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

Good morning, everyone. Next up, we have Werner Enterprises kicking off the TL portion of the day. Very happy to have with us Derek Leathers, President and CEO; as well as John Steele, EVP, Treasurer and CFO. Gentlemen, thanks so much for joining us. Before we kick off, please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out your Morgan Stanley sales representative. As always, if you have any questions for the management team, please submit them through your webcast, and I can pass those questions along.

With that, Derek, John, welcome to the Virtual Laguna Conference. Obviously, big difference versus where we were at the Laguna Conference last year in terms of where we are in the cycle. Maybe you can kind of take us through what you're seeing out there. Clearly, the market is superhot. But there are some initial kind of just whispers, hints or maybe it's kind of cooling from being kind of as rank hot as it was over the summer. Are you seeing that? Are things getting tighter? Kind of which areas are you seeing the tightness in, particularly, maybe just a demand overview would be a great way to start.

Sure, Ravi. First off, thanks for having us. We appreciate being a part of this conference. And you're right, Laguna would be better than webcasting from Omaha. But on the demand front, look, it's been strong really and consistently picking up, starting really in May. But when you get into June, that strength really started to build more noticeably. July was one of the strongest Julys we've seen on record. July is traditionally the second worst month of the year, February being the worst month. And there was no indication of anything like that this July. You get into August, and we've seen building from there. And it still is very tight right now. As for the whispers, I can't speak to what is causing some of those concerns. What I look at is what's the overall backdrop. And the overall backdrop right now is inventory levels are at historic lows, the amount of restocking that's still ahead of us that needs to be done is significant, peak is still around the corner. With all the changes in 2020, Christmas is still on the 25th of December, people are still going to be shopping and buying and participating. Consumer is engaged. If you look out across same-store sales of successful retailers, they've done very well through COVID and very, very well since as things have started to reopen. So our perspective on it is demand is strong, the setup is strong. It's wide-based. You mentioned geography. I think that's important to talk about. There's often times in trucking where a carrier might be way oversold. But if you look under the covers, what's really true is that maybe the West Coast is very strong, but there's pockets of weakness that balance it out. And so you end up with this imbalanced strength. And that's not good for utilization. It's not good for optimization, production and, ultimately, your financials, not as good anyway as when you see it wide-based. And right now, it's wide based geographically across the country. Certainly, the West is even stronger still. But the rest of the country is plenty strong to keep the networks flowing. So there's a lot of good news to tell right now. There's a lot of strength as we look into peak. Our conversations with shippers remain strong. Their conversations and projections around this peak season are strong. So the setup is really good in my view.

Got it. Derek, I think the important thing and what you said that really stood out was when you said the inventory levels are still extremely low and restocking is largely ahead of us, but we are already at a truck spot rate that's almost at all-time high levels we last saw in 2018. That would imply that pretty much the entire run-up in the rates you've seen so far has been driven by the supply side. Would you agree with that, kind of? And what are you seeing on the supply side that's been driving that. And more importantly, is that over? Or is there more to come in terms of supply tightening in the coming months and quarters?

