Knight-Swift Transportation Holdings Inc. (KNX) Earnings Call Transcript & Summary

Good afternoon, everyone. This is Tom Wadewitz from UBS, moderating a fireside chat with Knight-Swift. It's our pleasure to have Dave Jackson, the President and CEO; and Adam Miller, the Chief Financial Officer, on the line. It's great to have Dave and Adam. Thank you so much for joining us. It's great to have you.

We are going to just go ahead and get started with the fireside chat and with the questions. So I think to start with, Dave, maybe if you want to -- Dave or Adam, if you want to give us some thoughts on the trend that you've seen in terms of activity in the market? It seems like things have improved in May from the spot data from what we've heard from some others. But if you could offer some perspective on kind of what you've seen from activity in April and May? And why don't we start there?

Okay. Thanks, Tom, and it's good to be with everybody. I hope everybody is safe and healthy. We've talked a little bit about how April saw kind of a deceleration from May from a demand, even from a rate perspective as we saw quite a bit of acute tightness and spot activity to the positive side in the month of March as we finished the first quarter. And as we reported out for the first quarter, we talked about expecting to see things slow in late April and early May and likely that would be a bottom. And so I would -- if you looked at the third-party data, it would suggest that something very similar to that happened. And so the good news there is we're -- is we feel like the bottom or the worst of it is behind us. And that bottom, that plateau, if you will, at the bottom was not very long. And so we've seen that pick up, particularly in the one-way truckload side, if you were to look at something like the dedicated world, that business, if you had dedicated with a customer that was not severely impacted by COVID-19, which wasn't the case for all that many. But certainly, there's cases like that. Then you had some nice stability there. And if you had a dedicated operation that was connected to a retailer, like a clothing retailer, for example, where clearly, their business was rather severely impaired there for an extended period of time. Those dedicated operations would take probably a little longer to ramp up in part because the -- during much of April and that first part of May, I would say there was a lot of looseness in capacity, and it would be then they may consider supplementing some of that dedicated with one-way. So most of my comments when I talk about the kind of strength directionally that we've seen, would relate to the largest part of our business, which would be a regular route one-way truckload. So the reality is as stores open, truckload increase and truckloads often begin to move in advance of stores opening and in anticipation of that. And we've seen some good store openings start to happen here as we've gone through May and now especially as we get into June, we had rather light inventories before COVID-19 began. And so now the ability to have a large network that has trailers where they can store, they can stage products in trailers and be prepared to try and take advantage of what might be some pent-up consumer demand and as consumers find themselves with some stimulus check money still in their bank account, and obviously, in many cases, like my household savings rate goes up a little bit when you're limited from travel and other activities. So that all feels like we're moving in the right direction. And of course, produce season is something we always expect seasonally this time of year, produce has been good, probably stronger on the West Coast. Southern Arizona would be real big right now. Florida seemed to get a lot of rain, and that seemed to have been a bit of a negative on the quality of some of the produce coming out of Florida right now. But -- so seems though as though companies are willing to pay a little bit of a premium to bring it to a -- have it travel a little bit further from the West Coast but nonetheless produce season, beverage season coincide with temperature, and so we expect that to continue to grow. It's just a supplemental element to everything else that's going on as supply chains are opening back up throughout the country. So Tom, hopefully, that gives you kind of an overview on demand.

Sure. Yes, that's great. So as you seen some contribution to activity from some of the areas that were hit pretty hard so food service and specialty retail. Is that kind of early on that, that was seeing some benefit, but that would ramp as you see further reopening, and that would be in those 2 segments would continue to be drivers of improving the loads as you look into June. Is that a fair way to look at or even as you look in second half?

Yes, I think that's a fair way. I think that some of that has already started. Food service businesses were severely impacted with all the restaurant closings and so that is -- that's already begun to ramp up from what we can tell in the marketplace. So yes. I think that those that plan to reopen to some degree or another have already started, at least positioning goods, if not starting to fill and replenish stores. So feels like it has the potential just to continue to ramp from here. And based on what we see in the third-party data, measuring the market and measuring trucks, it sure feels like we're -- we have a lot less supply as we start June than what we had when we left off in March. And so that is a key factor. So I mean that's a big piece to what we're seeing and feeling now and will have a big impact on what the rest of the year looks like.

