Werner Enterprises, Inc. (WERN) Earnings Call Transcript & Summary

Great. Good morning. Everybody, this is Ken Hoexter from B of A, the airfreight and service transportation and marine shipping analyst. Next up, we have Werner Enterprises. This is one of the largest and best-managed truckload operators in the U.S. Joining us is Derek Leathers, President and CEO. Derek, who's joining us for the second time, has been CEO since 2016, president since 2011 and prior to that, was COO. John is making his eighth appearance here at our conference, and could be up next to join us for the 10-timer club in a few years. He's been CFO since 1996, having been on the job for more than our nearly 2 decades of coverage. So happy to welcome them both here this morning. Derek, let me just open up with the port of L.A. and New York this morning. Both of the carriers mentioned that the dollar store demand remains one of their strong volumes in moving product. So great job in choosing your end markets over the years.

But Derek, let me just throw it over to you maybe for some initial thoughts on the market. Obviously, a recent update on what's going on in the market, but include your thoughts on demand as we wrap up April, and now are well into May. And how is the slow reopening impacting operations as you see it?

Yes, sure. Well, first off, thanks for having us, Ken. Appreciate being here. As it relates to demand overall, it's certainly been a bumpy ride over the last 6 weeks or so. It was -- we're heavy in the discount space, discount retail, essential goods space overall, large Dedicated presence, as you know. And that's held up much better than the One-Way market has. But if you think about demand overall, it actually increased with the early weeks of COVID and as people were doing a lot of replenishment of essential goods and supplies. People have migrated from a retail perspective to closer-to-home stores, not making larger drives to bypass maybe what would have been closer to their home location, but instead staying tighter. And so that's worked well for the dollar business overall. Our volumes were pretty robust at the end of the first quarter and then started to taper off maybe the last week of March a little. As we got into April, we knew it would slow down. We've seen some slowness, but really fairly normal year-over-year, if you will. A little slower this year, obviously, as people have been sheltered-in-place. So the real question becomes as stores start to reopen, we've seen the replenishment supply volume kind of decrease. We've not yet seen a lot of the reopening volumes take its place, so thus, the step-down in volumes overall from March to April. But we are -- early indications are pretty good about some of this reopening work and we're starting to see volumes trickle in that are increasing fairly readily, and the outlook over the next several weeks looks similar. We're going to stick with what we said on our last call, though, that the second quarter is still going to be tough. It's too early to say otherwise. But there's optimism kind of, at least in my mind, toward the latter part of the quarter. But right now, that's really -- it's too early to kind of count on it. But signs are improving, would be the best way to maybe describe it.

Yes, certainly. We had a -- our truck shipper survey that we do every 2 weeks certainly bounced up a touch after setting for all-time lows. So maybe just kind of continuing on that. So if there's hope for maybe a bottom or a turn, obviously, the big question is how big is that ramp-up then. But you kind of left your thoughts for -- as you thought about One-Way TL revenue per total mile down 7% to down 5%. Maybe talk about how bid season is progressing and your thoughts on rates. It seemed like those rate targets were kind of unchanged for the year when you reupdated them. Maybe just your thoughts on what signals you were seeing in the market there.

Yes. I think the tough part on the rate is less about rate negotiations and more about what level of reliance we'll have in the spot market during this downturn or during this difficult period. The spot market has been really devastated from a rate perspective. I mean you're seeing rates that are 20% to 30% below people's kind of core operating cost. And so we have to play right now, in the spot market, a little more than normal. And there's a couple of reasons that happens. One is network balance is kind of in an ongoing state of flux because although the market is down, there are shippers whose volumes are actually up, and it remained up through the pandemic because of the kind of products they supply. However, the backhauls that enabled us to put trucks into headhaul markets where those shippers were located, those might be closed or curtailed to a great degree. And so you end up with trucks in spot markets even in a market that might be otherwise overall demand-healthy. And so it's hard -- we decide to stay with our guidance because if spot stays elevated in our network and the spot market rate stays depressed because of some of the underlying weakness in nonconsumer staples, it's too early to tell or to say otherwise. So first quarter, we weathered the storm better than most, and our rate held up a lot better than our guidance. But we just feel it's a little premature to change that guidance. I think the risk is to the upside, obviously, but if we were to wake up to a world in the second wave or a second shelter-in-place, we'd be right back where we started from. So for now, we're leaving the guidance unchanged. We have more optimism probably than we did, but it's a little too early to change that underlying guidance.

