guess, more importantly, I would expect we're going to be selling more through retail and less through wholesale. So that mix is going to help us overall also on the used vehicle results. In terms of lease pricing, I think it's still too early to tell. We have done a lot of redeployments, and John and his team have done a lot of redeployments this year of vehicles coming out of rental and idle vehicles. So new capital has been very limited, as you can see from our CapEx numbers. In the deals that we have gone after and signed, we've been able to get the pricing. But I think as we get into next year, it's going to be a better test of how that goes. And we do play in a pretty rational market, so I would expect the market over time is also going to move in that direction.

And next, we'll hear from Jeff Kauffman with Loop Capital Markets.

Well, congratulations. Just terrific to see a turnaround like this in the market. I want to follow-up a little on Todd Fowler's CapEx question. And I know it's early to think about 2021, but maybe if we could think about it this way. If you decided just to hold the fleet steady, before we think about the growth of 3,000 to 4,000 units that you would want to do normally in a cycle in FMS and we just looked at replacing and holding fleet count steady. What kind of capital spending would that be?

Our replacement CapEx, I believe, is about $1.5 billion. Scott, you got that number, the replacement CapEx...

Yes, about $1.4 billion and then you have -- Jeff, you would have a little bit on the rental side. So rental clearly expected with the defleeting, not to be at historical levels, but we would expect to have a little bit of increase year-over-year in some of the rental CapEx.

Yes. No, I would agree with that. I was just thinking if we're still defleeting in the first part of the year and maybe refleeting in the second part of the year, if I just decided to call it flat, what would you be spending? And that's a gross figure, that's not net of any sales of equipment or is that a net figure, $1.5 billion?

That's a gross number.

And Stephanie Benjamin with Truist has a follow-up.

On the commercial rental side, you said in the past that this has been a leading indicator on the demand side, so would love to hear a little bit about what you're seeing as that business has improved into October. Is this being fueled by some of the e-commerce driven holiday customers or are you seeing some broader improvement? Thanks.

Let me let John give you some color on what we're seeing, which sectors we're seeing a pickup in. But it is typically a leading indicator because as the economy starts to come back, customers will come and rent trucks before they go out and buy and lease. And as there's more uncertainty, you're going to see rental also do well because customers aren't willing to put down the capital yet, so they're going to run initially. So John, I'll let you give us some color on that.

What we've seen during the third quarter, and that's picked up going into Q4, is you're seeing, certainly, the freight environment pick up. So our tractor classes are back to normal utilization levels and demand continues to be strong there now from September into October. I think the 1 industry that you are seeing a pickup in without a doubt is the parcel space with e-commerce, which you mentioned, Stephanie, that's driving a lot of activity for the light-duty space. To balance that, I will say we still see a little bit of a drag on the event side, so some of the straight truck market is still being impacted by COVID. You're seeing also the restaurant side of the house with refrigerated straight trucks also lagging. But I would tell you, e-commerce, the freight environment, what we saw in auto during the quarter and then some of the other segments have picked up sequentially from Q2 to Q3 and really, during the quarter, it kind of sequentially picked up through the quarter. So very encouraged by that. I think Q4 is going to be a good demand environment. As we mentioned, we expect our utilization to be back in line with prior year. And again, we'll see what 2021 brings forward as we get deeper into the quarter.

We'll return to Scott Group with Wolfe for a follow-up.

I was wondering, Robert, if maybe you had some directional thoughts on some of the broader puts and takes for next year. So it feels like used and rental should be tailwinds. Maybe I'm just thinking about some of the other parts, the contractual business more broadly, do you think about that as tailwind or headwind next year? And then anything, either good or bad on the cost side? I know we've had some big years of strategic investments is that -- should we expect another year of that next year? Does that start to go away? Just any thoughts on some of the other parts here. Thank you.

Yes. I think you hit the two big ones, rental and used vehicle sales, I would expect as we get into next year. If we keep on this trend, will certainly be tailwinds. On the contractual side, supply chain, dedicated certainly continuing to grow and provide some tailwind also. On the lease side, it depends how much we grow but lease will be -- you'll see a benefit -- outside of the depreciation piece, you'll see a benefit based on the amount of growth we get. And then we've got initiatives around maintenance cost and other cost initiatives that are going to help us. On the headwind side, I think you're going to see -- obviously, we will continue to have investments, especially around our supply chain business as we invest in things like RyderShare and some of the technologies that we need to make sure that we continue to have a leadership position there. And then also, you're going to have just normal inflationary type costs that we come across within the businesses each year. You'll have that as we go into next year. I mean those are kind of the big picture items as we go into 2021 that we're going to see. But again, it's still too early. I think with everything going on, we've got an election coming up, we've got still a lot of uncertainty going into next year, we'll be in a much better position to talk about that in February.

