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

So taking a little bit of a break from LTL land to go over to [ PL land ]. And next up, we have Werner Enterprises. I'm very happy to have with us CEO, Derek Leathers; CFO, Christopher Wikoff and IR, Chris Neil. Gentlemen, thanks so much for joining us.

Yes, thanks for having us.

So Derek, you are a longtime attendee of the Laguna Conference. So you sort of know the drill, we would love to kick off with your views on what the world looks like. Obviously, it's been a bit of an up and down year. It looks like we are sort of at the down waiting for the up. So I would love to get a sense of where you see the cycle as we stand?

Yes, sure. First off, thanks for having us. We appreciate being here and certainly the location. But with that said, where are we at, I think there's been some themes playing out as we came out of COVID, and we know that there was -- the significant amount of capacity that came into the market during COVID and found ourselves pretty quickly in an overcapacity marketplace with a -- coupled with overstocked inventories kind of as a national trend. You add the third leg to that stool, which was the consumer kind of having a more dramatic shift from products to services that I think even the most bullish people had expected, and it resulted in what we've seen in kind of a falling line in the spot market situation where rates just didn't seem to be able to find a bottom. And although capacity has been trading down to the industry, we -- since September, call it last year, we're only now starting find some sense of balance in the market. If you look at inventory, I think the destocking is largely behind us. That's encouraging, especially with people that are winning in their space, some of those leading retailers, et cetera, have really gotten through that and have more optimistic views as they go forward relative to replenishment. If you look at capacity attrition and although it's been happening consistently for 50-plus weeks, it happens still at a lower volume level than we would have expected, and we really reconcile that with the fact that we underestimate how much cash they brought into this down cycle and how long it was going to take them to burn through that cash. I think that cash burn is behind us as well, just like inventory destocking is behind us. And so we expect some accelerated departures in the industry as we look to the back half of the year. We think normal replenishment starts to take place. I think a normalization of services to products is more likely than not. And the consumer has held up relatively speaking, in a resilient way. And so we're fairly optimistic as we look forward, but we're certainly still in a day-to-day fight. As we sit here today.

Got it. So what are your biggest customers selling you from an inventory perspective? Kind of where are they right now? When do you think they'd be comfortable pushing the button to try and start restocking?

So I think our biggest customers and those that are, again, the winners in their respective areas, that destocking, they feel good with their inventory levels today. They don't feel like they've got more that they've got to burn off. They feel like the inventory levels are in relatively good shape. I think more importantly, they feel good about what is in that inventory number. There was a long time where they might have looked either a little heavier or normalized inventory, but they had the wrong stuff in there and the consumer shifted their buying habits and bought different products. So it took them even longer than expected to get to the right mix and more than the majority of them feel that mix is right. The level is right. I do think they're going to be conservative, though, as it relates to restocking and betting on the peak season because that pain is too recent that over-inventory pain. So I think we'll see conservative replenishment going on through the remainder of the year, which gives opportunity for improvement from where we're at, but not necessarily opportunity for the sort of sudden up and to the right movement in terms of volumes.

Is there a tiers to be made that the longer the downturn or this air pocket or whatever it is we are in right now last, the more that's kind of water building on the other side of the dam and kind of sets up for a more powerful upcycle or restock when it comes?

I think that's actually -- that's exactly right. I mean if you drag -- if spot drags along the bottom and continues to sort of bump and just even marginally move up into the right I think what happens is you have a dam breaking moment at some point where the movement when it does take place is much more a sudden, much more significant in its slope. But we've talked about this for a few years as transparency has increased in the industry as technology has gotten better and better. It's always been our belief that what you're going to see in the waves, if you will, if you think about a cycle, the waves are going to be closer together and steeper in pitch because technology really brings these pivot points upon you in a hurry when they happen. I think we're really close to the end of this one and on the up cycle, but not quite there yet.

Got it. I'm going to come back to the technology question in a second. But just to round out this discussion here, peak season like you should be kind of seeing signs of it if it's going to be there. Kind of do you have a sense of what that looks like over a year-over-year or versus on normal basis?

Yes. I mean I would say conversations about peak this year are certainly more widespread than they were a year ago, that's the good news. The bad news is we had a couple of secular projects that were unique to us last year that may or may not be repeated this year because that particular -- the underlying demand for that project isn't probably in the cards this year at that particular customer. So we'll have a more widespread basis for peak. But I think from a comp perspective, roughly the same as a year ago. And that's just a unique situation that we're going through within our customer base.