So just to clarify there, though, the optimism is more on the -- because if spot is being devastated just given the shift of some of those -- of some of the business and lack of backhauls, you're saying that optimism would be more on the contractual side? Or that spot is starting to fix itself?

No, I'm saying the optimism would be as our network stabilizes, our ability to get out of spot, whether it fixes itself or not. So there's multiple ways that we could become optimistic. One would be, spot market recovers and you start to see reasonable pricing take place in that market. And a totally different way would be our network balance gets dialed in a little better than it is and we've seen progress toward that end as of late, and you simply expose yourself to less spot. So whether it improves or not, doesn't necessarily matter if you can expose yourself to less of it. And so that gives me some signs of optimism. And then the third leg of that is, by and large, we're about 40% way through the contractual business, and those renewals have held up better than prior guidance, and we expect that they will continue to do so given the amount of capacity that we think is trading out of the market right now. And so there's several different ways you could get there. It's just a little too early to tell you which one of those will play the largest role.

So let me talk -- let's stick with your outlook for a second. You -- actually, while I'm -- before I ask the question just for investors and everybody listening on the line, if you do have questions through the Webex, feel free to submit additional questions. Or of course, you can always e-mail or IB me through the presentation. But Derek, talking about your outlook, you kind of set down 5% to flat total truck services truck growth from year-end after down 2% in the first quarter. And that was, what, about 200 basis points worse than your prior target. How do you think about that in terms of what is driving that? So now would you suggest that, that could also improve a little bit? Or is that kind of what you're targeting with your CapEx dollars? Maybe just walk through your thoughts on that target set.

Yes. We think that range gives us enough room where the improvement will take place within the range. It's not necessarily that we'd be resetting that range. But what happened thus far this year, so first quarter Dedicated pipeline was as strong as it's been in 8 quarters. So we feel good about what that pipeline looks like. The problem is implementation has been really slow. So nobody wants to implement new Dedicated fleets or to turn the lights on, on a major fleet transition in the middle of COVID. So the result of that is that we had fleets sort of slated to go out the door to be replaced by fleets that were coming in. And those fleets coming in dictated that there would be net growth. Well, if those fleets don't get implemented and those implementation dates are pushed off, that puts pressure on truck count. Unless you're willing to grow or park those trucks temporarily in one way, we didn't feel that was a prudent decision. In fact, we wanted to kind of reduce that One-Way exposure slightly, not real actively, not aggressively, but just a slight reduction of the One-Way side. And so that caused us to have to rethink truck count and broaden that range a little bit from the previous guidance. And so somewhere between negative 5 and 0, I don't think you'll see a year of plus trucks. But it could -- the way it could happen, if it were to happen, would be based on a sudden renewal of energy around implementation of bids that are already in the pipeline and/or won, but not yet implemented. And we're going to keep pressure on getting those done, but we also want to be respectful of all the various COVID protocols the customers have in place. So it's -- again, you'll probably hear this a lot through the conference, but it's just a bit early to try to give great -- any better color than that because we can't speak on behalf of our customers and each one of them, based on geographies and situational facts, have different reopening plans. But in summary, Dedicated pipeline is strong, Dedicated implementation is slow, win rates look good, One-Way is overly exposed to spot and therefore, not a strong desire to grow and if anything, rightsize that a little bit through the quarter. And driver availability, because of what's happened, unfortunately, with the economy overall, has increased. And so when we get ready to grow, if we have the opportunity and the market looks right to do so on the One-Way side, we know we can do that when the time is right. And there's no reason to hold trucks in anticipation of that and rather do it when the time is right.

