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RYDER SYSTEM INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW The following discussion should be read in conjunction with the unaudited Consolidated Condensed Financial Statements and notes thereto included under Item 1. In addition, reference should be made to our audited Consolidated Financial Statements and notes thereto and related Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2013 Annual Report on Form 10-K. Ryder System, Inc. (Ryder) is a global leader in transportation and supply chain management solutions. Our operating segments are aggregated into reportable business segments based upon similar economic characteristics, products, services, customers and delivery methods. We operate in two reportable business segments: (1) FMS, which provides full service leasing, contract maintenance, contract-related maintenance and commercial rental of trucks, tractors and trailers to customers, principally in the U.S., Canada and the U.K.; and (2) SCS, which provides comprehensive supply chain management solutions including distribution and transportation services, in North America and Asia. The SCS segment also provides dedicated services, which includes vehicles and drivers as part of a dedicated transportation solution in the U.S. We operate in highly competitive markets. Our customers select us based on numerous factors including service quality, price, technology and service offerings. As an alternative to using our services, customers may choose to provide these services for themselves, or may choose to obtain similar or alternative services from other third-party vendors. Our customer base includes enterprises operating in a variety of industries including automotive, industrial, food and beverage service, consumer packaged goods, transportation and warehousing, hi-tech and electronics, retail, housing, business and personal services, and paper and publishing. Total revenue increased 5% in the second quarter of 2014 to $1.68 billion and increased 4% in the first half of 2014 to $3.30 billion. Operating revenue (revenue excluding FMS fuel and all subcontracted transportation) increased 6% in the second quarter of 2014 to $1.39 billion and increased 5% to $2.72 billion in the first half of 2014. The increase in total and operating revenue for both periods was driven by growth in both the FMS and SCS business segments. See "Consolidated Results" for further discussion of operating revenue, a non-GAAP financial measure. Earnings from continuing operations before taxes (EBT) increased 23% in the second quarter of 2014 to $120.0 million and increased 22% in the first half of 2014 to $195.0 million. The increase in EBT in both the second quarter and first half of 2014 reflects improved performance in the FMS business segment. 23-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) EBT, earnings and EPS from continuing operations in the second quarter and first half of 2014 and 2013 included certain items we do not consider indicative of our ongoing operations and have been excluded from our comparable EBT, earnings and EPS measures. The following discussion provides a summary of these items, which are discussed in more detail throughout our MD&A and within the Notes to Consolidated Condensed Financial Statements: EBT Earnings Diluted EPS 2014 2013 2014 2013 2014 2013 Three months ended June 30 (In thousands, except per share amounts) EBT/Earnings/EPS $ 120,045 97,362 $ 75,694 62,575 $ 1.42 1.19 Non-operating pension costs (1) 1,544 4,999 798 2,924 0.02 0.06 Comparable (2) $ 121,589 102,361 $ 76,492 65,499 $ 1.44 1.25 Six months ended June 30 EBT/Earnings/EPS $ 195,049 159,870 $ 124,792 103,377 $ 2.34 1.98 Non-operating pension costs (1) 4,858 10,243 2,686 6,005 0.05 0.12 Benefit from tax law change (3) - - (1,776 ) - (0.03 ) - Foreign currency translation benefit (4) - (1,904 ) - (1,904 ) - (0.04 ) Comparable (2) $ 199,907 168,209 $ 125,702 107,478 $ 2.36 2.06 __________________(1) Includes the amortization of actuarial loss, interest cost and expected return on plan assets components of pension and postretirement costs, which are tied to financial market performance. We consider these costs to be outside the operational performance of the business. (2) Non-GAAP financial measure. We believe comparable EBT, comparable earnings and comparable earnings per diluted common share all from continuing operations measures provide useful information to investors