Got it. You're a little bit different from your peers in that you have this bedrock of a dedicated business that's out there, and that's been one of the bigger areas of growth during the pandemic. Maybe a structural growth area as shippers look for more visibility and certainty in their supply chains. Have you seen that same level of drop off in Dedicated? Has that surprised you in the last kind of 12 to 18 months? And also, how does that transition to the up cycle happening that you see it in the one-way business first?

Well, I think the Dedicated business has been nearly as resilient as we had expected it to be coming into this down cycle. It's held up very, very well. We've seen virtually no fleets that have gone away. Our retention rate has been strong. Our pipeline has remained fairly robust. But the pain and dedicated has really been seen within contractual language. So every fleet we have, you have to provide some ability for that customer to flex up and flex down with the reason. And if you have 150-plus fleets like we do and every one of them goes down by 3 to 5 trucks it's a meaningful drop in your Dedicated exposure. But yet, our truck count in Dedicated did not drop by the kind of numbers I'm talking about because of new business that came in. That's net a positive for us because as we look into next year and we know that things normalize and we start adding back the 3s and 5s that are already kind of inherently baked into the cake and put in new business on top of it, we can get back to a growth rate and see that 63% dedicated exposure expand to 65% or 66% or some number that's still at this point yet to be determined until we know where we're at in the cycle.

Got it. But are you seeing that ask from customers do you feel like the market is structurally gravitating towards Dedicated? Or do you feel like shippers that have maybe had kind of really averse to spot in the up cycle, but now in the down cycle, they are more open to kind of one way and in the spot business?

Yes. I think span and Dedicated are 2 lines that just never intertwined. I mean to be perfectly blunt. I mean, if you can move freight -- if you're even capable of moving freight in the spot market, then that freight is inherently not that Dedicated. And so it's really -- I don't want to confuse anybody about that. Those 2 things have nothing to do with one another. I think what drives Dedicated long term is the consumer ultimately wanting more and more transparency, more and more accuracy on the ability to receive goods when they want them and the quantity they want them with no exception. Only inherently structurally pushes more towards Dedicated over time. And that's -- when I'm saying that, I'm referring to true Dedicated that is the only kind of Dedicated we have our eyes set on, not continuous move Dedicated, not structural kind of engineered Dedicated, but rather, this truck is Dedicated to this customer all of the time to haul freight at a 99% on time or better with absolute visibility and transparency.

Got it. And on the one-way side, I think your guidance is for down 4 to down 7. Do you think there's still hope or kind of a possibility that at spot rates inflect here kind of going into peak season that you can get to the high end of that range?

Yes. It's probably going to be challenging at this point. I mean we only have 2 weeks left in the quarter. Spot has not changed much. As Eric just said, it's been relatively stable throughout the quarter so far. So we might get a little bit of lift here at the end. But unfortunately, spot is not going to help a lot in the quarter. Hopefully, we can decrease our exposure to spot in our one-way side, which is less than mid-teens right now. It's come off a few percent from where we said it was in our Q2 call. So that's been some improvement. .

Got it. What was that number historically kind of, it felt like that was -- it used to be a lot lower than that.

Yes. Historically, it's been 10%, plus or minus. We did exert what we thought was good pricing discipline this year. And as a result, we ended up with a little bit more exposure to the spot market than what we've had historically as we held the line with some of our one-way pricing. So we would expect that to come down a little bit more throughout the rest of the year, assuming we see some seasonal activity.

And maybe just to add to that, we are happy with the results, at least relative to our peers in terms of that volatility in One-Way. We don't want to have that volatility. Obviously, we would prefer for the rate per mile to not be where it's at. But given the backdrop of the market in comparison to our peers, we feel like that is a good metric in our ability to mitigate as much volatility as possible.

Got it. Derek, to your comments on kind of you expect to see the pain on smaller carriers to really kind of accelerate through the end of the year. Are you surprised that you haven't seen that kind of more of that just yet. And you said something about you probably underestimated the amount of cash they sort of brought in. But do you feel like you're seeing in the data or anecdotal kind of feedback that you get at that pain point this year?