Yes. And Tom, just to add to that, some of the retailers, particularly apparel, they've started to reopen. I think some are getting close to 50%, some are above that, but there's still certain -- certainly some areas where there were some COVID-19 hotspots, have been slow to ramp up. And so I think there would certainly be more to come, which would result in some additional demand. It's encouraging to see what the MDI trends have been despite that you still have some stores that need to reopen. And I think it's just an indication of how much capacity has come out of the market due to what's happened with spot rates, how depressed they've been, we've seen the truck orders, they're down at historic lows. Trade orders are at historic lows. And even -- and we start even looking at some FMCSA census data that shows the number of DOTs to change month-to-month, that's declined, I think, almost 3,000 over the last 3 months. So I think we would expect to see some continued strength from an MDI standpoint on a go-forward basis here as we open and stores start to ramp up. The real question is, how does the consumer return? And I think thus far, commentary that we get from some of our customers is demand has been relatively strong. And then there's some -- the savings rates have been as high as we've ever seen, as Dave mentioned. And so like we do as Americans, we want to get out and shop.

Indeed. You -- Dave, your comments on produce and kind of seasonal patterns seem constructive. Would you expect the kind of normal seasonal strengthening? So May ramped up versus April for a variety of factors, but when you think about June versus May, do you expect kind of a normal seasonal pattern with produce and beverage?

Yes. The shortest answer I've ever said.

I would say that goes on record for Dave's shortest answer.

But yes, no, we expected to see that normal trend, which builds sequentially. And so all indications are that's what we should expect.

Right. Great. How do you -- I mean, I guess this is almost kind of a backward-looking question as activity ramps. But just to get a framework, how do you think about the mix of fixed and variable costs that you have. I tend to think of the truckload model versus some of the other freight network businesses that have pickup and delivery moves that you have a meaningfully higher variable cost component, but maybe at a high level, how you think about how much is fixed and how much is variable in the cost structure?

Yes. So we'd estimate that comp to be about 60% variable, 40% fixed. What would change that? If you just look at the cost per mile, certainly, if there's an impact to productivity, then your fixed cost on a per mile basis could increase as a percentage, but generally speaking, in a normal environment that would be the mix between the two.

Right. Okay. And how do you think about what's happened with the bid season? It seems that, I guess, the most pronounced weakness didn't last for a long period. April was probably pretty weak, but it seems that things started to improve fairly quickly, but that said, did -- how do you think things are kind of progressing out of the bid season? Is it kind of -- if you're getting low single-digit declines, you're doing pretty well? Is it more like -- is it -- I don't know, we had fireside with Echo Global Logistics earlier, and they talked about contracts being down kind of mid-single digits or more, but I guess when you have an asset framework versus a broker framework, the outcome on contract can be quite a bit different, so any thoughts you care to offer in the bid season and how things are playing out?