because they exclude non-operating pension costs, which we consider to be those impacted by financial market performance and outside the operational performance of the business, and other significant items, such as the impact of tax law changes and foreign currency translations that are unrelated to our ongoing business operations. (3) On March 31, 2014, the State of New York enacted changes to its tax system, which impacted net operating loss provisions and reduced the corporate income tax rate from 7.1% to 6.5%. The impact of these changes resulted in a non-cash benefit to deferred income taxes of $1.8 million. (4) See Note (O), "Other Items Impacting Comparability," for additional information. Excluding the special items listed above, comparable earnings and comparable EPS from continuing operations in the second quarter of 2014 increased 17% to $76.5 million and increased 15% to $1.44 per diluted common share, respectively. Comparable earnings and comparable EPS from continuing operations in the first half of 2014 increased 17% to $125.7 million and increased 15% to $2.36 per diluted common share, respectively. EBT growth exceeded the EPS growth during the second quarter and first half of 2014 because the average number of shares outstanding has increased 2% and 3%, respectively, over prior year reflecting the impact of stock issuances under employee stock option and stock purchase plans. In the second quarter of 2014, net earnings and EPS increased 21% to $75.4 million and 18% to $1.41 per diluted common share, respectively. Net earnings and EPS increased 21% in the first half of 2014 to $123.6 million and 18% to $2.32 per diluted common share, respectively. 24-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) CONSOLIDATED RESULTS Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (In thousands, except per share amounts) Total revenue $ 1,684,571 1,603,999 $ 3,295,308 3,167,016 5% 4% Operating revenue (1) 1,393,049 1,313,339 2,715,527 2,580,860 6% 5% EBT $ 120,045 97,362 $ 195,049 159,870 23% 22% Earnings from continuing operations 75,694 62,575 124,792 103,377 21% 21% Net earnings 75,358 62,194 123,590 102,118 21% 21% Earnings per common share - Diluted Continuing operations $ 1.42 1.19 $ 2.34 1.98 19% 18% Net earnings 1.41 1.19 2.32 1.96 18% 18% ------------(1) We use operating revenue, a non-GAAP financial measure, to evaluate the operating performance of our businesses and as a measure of sales activity. FMS fuel services revenue, which is directly impacted by fluctuations in market fuel prices, is excluded from the operating revenue computation as fuel is largely a pass-through to our customers for which we realize minimal changes in profitability during periods of steady market fuel prices. However, profitability may be positively or negatively impacted by rapid changes in market fuel prices during a short period of time as customer pricing for fuel services is established based on market fuel costs. Subcontracted transportation is deducted from total revenue to arrive at operating revenue as subcontracted transportation is typically a pass-through to our customers. We realize minimal changes in profitability as a result of fluctuations in subcontracted transportation. Refer to the section titled "Non-GAAP Financial Measures" for a reconciliation of total revenue to operating revenue. Revenue and Cost of Revenue by Source Total revenue increased 5% in the second quarter of 2014 to $1.68 billion. Operating revenue increased 6% in the second quarter of 2014 to $1.39 billion. For the first half of 2014, total revenue increased 4% to $3.30 billion and operating revenue increased 5% to $2.72 billion. The increase in total and operating revenue reflects growth in both FMS and SCS. The FMS growth was primarily driven by higher lease and rental revenues and the SCS growth was driven by new business and higher volumes. Lease and Rental Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (Dollars in thousands) Lease and rental revenues $ 733,763 688,048 $ 1,423,445 1,347,756 7% 6% Cost of lease and rental 508,091 476,662 1,001,134 949,739 7% 5% Gross margin 225,672 211,386 422,311 398,017 7% 6% Gross margin % 31 % 31 % 30 % 30 % Lease and rental revenues represent full service lease and commercial rental product offerings within our FMS business segment. Revenues increased 7% in the second quarter of 2014 to $733.8 million and increased 6% to $1.42 billion in the first half of 2014 primarily driven by 2% full