I do believe that pain points here. I mean I think there's a few things going on, right? They had -- fuel was not hurting like it is now in the first half of the year. They had this cash influx during COVID that carried the day and carried them longer than we thought. Lender leniency was greater than we believed that it would be. You put all those things together, and I think more of them have kind of hung in there. I also think they probably like us, maybe mispredicted a bit when thought this turn would happen. We thought the bottom when we came into the year, we were -- we had some conviction that the bottom would happen right around the July time frame. It feels a little more like that's happening now. But that -- and that may not seem like a big gap. But if you're sitting here in March, April and you're bleeding pretty badly, but you think the turns coming in July. I think a lot of them hung on until they couldn't any longer. And I think you're going to start to see that wash increase from here.

Got it. Let's Derek talk about Logistics, kind of -- obviously, it's a tough environment for the asset-heavy business, it may actually be even tougher for Logistics, but obviously, you guys have deployed a bunch of technology tools. But before we get there, how do we think about the sort of dead spot market, if you will, kind of what that means for the Logistics business in 3Q and 4Q?

Yes. I mean I think the opportunity, if we're right on all of the things we've been talking about up until now, Logistics could have more pressure before it gets relief because you're going to see buy rates starting to move quicker than you're going to be able to move cell rates. For a quarter or two. I think that's going to put it under some duress. Understand though that within our Logistics book, the fastest-growing portion of that book is power only. And that freight isn't spot freight. That's actually a contract freight that we're doing business with. Under both buy and sale kind of longer-term agreements. And so we think that gives us some insulation. And you've seen that in some of our results, although the margins are compressed. They're not as compressed as many in the marketplace. Furthermore, we've held on the volume and actually grown volume year-over-year in a very slow market because the product is gaining statements, gaining acceptance, it's doing what we said it could do. So we're pretty excited. We love the Reed acquisition and the capabilities and leadership capabilities that came with that acquisition, some strong talent in that organization that we think makes us better. And so we're just excited both about our legacy organic Logistics as well as the Reed business, and those are now integrating and coming together finally in the back half in a way that we believe sets us up for some productivity gains. And some cost enhancements as well.

I was just going to ask you about that. And if you talk about the integration there kind of is that something that gets done by the end of the year or kind of what earnings are you in right now?

Yes. So Reed is -- ironically, Reed was the last of the 4 acquisitions, but it's the first on the tech integration road map because of the size and scale of it and the complexity of what we do in Logistics and brokerage. And so we're full steam ahead right now on the integration of Reed into our new Werner EDGE TMS system, whereas some of the asset acquisitions that are still operating more on a stand-alone basis with centralized purchasing and procurement will be later in the road map. And so Reed is -- should be predominantly integrated by the end of the year. That's the current goal, and we are on schedule.

Got it. One of your 5 Ps in technology obviously probably shows up in Logistics more than any other business. Do you feel like you have all the tech tools kind of you need for where the Logistics business is going from a technology standpoint? Do you feel like there's more you need to acquire, you need to build? And kind of what does that mean for kind of growth and profitability of that business over time?

Yes. I mean, so first off, just back to the start of the question, I don't want to underestimate the amount of tech spend that we're doing as part of this global integration to one TMS. So both the asset side and the non-asset side, we have significant investment going on. We're going to work to be more transparent on that in the next call, but we've got some analysis that we want to complete first and make sure that we've checked our numbers and have better conviction to when that spend starts to tail off a little bit. And more importantly, to your point, when does that productivity enhancement start to take hold. Right now, we're about halfway through a multiyear tech journey. We're kind of at the abyss of it at the moment, meaning the part where spend is at its peak, productivity impacts are sort of at their least and the reason for that is because in many cases, at the front line level, we've got folks operating in more than 1 system, having to do work that's actually more difficult, not less difficult because of where we're at in the evolution. So we want to frame that, and we'll put some work and color on that in the next call. But as we look forward, I'll take it 1 by 1 on the Logistics side going into next year. We love the opportunity. We're already seeing it now for seat level productivity enhancements. And so we're getting those as we speak, and we think we can grow and expand on those in the back half and in '24. While on the asset side, we're going to be entering that canyon for a couple of quarters here where we've got some difficult work to do, from an integration work, and that will carry through '24, but with enhancements coming along the way. And then you asked me about a menu of services or kind of where we are there. I love where we're at on the Logistics side, especially as we get full integration going forward, I don't feel we have a competitive disadvantage in really any part of that tech stack. It's about now reaping the benefit of all of the investments we've been making. And on the asset side, we've got a lot more work to build out the future state based on what our network looks like today, which let's be frank, as we go forward. We're predominantly a dedicated carrier with one-way assets that support our ability to surge and grow dedicated with 3 major pillars in One-Way, which is cross-border Mexico, team expedited and engineered lanes. All of that takes development work to make sure our future stay tech is designed to support that specifically, and we're working very aggressively to do so.