So Derek, maybe as we see things that are going to start to open around the country, I would expect that we're going to see some pinch points, maybe as auto manufacturers begin to reopen on May 18, maybe as inventory replenishment starts to rebuild. Obviously, we saw some of that in March when there was a rush and a change in buying patterns, but maybe as some inventory replenishment. How, as CEO, do you look for those, and where do you anticipate some of them will come from? And I know auto is not necessarily large for Werner, but just given the supply chain, it could pull trucks away from certain areas and maybe that causes pinch points for you. So how do you think about that as we just start to get into this reopen? Or do you think it happens so slowly that you don't get any extreme pinches?

No. I think there'll be disruptions ongoing. I think this whole issue of like needing to rebalance and reoptimize the network kind of real-time is something we're going to live with for the next several months and probably a few quarters, to be frank. Because whether an automotive plant opens up that we do no business with or, in theory, we did a lot with, it has a similar effect on our network because as those -- as capacity moves into that space to support that big auto opening and the kind of volumes they produce, customers come calling and look to replace that or need help. And so it causes a lot of fits and starts in the network. And I think that's going to be a reality for the coming months. Same thing with some pent-up demand on nonauto type of industries, that really people haven't been doing any purchasing of things that involve getting into the home and delivering the appliances and durables into the home. People have kind of shut that off altogether, and yet there's still going to be a demand out there for it as they engage in the reopening. So we're going to see some ups and downs, and I think the network is going to have to be a little more fluid than we like it to be. Truckers make money off density and elimination of deadhead and empty miles. And when your volumes are fluctuating wildly week-to-week, market-to-market, it makes it tougher. But it also presents opportunities, and we'll certainly be presenting solutions to our customers in response to those opportunities.

So a lot of truckers have been talking about the industry-wide capacity rationalization has been underway. It seems like from our survey that we still see an extraordinary amount of capacity in the market. Can you talk about where you think the capacity stands from your point of view? I guess have you -- any anecdotal evidence or -- suggesting that the rationalization is picking up given what's going on in the COVID world?

Yes. I mean I think if you look at truck orders and how just unbelievably low those are, that's an indication of far-below replacement levels. I think you look at, anecdotally, across our brokerage network, and we know from speaking with many carriers that they have assets parked that they would normally look to sell but can't sell them, can't run them at current spot market rates, which are 20% below their operating costs. And so there is idle capacity out there, but there's also capacity that's just going to exit. There will be a spike in bankruptcies, and I think you'll see a rise in truckers exiting the marketplace. They've been aided through the early portions of the cycle through some of the stimulus funds, especially at the 500-employee-and-less type truckers. They've been aided with some fuel tailwinds. They've been aided due to some things that have helped them kind of get through it. But that's only going to last so long. If you've got trucks parked, not moving and fixed cost to cover, they're not going to -- that solution will only get you so far. And so capacity, we think, will rationalize. I think we're seeing the early signs of it already. I think that continues as you go forward through the remainder of the year. Insurance costs are still skyrocketing across the industry. And many times, the increase in premium in even in 2020, because we went through it in '19 and 2020, looks just about as bad or worse of a market, is far greater than the total profitability of the carrier. And so I think you'll see more rationalization as we go forward and this thing gets tighter before this year is out.

Great. Maybe talk a bit about, obviously, over the last couple of years, we've seen a greater and greater shift toward the Dedicated side from the One-Way over-the-road side, with your Dedicated fleet up 3% in the most recent quarter and One-Way down 7%. Can you give a little bit more color on how that is trending and maybe the economics that you see in that Dedicated side from the One-Way market?