Yes. Well, it's been a very unique bid season. Clearly, it was completely interrupted kind of in the busiest prime time of bid season. And just to appreciate this, when you look at the MDI, the Market Demand Index from Internet Truckstop that Adam referenced earlier, it was off to a really, really good start in January and February. Now that hadn't translated into increased contract rates, but we very much felt here in 2020 that we were on to kind of the inverse of what we had seen in 2019. 2019, of course, came off of 2018, a very strong year, strongest year in trucking rates on record and kind of lost steam by the time we got to the end of the bid season. So we went from upper single-digit contract improvements down to flat or so by June. And we saw that based on the data and the attrition in supply, we saw 2020 being -- playing out the opposite, where we would start off with pressure on contract rates that would largely loosen. And by the time we got the seasonality in May and June, we thought it was reasonable to think that those rates would inflect nicely in a positive direction. And so that's where we were. So then we kind of have this -- then we get T-boned with the pandemic. And now that MDI is back on the same kind of steep trajectory working its way back. So we just take all of that into consideration. The environment we were in, where we're at today. We feel like more supply has come out. We feel like there are more constraints today now that the banks are less likely and have less interest in financing to support the cash flow needs, which are deep in this capital-intensive business. And so all the trends point to the fact that there are fewer trucks out there. So as demand comes back online and you have some of the seasonality that comes with like produce season here and then, of course, the seasons -- holiday seasons, we'll see in the back half of the year, they have the potential to create some very acute tightness. And so that being said, as we go through bids right now, you have some customers whose businesses were not terribly disrupted through this pandemic. And those groups have been accustomed to many, many carriers coming to them, trying to offer supply. And so they might have a little different view of the world on how supply to the world is versus you have others who didn't move anything for 4, 5 or 6 weeks. And now they're coming back and saying, "Hey, can we just kind of forget that we didn't do anything and pick back up where we left off, and then you have others who are somewhere in between that. The reality is, the decision was made long ago, we didn't make it, but the decision was made that this industry was going to move based on market rate. And so different than buying trucks, for example, where they just hit us for whatever steel costs are up and other cost factors and other inflation, and they take it up a couple, 2% or 3% year after year, and that's kind of how that works in that oligopoly world. In our world, the way it works is we all agree, hey, it's -- the market is going to determine this. And guess what the market said, 2018 was a catch-up year. So rates were going to be up double digits. And in 2019, as it progressed, it turned into rates down double digits in many cases, certainly in the spot world and pressure to the negative. And so the reality is, regardless of what people are doing or saying in the short-term on bids, the market is going to decide. And if there is acute tightness, we will see that manifest later on in the fourth quarter. And I think one of the reasons that the spot rates have such a big impact on contract rates is for most shippers, their full truckload moves or one-way moves, in particular, only represent a couple, 2% or 3% of their -- all their revenues. And these businesses have a significant portion of their revenues are tied up in marketing and building buildings and hiring people to be in those buildings and shiny lights that shine on that product that has to be there on the right day after it's been advertised, and so to try and cut corners on not in risk, not having those products there is just isn't a good bet for a shipper to make. And so when we have acute tightness that's when all of a sudden, we see spot rates pick up. We see contract rates go up because now it's about securing capacity consistently to get us through that. So it can be a little bit of a messy process, but we feel like we see it and measure it in all kinds of varying degrees. And it's not just a black or white. And so we try and anticipate, predict and be prepared for. And so we're not trying to get overly caught up on what exactly is -- are the demands on a contract process today as opposed to where do the returns need to be and how do we want to try and position ourselves to be closer and closer to the appropriate return. So I hope that helps.

Yes, that's helpful. I mean, do you think it's fair to say that there is a period which may be somewhat brief where there was some greater pressure on rates, and that probably has seen a bit of a headwind and then to your point on spot, hopefully, you can kind of work through that quickly?

Yes. I mean, there's definitely -- I mean with April and May being 2 of the 3 months in the second quarter, you're definitely going to see headwind there in that near term. And then, of course, we'll have to see to what degree June sees the seasonal strength, what degree that carries into July, which in really strong times it does. And we're just at a unique spot here where we have an economy that's trying to thaw out and has all kinds of capital that's been -- that's been infused that will then shortly after we see that kind of play out, we find ourselves in the holiday season. So there's reasons to be optimistic on demand being able to keep stepping up. And the truth is there's enough stimulus on the demand side that it's a very reasonable conclusion to come to that supply side can't keep up with a fast-growing demand side if things come back online. And so the fact that we've lost so much supply, the fact that there's still quite a ways to go for truckloads to get back to where they were, and yet we're already seeing spot rates, the gap between contract and spot tighten not because contracts are dropping, but because spot is picking back up above that level that was just unsustainably low. And what we see with MDI, and that's with very, very muted demand, still gives you a sense for the fact that we could find ourselves with supply that slowly comes back and demand that comes back much more dynamically or much more expedient rate.

Yes. And I think, Tom, if you even look at some of the surveys done on -- with logistics providers, particularly brokers, I mean, you're seeing margin compression happen pretty rapidly as you move from April to May, and that would just be an indication of capacity, really starting to tighten up in certain markets where the economy is open back up. And hey, it just opened up and is getting going. I think there's still a lot of runway for many of these states to loosen up restrictions. And so I think you're going to see the looseness that I think everyone is referring to, that gets sucked up with demand as that begins to build, and you could see some acute tightness across the country.

Right. Let's delve into that a little bit further. I had a couple of questions that came in here online. And so -- and I think they sit pretty well into the discussion. Are you -- do you think that the CARES Act and the PPP program, the kind of Payroll Support Program have affected the capacity attrition and maybe caused some of the capacity to stick around longer. I guess it's probably hard to parse that out. But do you think that's been an effect or not?