service lease fleet growth, higher prices on full service lease vehicles and increased commercial rental revenue. Commercial rental revenue grew due to higher rental pricing (up 5% in both the second quarter and first half of 2014) and increased North American demand. Cost of lease and rental represents the direct costs related to lease and rental revenues. These costs are comprised of depreciation of revenue earning equipment, maintenance costs (primarily repair parts and labor), and other fixed costs such as licenses, insurance and operating taxes. Cost of lease and rental excludes interest costs from vehicle financing. Cost of lease and rental grew 7% to $508.1 million in the second quarter of 2014 and increased 5% to $1.00 billion in the first half of 2014 due to higher depreciation from increased lease vehicle investments and fleet growth as well as higher maintenance costs on a larger average fleet. Cost of lease and rental benefited by $6.3 million in the second quarter of 2014 and by $12.5 million in the first half of 2014 due to changes in estimated residual values and useful lives of revenue earning equipment effective January 1, 2014. 25-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Lease and rental gross margin increased 7% in the second quarter of 2014 to $225.7 million and increased 6% to $422.3 million in the first half of 2014. Lease and rental gross margin as a percentage of revenue remained at 31% as a percentage of revenue in the second quarter of 2014 and at 30% in the first half of 2014. The increase in margin dollars was due to higher rental pricing and demand as well as benefits from depreciation policy changes. Services Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (Dollars in thousands) Services revenue $ 741,427 707,666 $ 1,451,126 1,397,127 5% 4% Cost of services 625,276 590,311 1,231,505 1,173,900 6% 5% Gross margin 116,151 117,355 219,621 223,227 (1)% (2)% Gross margin % 16 % 17 % 15 % 16 % Services revenue represents all the revenues associated with our SCS business segment as well as contract maintenance, contract-related maintenance and fleet support services associated with our FMS business segment. Services revenue increased 5% in the second quarter of 2014 to $741.4 million and increased 4% in the first half of 2014 to $1.45 billion primarily due to new business and higher volumes in our SCS business segment, especially in our dedicated services offerings. Cost of services represents the direct costs related to services revenue and is primarily comprised of salaries and employee-related costs, SCS subcontracted transportation (purchased transportation from third parties) and maintenance costs. Cost of services increased 6% in the second quarter of 2014 to $625.3 million and increased 5% in the first half of 2014 to $1.23 billion primarily due to higher revenue. Costs of services also increased as a result of greater than expected start-up costs on a new SCS international distribution management account, downtime and other costs related to severe winter weather in our SCS business segment and, to a lesser extent, shutdown costs related to lost business in the automotive sector. Services gross margin decreased 1% to $116.2 million in the second quarter of 2014 and decreased 2% to $219.6 million in the first half of 2014. Services gross margin as a percentage of revenue decreased to 16% in the second quarter and to 15% in the first half of 2014. The decline in margin and margin percentage was due to greater than expected start-up costs on a new SCS international account and severe winter weather-related downtime and associated costs in SCS. Fuel Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (Dollars in thousands) Fuel services revenue $ 209,381 208,285 $ 420,737 422,133 1% -% Cost of fuel services 203,613 204,626 410,818 414,919 -% (1)% Gross margin 5,768 3,659 9,919 7,214 58% 37% Gross margin % 3 % 2 % 2 % 2 % Fuel services revenue increased 1% in the second quarter of 2014 to $209.4 million due to higher fuel prices passed through to customers. Fuel services revenue in the first half of 2014 remained relatively unchanged from 2013. Cost of fuel services includes the direct costs associated with providing our customers with fuel. These costs include fuel, salaries and employee-related costs of fuel island attendants and depreciation of our fueling facilities and equipment. Cost of fuel in the second quarter of 2014 remained relatively unchanged from 2013 and decreased 