Yes. I mean look, we've been pretty upfront about a few core kind of philosophical beliefs. I mean one was that we're going to consistently invest across our 5 Ts, and we've talked about that, and basically, just as a statement of quality and that we're going to stay invested in our -- across our organization in the highest possible quality. We're going to lean into Dedicated because we think it provides a stable platform over the cycle. It doesn't -- if you look at '18, it didn't hurt us in the upcycle, which has always been the concern as that would provide some sort of anchor into our results. That didn't happen. We were able to achieve really strong results in '18 with a large Dedicated presence. One-Way is always going to be more volatile, and certainly, in the market that we think is coming, One-Way will become more lucrative. We think we can adapt and be nimble into a market that gets stronger on the One-Way side when the time is right. But getting to a 60-40 mix was a strategic decision made long before COVID. It's serving us well during COVID, and we think it stands the time after COVID. We think that's the right mix for us. But as we have opportunities that come to us every year as it relates to CapEx, investment, placement of trucks and allocation of resources, it's going to be an internal competition. I mean we will look and see where we think those can best be served and where we can both serve our customers and our investors, and we'll debate those facts. But for now, in the short to intermediate term, 60-40 is where we see ourselves being. There could be small fluctuations, 1% or 2%, one way or the other. But somewhere in that range is where we think the sweet spot is for our organization based on our structure and the kind of customers that we do business with.

So Derek, I do have some questions coming online. But let me just ask one more before I get there in terms of rates, right? So if we see a reopening and a -- obviously, you mentioned the replacements coming in below -- or new orders coming in below replacement, which could start to tighten up the market. And if we start to see the reopening and those pinch points we talked about earlier, could you see a place where we start to see those spot rates, which you mentioned were down so much now, really start to scale up? Is that kind of the market that you kind of envision as you look forward in kind of looking at the state of the market right now and how things are set up?

Yes, I think they're set up for a movement in spot rates that's going to need to happen. And I think it's going to be a pretty meaningful movement prior to the closeout of this year. But the reality is, with the pressure of the overall supply/demand issue, concerns for people keeping their trucks moving, the digital broker effect that's caused some sort of market share gains to outweigh any kind of eye toward profitability in the short term, all of that's really kind of concocted an environment where spot rates are not even covering core operating costs for the majority of the people that are playing in that market. That can't last long. There's a lot of truckers in this world that are smaller in nature that maybe don't have all the analytics that somebody of our scale would. But you give them a month or 2, and they pretty quickly realize that they're not covering even their variable costs at some of the rate structures that are out there. They'll stop doing it. They'll park trucks. They're doing it now. We were hearing stories across the country of them doing it. You see the protest in D.C. going on about some of the spot rate levels. It is real. They need to come up, they will come up. And the question is, how steep is the slope? I think if the reopening goes relatively smoothly, and we have the expected hiccups that will come with it, but no major meltdowns as a result of it, I think spot market goes north from here. And at some point, it will need to accelerate pretty meaningfully later in the year as capacity rationalizes further.

Great. And then just moving to the -- one of the online questions. What are you seeing in your Cross-Border segment with Mexico? Are the volumes getting hit harder? I think there's a lot of questions just in the state of Mexico right now, just trying to understand if we're seeing a greater deterioration from the Mexican market. So given your heavy Cross-Border exposure, maybe just talk about that a little bit?

Yes. Mexico has been pressured certainly. I mean there's a few things that are -- where there's economic pressures, obviously, the same economic kind of shutdown, shelter-in-place type pressures in Mexico that you see in the U.S. But then you layer another complexity on there, which is that we didn't have our kind of essential business designations very lined up between the countries. So the NAFTA countries really didn't have -- or I should say, the USMCA countries, at this point, really didn't have good alignment on what was considered essential. So businesses in the U.S. that were open and able to ship maybe had counterparts or parts suppliers in Mexico that were closed and considered nonessential and vice versa. So the effect has been a little greater with Cross-Border than maybe what we've seen even domestically. But that is getting aligned and fixed as we speak, and we're starting to see a lot of things kind of line up for a brighter picture. My bigger concern in Mexico is really more economic. It's will they get their arms around this issue from a medical perspective? What effect -- when they went into it with sort of negative to maybe 0 GDP growth, negative 1 to 0 is where they -- that's their starting point before COVID. They've clearly suffered through COVID. The country of Mexico, in many parts of that country, where a lot of the workers come from to these warehouses and manufacturing plants, don't have the medical infrastructure even close to what the U.S. has. So how much longer might it linger? So we have concerns there, but again, our customer base is very carefully selected. They're winners that are high-quality companies with high-quality processes. We'll get through it. We do some -- a decent amount of OEM truck business in Mexico, and they've suffered just like the auto makers have with shutdowns and interruptions. That's impacted our network. But that was going on in March. That was going on in the first quarter, and we got through the first quarter pretty well. We're going to continue to be creative and try to weather and hunker down right now in the second quarter. This will be the worst of it, and then I think it gets better from here.