I think it has been a meaningful factor. Those -- I think those funds got snatched up pretty quickly. But based on -- based on one part of the -- based on a program that the TCA has with 240 carriers, midsized carriers, they average 167 trucks. That group says that somewhere between 2/3 and 3/4 of those 240 midsized carriers were applied and were approved for the PPP program and those that didn't -- most of those that didn't apply or be approved, they were largely independent contractor fleets or they were -- a couple of the larger ones that had more than 500 employees. So what that tells me is of the midsized ones, which you would think would fare a little better than the 5 to 10 truck player, which happens to be the majority of the capacity, but for this group of, in particular, 240, were it not for the Paycheck Protection Program, they -- there's a good chance they may not be there. And the reality is this is a very temporary thing. And there's very, very serious cash flow problems that they face. And you've got the whole used equipment market that is a huge wet blanket on these businesses and their ability to generate enough cash float when they need it or to survive a difficult time. And some have estimated that, that -- over that April and May time period, that was the most difficult time for small and mid-sized trucking companies in the history of trucking with massive losses. And so that's -- the market -- I think we're seeing some of those signs when we talk about the kind of strength we're seeing this quickly with this new demand already coming back. Rates are not necessarily going to come back maybe fast enough for some of these guys to dig out as fast as they need to. I mean those rates still may take much of the third and into the fourth quarter. And there's a lot of OpEx to be issued. A lot of fuel bills to be paid between now and then, so...

So if that program is not extended beyond, I think it's late June or July, then that potentially would add some pressure to the market if you look at kind of maybe third quarter?

We think so.

Right. Okay. What's your best sense of when you think that capacity attrition is really going to drive the market to be tight? I mean, obviously, you got supply and demand, and it's kind of hard to have a perfect read on both. But assuming you get some ramp in demand in the second half of the year, do you have kind of a normal seasonal pattern where you got kind of peakest level in June and then you fall off a little bit? And then you build in fourth quarter? Or when do you get some capacity benefits sooner? Or how do you think about that equation?

Well, in really strong years, the strength you feel in June, you almost always see seasonal strength in June, in strong years, that strength sometimes carries all the way through July. And then August is sometimes a little bit of a catch your breath, and then you have some strength into the Labor Day holiday. And then sometimes, it starts to pick up. It doesn't drop off much. And then October, November pick up for the -- going through the end of the year. That's in a really, really good year. And so even in a typical, just a normal year, you almost always see that seasonality in June, but then right after the Fourth of July, it just really, really goes quiet. I think the way to look at this is supply, from all indications, supply most likely grows at tens of basis points, and while demand is growing at hundreds of basis points. And I don't know that it grows at tens of basis points for all carriers across the board. As we remember, in 2018, we saw a record number of new trucks purchased by small carriers and we tend to think that, that has a lot to do with trying to recruit drivers. So they definitely can't do that this go around, we've seen through the pandemic a record number of driver -- experienced drivers looking to drive for us as measuring that by a percentage of the drivers that are experienced drivers versus trainees that we would hire. And so we interpret that to some degree as a flight to quality, if you will. So not only do we continue to have younger equipment and a bigger and better network and benefits and stability that they seem to recognize in a time like this, but it would just be very difficult for a small guy to compete with an older truck and a less stable freight network. So I think that supply side is going to stay a little more muted here as we move throughout the year, regardless of the fact that demand is picking up at a faster pace. So hard to predict exactly when and where that seasonality for this year relative to what we've seen in other years or other strong years go, but it does feel like there's a good sequential runway story that we kind of see for sure.

Right. Okay. And you think that capacity attrition has an impact fairly quickly?

Yes.

How would you think about the opportunity for pricing? I mean, I guess, in 2021, I think the way that I'm thinking about 2021 from a demand perspective and who knows, but you got to have a cycle view. And so it seems like considering 2010 as an analogous period is reasonable. And so if you do that, you say, well, freight activity off a low base was up a good percentage in 2010, so you could look at rail activity up kind of 10% rail volumes in 2010 or you could look at truck metrics, probably cash up a similar ballpark. And so if 2021 has that demand improvement and you get some of the attrition that comes through, do you -- how would you think about pricing? Because it's like you could have a lot of tightness and have a really big contract year or maybe it takes longer for the capacity to really leave the market. So I mean, obviously, nobody knows at this point, but would you think 2021 could be a very tight year and you could see a pretty big pricing? Or is that too optimistic that it usually takes a couple of years to kind of get that really tight kind of mid-single digits or better pricing?