Yes, it's a great question. I mean, so if you think on the supply side, I mean, first off, let's talk about some of the math behind it. There's 100,000 less CDLs that were issued in the first 6 months of the year year-over-year to new CDL holders. That's probably the best window into what is COVID reality looked like and what happens when SDLAs were shut down around the country, when driving schools were forced to go to social distancing and when, frankly, the appetite to enter an over-the-road frontline worker-type environment for new entrants wasn't what it once was. You couple that with retirements that are on the uptick. So you also got on the other end of the spectrum, this is an older demographic industry. Our drivers' demographics are about 10 years below the industry average, but there's a lot of drivers out there in that sort of at-risk category that over the last few months, we've seen retirements accelerate. So that tightens the truck or driver supply even further. Drug & Alcohol Clearinghouse was 30,000 new names in there with 90% of them -- 80% haven't even attempted to kind of come back, 90% are nowhere near any ability to come back and be reinstated and 10% are in the process, but very few have actually been able to reenter once they've entered into that clearinghouse. So you think about that on an annual basis. And I think it's a very comfortable number to think about somewhere between 200,000 and 250,000 less drivers this year on the entrance side and/or elimination side. Then you layer retirements on the top of that. And retirements will continue to, I think, be accelerated. So supply is going to be constrained. It's been a big part of the story. But I think folks underestimated the consumer in all of this. PPP was pretty stabilizing in its effect. People have money where there's tons of studies out there that talk about what's happened with people's individual bank accounts. They've learned and transitioned to an e-commerce world versus a brick-and-mortar world, maybe more rapidly than they would have without COVID, but they're still out participating. And so when I -- we think about demand today, one of the interesting things that I think gets overlooked is we are vastly oversold as an industry right now. Capacity is very tight, and the economy is not fully open. This is in a semi-opened economic state. And so as the economy opens up further, as people continue to participate and the consumer stays engaged and there's a lot of structural headwinds, not disciplinary actions being taken by carriers, where they're being disciplined in their approach, it's just structural headwinds that make growth difficult. I think it stays this way longer than people realize. The last piece I'll throw in there is just the simple reality around any manufacturing environment today, and that includes OEMs. They've been up and then they were down. They were closed and then they were up but with reduced production. I don't think a really reasonable person believes that we're going to see OEM production at full scale for an extended period of time without interruptions as we go forward. So yes, people are going to have some urgency around their orders. They're going to think about making sure their truck orders are in because nobody knows exactly when these interruptions in that truck supply chain will happen. And at least at Werner, we don't want our fleet to age. So we're going to make sure we've got our place in line, so to speak. But our guidance is a range of negative 1% to negative 3% fleet growth in the back half for an annualized guidance, and we think that's where we'll be. And certainly, very little risk to being on the high side of that because that's just how tight it is and how difficult growth is today. And that's for a well-capitalized carrier with very low turnover with a strong morale right now within our fleet. Many fleets are not in that position, and that growth will be even more difficult for them.

Got it. So maybe piggybacking off that comment on the supply side. I think historically investors have gotten a little bit nervous whenever rates have hit an all-time high because while it's obviously good that the market is really tight and you guys are doing really well, that's also typically a sign of supply coming in to normalize those rates, and that typically marks the end of the cycle. But it looks like this time may be different, given some of the demand supply dynamics. So again, you've touched on a few of these points, but do you have confidence that these rates are sustainable and can push to new all-time highs, given that big demand wave that's ahead of us and some of these supply constraints? And do you feel like the new supply coming in this time is going to be more restricted than typically is?

Yes, I think it will be. I mean I think the reasons I outlined are bigger than maybe are fully understood on the driver side. On the equipment side, there's uncertainty there. On the recent order level, you're talking about replacement or even slightly below replacement levels when you factor in fleet aging due to OEM shutdowns, meaning people's fleets have aged by 2/10, 3/10 of a year. We don't like that. We pick our ages based on our models and based on how we feel is our best operating ability. And so we're going to at Werner work to make sure our fleet age freshens slightly over the coming few quarters, and that takes truck orders to do that. We're not looking to grow our One-Way product. Dedicated will grow over time. I think there are structural headwinds. I mean one of the things that I think is interesting is there's a belief out there that there's 15% capacity still sitting on the sideline that's going to come back at some point in the future. While going back to your opening question, if spot rates are at all-time highs, and if the market is as hot as all of the spot indicators would portray, there aren't truckers that sit those out. I mean, they're not just sitting on the sideline in this market, they're back in, or if they're not back in, it's because they're struggling to come back in because of these very structural impediments that I'm talking about. So the calvary is not coming. There's not some big wave of people on the sideline that are going to suddenly enter in our view. There's an appetite across carriers to grow longer-term structural business units like Dedicated. But there's very little appetite for anyone. Nobody is talking about trying to grow their One-Way business because of some of the volatility that we're speaking of right now. Our One-Way business is more than booked. And our biggest concern right now is I've never spent as much time as we've spent this year conversing on how are we going to cover or be effective during peak because we're at peak levels today and peak hasn't started. That's new. That's a new phenomenon. And so I think the -- and I'm talking about peak as it relates to freight volumes during the peak season. And so there's more volume coming, and we know that from committed conversations with customers. And we're going to work our tails off to make sure we fulfill their expectations, but it's going to be tough.