You talked -- I don't know if this is for you or for John, but you talked about some of the smaller carriers and the costs, and they're not covering some of their variable costs. How do you see the variability of costs for the truckload market when you think about, I don't know, whether it's salaries and benefits or purchased transportation rents? How do you think about the variability on the Truckload side in terms of your cost structure?

John, do you want to take that...

Yes, I'll jump in on that one, Ken. Yes. So as we measure it, we're about 60% variable, 40% fixed. The wildcard and classification between fixed and variable would be the nondriver workforce. It has more of a fixed component to it than a variable, so we've classified it in the fixed category. But the biggest variable cost would be driver pay, which is on a per-mile basis, fuel, equipment maintenance, insurance and claims. The steps that we've been taking on costs have been to try to adapt to this much more challenging marketplace in second quarter. So we've been aggressively attacking controllable costs. We did voluntary pay reductions for the exec team, hiring freeze for almost all of our open positions. We've deferred nondriver pay raises. We've got over 140 items in place for 2020, and the annual savings are well north of $10 million at this point. So while it doesn't offset the challenges of the pricing market, currently, it does help them make a dent in it. And we're doing everything we can to adapt on the cost side with controllable costs. One last thing I'd mention is, when it comes to drivers, we are absolutely not lowering driver pay. Our drivers are the heroes who are getting the essential products delivered in this economy. And we owe the world to them for the steps they're taking to keep America moving. And so on the variable side, we do not have any intentions of lowering driver pay at this point in time.

So Derek, in looking at the shift in the market, obviously, from stay-at-home measures and the shift to e-commerce, yet your focus has been on dollar stores. Have you noticed any, I don't know, share shifts in that, given your dedicated focus? Have -- it sounds like, again, even from the ports this morning that the -- those particular stores stayed strong going through this phase. Maybe just your thoughts on your end-market exposure through the COVID and through a rebound potential market?

Sure. Well, I mean, if you think about the market overall, we're a heavy retail carrier in terms of our customer base. But along with that, we worked aggressively over the last 3 years to align ourselves with winning strategies. Well, winning strategies are heavily composed of having an e-commerce presence. That was pre-COVID. It's more real now. Obviously, it's been accelerated or heightened. But the folks we work with are either in that dollar space that are -- whose bread and butter is made on people being in close proximity to their customer and their customer feeling comfortable going out in a small footprint environment and doing their shopping and taking care of their basic needs or it's a large big box retailer that has an omnichannel kind of strategy and approach. And those strategies have been developing and been executed well over the last several years and now are even accelerating. So in our current Dedicated portfolio, we have Dedicated fleets that are supporting aggressively e-commerce-type fulfillment operations, whether it be fulfilling warehouses and/or backup storefronts where they do home -- where they then take it, use the back of the store for final fulfillment to the home. And so we have a lot of exposure to it already. What I think matters more than what channel that retailer is, is strength lies in -- is whether that retailer is a retailer of strength to begin with. And so if you've aligned yourself with winning strategies that have been successful through the cycle, those are the folks that are doing well right now, both in home improvement, dollar businesses and discount retail overall. And we think that bodes well. So we like the alignment. We like our customer mix. We're going to stick with the -- kind of dance with the ones that brung us, so to speak, and continue to develop deeper relationships with them to help them get through this crisis, as well as ourselves.

So let's talk away from COVID for a second. Obviously, I mean, the fuel prices have really significantly changed and continued to increase the competitiveness of truck, in particular, in relation to rail. Have you seen kind of any rail intermodal competitive market switch? Or is just the COVID market too big a picture to see any shifts going on because of the decline in prices?