Well, I think 2021 could be a pretty strong year with rates, but that is because it does take a couple of years. And we've had a couple of years. It was August of 2018 that the spot rates peaked on the load boards for the smaller players. And so that played out through the remainder of '18 and a little bit softer seasonal demand market. For players like us, we had already secured and allocated capacity, the market was a little more efficient. And so we were still paid for that, but we had belt and -- provided belt and suspenders for many of our customers to have enough capacity to be ready for a really strong fourth quarter of '18 because fourth quarter of '17 was so chaotic, and acute in the tightness. So if we go back, this August will represent 2 years since rates started to decline. And I would say that rates are still for the small player, the rates are still at an unsustainably low level. That group I referred earlier, of the 240 group that participated in a program to the TCA their average operating ratio in 2019 was a 99% OR. So we're -- we've already come a pretty long way where it's been a difficult environment made significantly worse so far in the first half of the year for us, particularly for a smaller carrier. So I don't think -- so there's a precedent for there to be some pretty healthy strength that following year. Now it usually is -- it's -- the strong year usually comes after some seasonal tightness. And that's what happened in fourth quarter of '13, leading to 2014. That's what happened in 2015 bid rates compared to a very robust 2014. So -- and then again, fourth quarter '17, very, very strong year in '18. And '18 was still strong enough that the '19 contract rates were still -- still carried a lot of strength to them. And so it seems like we're in for something more than that. What's a little bit different this go around, maybe not a little but a lot different is we have ELD. So when you saw the network disruption that happened when, yes, some of your customers still haul loads and they were hauling twice as many loads and other customers were hauling nothing that is incredibly disruptive to a freight network, which is what we saw in March, and we've seen that in April and May as well. And so not all carriers can quite adapt to that as easy as others. And so can you imagine if small carriers had paper logbooks with almost impossible to enforce logs in a cat and mouse game potentially. Can you imagine the amount of extra miles that would have been run and the capacity that would have been created at exactly the wrong time with a, call it, a 10% increase in miles that were not paid, but miles that were driven and capacity that gets provided, and that's not happening and those rate deficiencies can't be outrun or out worked through more miles like they have in previous cycles. So I think that explains why we've seen such discipline in truck orders. We've seen such discipline in trucking employment and perhaps why we see such a steep curve in MDI this early with this little demand coming back online.

Right. Okay. I want to ask you a little bit about technology and how you think about it. From the -- I guess, the risk perspective, you could say, well, technology tends to drive more transparency to pricing and maybe that's not -- it could drive a little more pressure on pricing? Or maybe it just caused this cycle to move more quickly. But at the same time, being the largest truckload carrier and having a lot of resources, you can spend on technology and do interesting things with it. So maybe if you could offer some of the key things you're trying to do in technology and how you think about how more price transparency affects truckload and perhaps brokerage as well?