1% in the first half of 2014 to $410.8 million caused by lower gallons partially offset by higher fuel prices. Fuel services gross margin increased 58% to $5.8 million in the second quarter of 2014 and increased 37% to $9.9 million in the first half of 2014. Fuel is largely a pass-through to customers for which we realize minimal changes in margin during periods of steady market fuel prices. However, fuel services margin is impacted by sudden increases or decreases in market fuel prices during a short period of time as customer pricing for fuel is established based on market fuel costs. Fuel services margin as a percentage of revenue increased 1% in the second quarter of 2014 and was unchanged in the first half of 2014. 26-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (In thousands) Other operating expenses $ 31,007 32,876 $ 67,652 70,475 (6)% (4)% Other operating expenses include costs related to our owned and leased facilities within the FMS business segment such as facility depreciation, rent, insurance, utilities and taxes. These facilities are utilized to provide maintenance to our lease, rental, contract maintenance, contract-related maintenance and on-demand customers. Other operating expenses also include the costs associated with used vehicle sales such as writedowns of used vehicles to fair market value and facilities costs. Other operating expenses decreased 6% to $31.0 million in the second quarter of 2014 primarily due to a $1.7 million reduction in writedowns on vehicles held for sale. Other operating expenses decreased 4% to $67.7 million in the first half of 2014 due to lower writedowns on vehicles held for sale of $2.8 million and lower property insurance costs partially offset by higher maintenance costs for FMS facilities due to severe winter weather. Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (Dollars in thousands) Selling, general and administrative expenses (SG&A) $ 200,430 195,033 $ 392,132 384,106 3% 2% Percentage of total revenue 12 % 12 % 12 % 12 % Percentage of operating revenue 14 % 15 % 14 % 15 % SG&A expenses increased 3% to $200.4 million in the second quarter of 2014 and increased 2% to $392.1 million in the first half of 2014. SG&A expenses as a percent of total revenue remained at 12% for both periods. The SG&A expense increase in the second quarter and first half of 2014 was driven by higher compensation-related expenses partially offset by lower pension expense. The increase in the first half of 2014 was also impacted by higher information technology and marketing-related costs. Pension expense, which primarily impacts SG&A expenses, decreased $3.7 million in the second quarter and $6.2 million in the first half of 2014 reflecting higher than expected pension asset returns in 2013 and lower service costs. Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (In thousands) Gains on vehicle sales, net $ 34,365 23,197 $ 63,183 46,203 48% 37% Gains on vehicle sales, net increased 48% in the second quarter of 2014 to $34.4 million and increased 37% in the first half of 2014 to $63.2 million due to higher average proceeds per unit. Global average proceeds per unit increased 15% in the second quarter of 2014 and 11% in the first half of 2014 partially due to an increase in retail sales. Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (Dollars in thousands) Interest expense $ 35,302 33,901 $ 70,411 68,355 4% 3% Effective interest rate 3.1 % 3.5 % 3.2 % 3.5 % Interest expense increased 4% in the second quarter of 2014 to $35.3 million and increased 3% in the first half of 2014 to $70.4 million reflecting higher average outstanding debt partially offset by a lower effective interest rate. The increase in average outstanding debt reflects planned higher vehicle capital spending. The lower effective interest rate in 2014 primarily reflects the replacement of higher interest rate debt with debt issuances at lower rates. 27-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) Three months ended June 30, Six months ended June 30, 2014 2013 2014 2013 (In thousands) Miscellaneous income, net $ 4,828 3,575 $ 10,210 8,145 Refer to Note (Q), "Miscellaneous Income, Net" in the Notes to Consolidated Condensed Financial Statements for a discussion of the components of miscellaneous income. Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (Dollars in thousands) Provision for income taxes $ 44,351 34,787 $ 70,257 56,493 27% 24% Effective tax rate from continuing operations 36.9 % 35.7 % 36.0 % 35.3 % Our effective income tax rate from continuing operations for the second quarter of 2014 was 36.9% compared with 35.7% in the same period of the prior year. The increase in our effective tax rate in the second quarter of 2014 reflects higher non-deductible foreign operating losses. Our effective income tax rate from continuing operations for the six months ended June 30, 2014 was 36.0% compared with 35.3% in the same period of the prior year. The increase in the effective tax rate in the first half of 2014 reflects higher non-deductible foreign operating losses partially offset by a benefit from a tax law change in the state of New York. Three months ended June 30, Six months ended June 30, 2014 2013 2014 2013 (In thousands) Loss from discontinued operations, net of tax $ (336 ) (381 ) $ (1,202 ) (1,259 ) Refer to Note (C), "Discontinued Operations," in the Notes to Consolidated Condensed Financial Statements for a discussion of losses from discontinued operations. 28-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) OPERATING RESULTS BY BUSINESS SEGMENT Three months ended June 30, Six months ended June 30, Change 2014/2013 2014 2013 2014 2013 Three Months Six Months (Dollars in thousands) Revenue: Fleet Management Solutions $ 1,181,222 1,121,258 $ 2,316,309 2,220,990 5% 4% Supply Chain Solutions 627,579 597,177 1,224,920 1,173,656 5 4 Eliminations (124,230 ) (114,436 ) (245,921 ) (227,630 ) 9 8 Total $ 1,684,571 1,603,999 $ 3,295,308 3,167,016 5% 4% Operating Revenue: Fleet Management Solutions $ 907,921 852,527 $ 1,767,837 1,676,515 6% 5% Supply Chain Solutions 545,438 514,802 1,065,876 1,009,633 6 6 Eliminations (60,310 ) (53,990 ) (118,186 ) (105,288 ) 12 12 Total $ 1,393,049 1,313,339 $ 2,715,527 2,580,860 6% 5% EBT: Fleet Management Solutions $ 113,509 88,667 $ 190,500 149,412 28% 27% Supply Chain Solutions 30,728 32,968 52,512 57,404 (7) (9) Eliminations (10,523 ) (8,690 ) (20,151 ) (16,648 ) 21 21 133,714 112,945 222,861 190,168 18 17 Unallocated Central Support Services (12,125 ) (10,584 ) (22,954 ) (21,959 ) 15 5 Non-operating pension costs (1,544 ) (4,999 ) (4,858 ) (10,243 ) (69) (53) Restructuring and other charges, net and other items - - - 1,904 NM NM Earnings from continuing operations before income taxes $ 120,045 97,362 $ 195,049 159,870 23% 22% As part of management's evaluation of segment operating performance, we define the primary measurement of our segment financial performance as "Earnings Before Taxes" (EBT) from continuing operations, which includes an allocation of Central Support Services (CSS), and excludes non-operating pension costs, restructuring and other charges, net and the items discussed in Note (O), "Other Items Impacting Comparability," in the Notes to Consolidated Condensed Financial Statements. CSS represents those costs incurred to support all business segments, including human resources, finance, corporate services and public affairs, information technology, health and safety, legal, marketing and corporate communications. The objective of the EBT measurement is to provide clarity on the profitability of each business segment and, ultimately, to hold leadership of each business segment and each operating segment within each business segment accountable for their allocated share of CSS costs. Segment results are not necessarily indicative of the results of operations that would have occurred had each segment been an independent, stand-alone entity during the periods presented. Certain costs are considered to be overhead not attributable to any segment and remain unallocated in CSS. Included within the unallocated overhead remaining within CSS are the costs for investor relations, public affairs and certain executive compensation. Inter-segment revenue and EBT are accounted for at rates similar to those executed with third parties. EBT related to inter-segment equipment and services billed to customers (equipment contribution) are included in both FMS and SCS and then eliminated (presented as "Eliminations" in the table above). Prior year amounts have been reclassified to conform to the current period presentation. 29-------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued) The following table provides a reconciliation of items excluded from our segment EBT measure to their classification within our Consolidated Condensed Statements of Earnings: Three months ended June 30, Six months ended June 30, Consolidated Condensed Statements of Earnings |