Great. Derek, on the fleet comment, it's kind of very encouraging to hear kind of all the large carriers basically saying what you're saying, which is they're not looking to grow the One-Way fleet and then saying if there's going to be any growth, it's going to be on the Dedicated side of things. Is that -- are you having similar conversations on the marketing and sales side with your customers where if customers are kind of coming to you for more capacity and more growth, are you actively trying to push them to the Dedicated side of the business given the stability and kind of visibility in that business?

Yes. Under normal circumstances, that's exactly kind of the activity that would be going on, meaning we would be talking to them about Dedicated. And we still are today, make no mistake about it. But Dedicated, our pipeline there is as robust as it's been in a long time. We started commenting on that in the fourth quarter of last year, and we've reiterated those comments each quarter on each call. So my point being, there's not a lot of selling needed right now to garner interest in Dedicated. The real work to be done there is sifting through the opportunities to make sure they're truly structurally Dedicated in nature, meaning we want to participate in businesses that are hard to serve, high driver input and activity -- service levels at 99.5% or better with expectations that can't be displaced some day by One Way -- by a One-Way product. So if somebody wants to tide out from the One-Way pressures that will certainly exist over the next several quarters by creating a designated fleet, that's not the kind of Dedicated that we're looking to do because we know those things will go the other direction someday. The business we have in our pipeline is this vetted, high service, high activity Dedicated with winning customers that we believe have a model that succeeds in good markets and bad. So that gives us a lot more confidence as we think about our future mix.

Got it. So given that demand and supply construct, what does the pricing environment look like for the back half of this year and into '21? Obviously, in 2018, when we had similar conditions, I think contract rates were up double digits for a lot of the large TL carriers, including yourselves. Is that -- are we looking at something similar for 2021 and kind of what are some of the early bid conversations you're having right now?

Yes. So I think a couple of things bear commenting on relative to that. First off, so 2018 rates came off a very low base as you think about '16 and '17, building into '18. We at Werner, I'm not going to speak to the industry, but here at Werner, even in '19, we did a very good job of holding on to those gains we made in '18 through '19 and then into '20. And so that baseline has been -- or that bar is starting at a higher point and a more elevated position, if you will. With that said, the setup is better today than it was going into '18 in terms of supply and demand. The constraints and tightness is tighter than it was going into '18. And some of the pressures will be real, not yet, and we're not experiencing them today. But that we are having to start thinking about this new normal with driver supply. And so we've got to make sure that we price appropriately to be able to take care of our drivers and attract new entrants into the market as well as continue the progress we've been making on pulling away experienced drivers from other fleets that have found the Werner culture to be a better fit for them.

Got it. Maybe shifting gears again, Derek, or maybe John, how do you think about the cost side of things? Can you remind us again? Obviously, 2Q, you and the rest of the industry did a really good job of downsizing your discretionary cost base to adapt to what was going on. Can you remind us how much of that maybe comes back as the volumes return in 3Q and beyond? How much of that can be permanent? And kind of with this new environment, how do we think about driver wages over the next 6 to 12 months?

Yes, Ravi, we already had several cost initiatives in progress before the pandemic hit in March. And clearly, we doubled down on the cost initiatives when the pandemic started to address the uncertainty of how long would COVID last and how difficult would the environment be. We have something on the order of 170 items with $20 million of cost savings in 2020 that are already in place, and that's growing. That's procurement, that's productivity, that's efficiency. Our non-driver side of our business is improving significantly due to productivity and efficiency enhancements, and we expect that to continue. There will be some things that will come back like medical expenses and travel. I don't think they'll come back all the way to where they were pre-COVID, but they'll come back some as people start going to the doctor more and as the economy starts, traveling a little bit more to hotels and commercial airlines to conduct business. But I think some of that will be a permanent reduction. So overall, we think the cost savings that we've achieved, most of it will be sustained. The only couple of things I'd point out that are sequential cost headwinds, they're more minor, are we renewed our liability insurance August 1. That's on a quarterly basis, that's about $1.8 million per quarter, and that went into effect August 1. So it's $1.2 million in the current quarter. Also the driving schools are operating at 70% of capacity. So it's hard to be as effective on the revenue side and the cost side in an environment where you're 30% less productive than normal. So those are a couple of challenges that we're dealing with. But overall, we feel really good about the cost improvements we've made and keeping most of those as we move forward.