Okay. Well, and Adam can jump in and help me on this, too, if that's okay. But a couple of things on technology. Sometimes people measure our degree of innovation or how forward-thinking we are based on the number of press releases we make about IT or the number of ads we buy in magazines or online. And what I would tell you is you can't run a business -- an asset-based business in the upper 70s in great years and in the low to mid-80s in tough years without a tremendous amount of efficiency that comes through the use of technology. And so I hope that counts for something. It's funny. We've made a couple of press releases in the last 6 or 8 months about some pilot programs we've been on and I've had so many people make comments to me about how forward-thinking we are. And it's, all I can think, I probably shouldn't say this, but all I can think of is, if you had any idea of the solutions that have real substance in our business that we've been using that enable us to see and predict the market and enable us to move our rates and position our business with tremendous agility or to enable us to have one of the lowest, if not the lowest ratio of nondrivers to trucks on the road on the asset based side of our business we do that with a lot of technology. And so then you'd really, really be excited about that. So our goal is roughly to have at least 3 legitimate solutions to every one press release we ever put out in the public, just for what it's worth. And so I would say when we look at technology, one of the very first things we did when we completed the merger in September of 2017 of Knight and Swift, was to consolidate the IT group, not to save money on headcount, but to bring the best ideas because both businesses had different objectives and plans developing technology around the driver experience, particularly the driver experience in the cab of the truck, how they plan their day, everything they do, how they behave, safety wise, fuel wise and productivity wise. We had initiatives focused around our customers. We had initiatives in the third bucket, focused around working with third party carriers. And then the fourth bucket was technology that helps us become much more efficient as an overall business. And so we have data scientists. We have, we call them mathletes that help us solve mathematical equations, that help us do machine learning, help us with artificial intelligence. I'll let Adam talk a little bit maybe about API and some of the things we're doing there. I will tell you, we have made dramatic progress in all of those areas. And we're trying to catch up to the privileges we enjoy by owning 58,000 trailers. If we add all the container boxes to that, we're at almost 68,000 boxes or containers. The fact that we have 19,300 roughly at the end of the first quarter, power units with drivers, the fact that we have 20,000 carriers, the fact that we have access to what we believe to be the largest -- we have the largest view of freight because we have 1,000 customers. We see hundreds of thousands of lanes through bids, of which we participate in a very, very small fraction. And so there is a tremendous amount underway. We have beta testing of all sorts in all sorts of areas. The biggest opportunity with us and technology is how do we leverage a capital investment we've made that's unique that no one can quite replicate at least without spending a whole lot of money that, all by the way, is already profitable and used, but could be better optimized and how do we combine that with the desires and needs of customers that have shifted towards a new way of managing inventory and how can we leverage all the data we have in between. We think we have all of the pieces, and we'll keep working on that. I think in the end, there are platforms that can be developed that can truly create that platform effect where one begets the other. Nobody has done it yet. Nobody's done it. And there's many that have tried but the reality is they've not been able to create the upshoot in growth that truly comes when you create a platform effect. And so they've had to try and manufacture it, either with artificially low rates that the minute you bring that rate back to a normal rate, it evaporates or they've had to cannibalize other areas of their business, whether that be asset-based business originally that now is brokerage and brokerage that's now done in different way or as they drive volume through it, they become less efficient and less profitable with more people per load as opposed to less people per load. And so everybody is chasing it. Few want to admit they're really chasing it, but everybody is chasing it, and I don't think anybody has found the formula yet. And so, hey, we have the most to gain and arguably the most to lose, given our size and scale. But we think there's -- we have a uniqueness that we're looking at with technology. So it's something we like to talk about more after the fact than we ever do trying to telegraph in advance. So Adam, would you...

Yes. I think, Tom, you mentioned the pricing transparency. And to mention, I think of just the customer experience and how you can deliver a real-time price to them when they have a spot or an ad hoc need. And I don't think that maybe applies to when you're working through bids and securing contracted business, which is our committed business, which is the vast majority of what we do. But we've invested in a team of data scientists that have been able to develop pricing algorithms and develop connections with our customers into their systems versus them coming out to our site but connecting directly into their system to create a less friction in that transaction. And when they have a need or a load that they need to store, we can provide them real time pricing. That gives them an opportunity to tender that load through their system and to make it as easy as possible to work with. And I think the advantage is that we would be able to leverage, and it's different. It bears fruit in different markets is the fact that we can offer a real-time price with a trailer component, right, where they're not having to convert a load to a live load, live unload if they're dealing with a broker, but they can do it with someone who has trailers on a yard that provides them the efficiencies they pick up in their warehouse. Now surprisingly, there's a lot of customers that are intrigued by that, and we partner with many of them to provide this service, but there are many that want to head down that path, but just don't have the internal resources on their own platform to do so. But we want to be in the forefront of that. We have the relationships with the largest shippers in the world. And we're developing those tools that we believe make it easier to transact with. And so we're certainly making those investments. And hey, we're excited about the path we're on to continue to develop our tools.

Great. We -- I think that's a nice kind of -- I guess, a nice topic to close things with a lot of interesting things happening there, a lot of potential to leverage the assets with technology in the future or to do some interesting things, I think, with the trailer fleet. We're a couple of minutes over the endpoint, so we should wrap it here. I just want to say thank you so much, Dave and Adam, for joining us at the conference, for doing the presentation, a lot of great insights, and for doing the fireside chat. And yes, thanks again. We look forward to being in touch.

Thanks so much, Tom. Stay safe, everybody.

Okay. Thank you. Have a great day.