And just one just really quick one, just as we're back to sort of positive earnings, what's the right tax rate going forward?

Yes, given kind of the uncertainty that we're going through, if you look at our tax rate, we've had a tax benefit on a year-to-date basis with tax expense in the third quarter. So this year, it's kind of hard to kind of give you that precision without providing guidance. But if you think about what we've talked about in the past, the tax rate has been over the last couple of years, muted a little bit because of the depreciation charges that we've been taking. But on kind of a normalized basis, kind of -- outside of kind of where we are this year, on a normalized basis, we've talked about being in the high 20s, low 30s based on the income levels for the company.

Scott, the one other thing I would add is that it will be a tailwind next year, we can't forget is temporary cost savings from COVID that we had in the second quarter primarily but a lot of people are thinking to do the benefits of COVID, but they're also -- whether it's travel or medical expenses. And if that begins to maybe not go back to where it was pre-COVID but just starts to lift up a little bit next year, I see that as another item that we could be facing.

We'll return to Justin Long with Stephens for a follow-up.

I had one on dedicated. I know you called out this onetime gain from a customer contract termination. Could you help us quantify what that impact was in 3Q, maybe some more color around what happened there and any impact from that going forward?

Yes, that was a customer that we had in dedicated go changed modes. They went from dedicated to a different mode of transportation, more of an LTL type model. And as a result of that, we sold the equipment to the follow-on provider and there was a gain on sale of that equipment, so that's really what that is. And it was really not a change to another dedicated provider but more of a change in mode for that customer. Gain on sale, by the way, was a couple of million dollars.

And I know you're not giving specific guidance for the fourth quarter, but when you kind of put together all the different moving pieces you've discussed on the call. Is your expectation that adjusted earnings are down sequentially in the fourth quarter? Just maybe some directional commentary might be helpful.

Yes. Directionally, I would expect it to be down somewhat. The degree of which, it will be dependent on a lot of different things that are still -- depending on what happens in the economy. But we would expect it to be down some in the fourth quarter. But then as we go into next year, I think the important thing is as we start to continue to get the tailwinds from depreciation and the benefits from the used vehicle market continuing to be solid and rental, you're going to start to see then over a year period, you'll see earnings from that start to come back up. So some seasonal decline in the fourth quarter. But then as we go into next year, we're feeling really good about where earnings are going.

And we'll go back to Todd Fowler with KeyBanc Capital Markets for a follow-up.

So just two last quick ones for me. You've shared with us in the past that every 100 basis points of rental utilization is about $1 million pretax. Does that math still hold as we think about the utilization increase into the fourth quarter given the size of where the rental fleet is at right now?

Yes, I think the 100 basis points still works. As I mentioned earlier, we do expect, Q3 going into Q4, we expect that Q4 utilization to be in line with last year. So you are going to see a pickup there sequentially from Q3 to Q4 in the rental performance.

And then just one kind of theoretical one, I guess. In the past, the policy depreciation adjustment, it seemed like it was something that was done more annually. Now you kind of had this two year bogey out with 30% price increase from where you were in the middle of this year. What would kind of trigger the potential that you have to look at the policy depreciation again? I mean is it -- as long as the used equipment values are moving towards that 30% mark on the tractor side or if we saw something to take a step back, I guess, how do we think about the potential for a policy adjustment at some point in 2021?

Yes, you're correct. It's normally an annual process. We had a couple of adjustments because of some of the circumstances. The one last year was based on relooking kind of the trends, and then this year was really based on COVID. So as you mentioned, we're encouraged by the trends we're seeing from a perspective of sequential pricing improvement, especially on the tractor side. So that is kind of getting the gap between the 30% we talked about in the second quarter and kind of where it's trending. So I think those are all positive factors as we think about going forward our expectations around policy. So we will do that annually view at the end of this year. We'll continue to do that going into the following years. But the trends that we're seeing right now are encouraging from that perspective.

So it sounds like maybe it'd have to be something significantly different in the trends or what your expectations were?

Correct.

Okay. Let me just add to Justin's question on the fourth quarter. I forgot to mention, which I mentioned in the script, that we do have the $30 million expense for the bonus to the nonbonusable frontline employees, so that's a key contributor to why we look at -- why we think earnings will be down in the fourth quarter versus the third. Again, it's a onetime item.

And 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. Well, thank you, everybody. Thanks for being on the call. Again, we're excited, number one, is a return to profitability and really seeing the benefits of not only an improving environment but also the actions that we've been taking and continue to take. So thanks, everyone. Look forward to speaking with you guys soon. Stay safe.

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