It's hard to say with great certainty, but it would certainly appear as though -- first off, with fuel where it is today, truck is certainly reputably more competitive on lanes that maybe in the past were more of a toss-up. Lanes that were maybe clearly rail that have become a toss-up, there's some of those, with fuel being where it is today and truck becoming more competitive. But the bigger reason I think we've seen some migration is some of the network disruption I talked about at the beginning of the call. When you have certain shippers that are needing to increase volumes by 30%, 40%, while other lanes and other regions are down 30% to 40%, it really disrupts balance across the network and causes the need for sort of more urgency in the supply chain to make it all work. And so to get back to that oversold environment more quickly, so you can then serve that again with that same asset, really bodes well for truck. And so there's been some of that type of migration. How sticky some of that will be? It's always hard to tell. It would seem to me that some of the lessons learned through this are going to stick beyond COVID, meaning, the nimbleness of truck versus rail, the service sensitivity that trucks can provide in times of crisis. But at the end of the day, economics play a major factor, too. So do I suspect we'll see a little bit migrate back over time? Sure. But I think some of that that's now landed on truck will stay on truck for the short to medium term, 1- to 3-year kind of time frame, while a little bit around the edges will migrate back.

Let me throw one question, before we wrap it up, on the Brokerage side. Obviously, it seems like it exacerbated an already difficult operating environment with the OR up at 99%. Maybe just talk about your thoughts on that market. Is that just, a, it's temporary? Or is anything structurally changed within the brokerage market? Maybe you want to just throw your quick thoughts on that one.

Sure. I mean this is -- it's a tough market right now. It's a very tough market. It's somewhat ironic because some of the things in the news right now are about a lot of contention out there about brokers and their margin levels and maybe taking too much of the pie. Well, that's -- the issue is the pie is too small to begin with. I mean rates can't go as low as they went and brokers be able to cover their cost while having enough for the carrier to cover theirs. And so everybody is kind of squeaking right now, and it's a little painful. But I believe in being mode-neutral. I think our portfolio sell is an important and critical part of our future. Our ability to go to customers and give them both asset and non-asset solutions is what sells and what they're looking for. We did operate, as you said, at 99% OR, but we didn't blink and didn't hesitate to continue to invest through this crisis on the tech stack that we think is necessary for the future. So to do all of that and still actually turn a profit and not end up kind of bleeding at any point is something we're proud of. But more importantly, we're proud of the progress we're making. So that brokerage capability is getting better all the time. That ability to kind of increasingly approach truly frictionless brokerage is in front of us. And so I'm excited about the future there. We're not looking to turn away from it, but we're not going to go try to gain share at the expense of big losses. There's enough people doing that on a regular basis, that I don't think they need one more participating in it. We're going to try to be prudent and rational through this -- through the crisis, but also keep our focus on developing that non-asset portfolio. It's still my goal for that to grow and become a $1 billion business, but we're just going to be a little more cautious in our approach as to when is the right time to put the foot on the gas versus the brake. And we think right now, just being prudent on the cost side and prudent on the pricing is the right place for us to be.

So just to sum up, I guess, I hear the potential for a rebound. Obviously, you expect spot rates to improve just given the shifts in the market so on balance to improve. And then you focus on -- keep your focus on your key core growth customers. Did I capture that right, in sum there?

Yes, I think we're ready for the rebound. The rebound is near. I think you're going to see a tough second quarter followed by capacity rationalization. If the return to work is even remotely successful, you'll see a return to volumes at some level elevated from where it is today, maybe not where it was before. That causes a tighter market, that causes a spot rate inflection. The carnage in the industry is real during times of this type of crisis. Insurance premiums are rising at rates never before seen and making it really untenable for some carriers to make it through the other side. And for those that are well capitalized and well ran and well managed, we think there's probably positioning us coming out the other side, really better than we've been in a long, long time. So we're pretty excited about the future, focused on the present and the health and welfare of our customers and our associates. But I like what the future looks like as we get later into the year, and especially in the next year.

Wonderful. Derek, John, truly appreciate your time, thoughts here today, and thank you for joining us at the 27th Annual Transport Conference. Thank you, guys.

Yes. Thanks for having us, Ken.

Thank you, Ken.

All right. Next up, we're going to have Kirby at 10 o'clock. So thank you very much, everybody.