Got it. So it sounds like you're saying middle of '24 is when you really have a transition handoff between investments you're making and the productivity coming through.

I think that's a good estimate. There will still be ongoing investments really through all of '24. But the bulk of the pain, if you will, and when we really start to feel better about the productivity enhancements offsetting some of those investments is certainly in the first half of '24 culminating in the back half.

Got it. I think over the last 10 years, in particular, is a real debate in the industry as to what's the right ratio between asset-heavy, asset-light. So especially with these opportunities with these tech tools you have in both asset heavy and Logistics, kind of where do you think that ratio is like what's Werner kind of revenue split going to be like in 5 years between Logistics and asset heavy?

Well, I think at this point, it's highly likely you're going to see Logistics growing at a more rapid rate year in and year out than you will on the asset side, but we're very bullish and dedicated in the resiliency of Dedicated has only reaffirmed our bullishness during this downturn. So as we've seen this downturn play out and it was more severe than we maybe originally expected. Dedicated has proven to us that that's where we want to be. That's the kind of sophisticated work we want to do. So that will also grow. I think one way will not be a growth engine as we look forward, but it will always be a part of the portfolio because it's what supports our ability to do the things we do and dedicated. It's sort of -- it's the farm system where you get to know customers on a more transactional level, it's where drivers get to cut their teeth and get really to hone their skills. There's so many reasons to have One-Way, not to -- and probably the most important one is it's the surge fleet, it's the reserves, if you will, that you bring into the battle when you need to provide that 99.5% type on-time service in Dedicated that our customers have come to expect.

Got it. So let's view the segue into a fleet question. What do you think the fleet growth looks like over the next 12 months? Obviously, with constraints in capacity continuing at the OEM level, but easing up a little bit kind of I think some carriers are saying that they're getting the trucks that they need right now. At the same time, do you think the used truck market goes through a little bit of an existential crisis, especially if some yellow kind of capacity goes in there.

Yes. The used truck market is certainly under duress, and that's certainly going to play a role. It won't be the primary factor in how we think about our fleet growth, but it will be under duress, we think, for a few quarters here. But yellow, less of a factor. If you think about the trucks we sell, we're talking low mileage, late models fleet and in-cabs, very little of yellow fleet is in that category. So it's going to have impacts but not necessarily on the category we sell. But the broader used truck market is certainly weakening. When we think about fleet growth, it's too early for us to give estimates for next year. Dedicated will be the driver of that growth. So we've got to see how this 3 to 5 truck growth back into our standard fleet size on all these fleets we have that will determine a lot what the growth looks like because we know what that new business pipeline looks like it's less certain exactly when these other fleets all return back to their normalized level.

Got it. Just to give us a little bit. I think one of your largest customers, I think your largest customer kind of is making some changes in the way they're sourcing and kind of using truck capacity and such. What does that mean to Werner? I think you said on the last call that it's going to -- there could even be some opportunities there. Can you just unpack that a little bit and tell us kind of how do you think that relationship evolves in the next few years?

Yes. We've been hand-in-hand with that customer throughout this transition. We work with them very, very closely on their strategic plan. We will continue to do so as we go forward. Our dedicated fleet with them is solid. We have, in fact, grown with them recently, and we talked about it on the last call. We had fleets that we're implementing at the time of the call, and we will continue to look for new opportunities to do so. They are going to grow their private fleet. We understand that. But so as their store count going to grow. And if you look at a retailer since it's -- we all know what we're talking about that adds 1,000 stores a year, Werner alone can't grow and support that entire store count. . And I think what the read-through is in my mind, it shows how hard it is for them to source what we do really anywhere other than us. We do quality work for them others struggle to replicate what we do. We can't support 1,000 stores of that growth at the level of quality that we are -- we've come to expect. And I don't want any one customer to be overleveraged in our portfolio. And so we work in conjunction. We know where their fleet is growing and why we know what buildings we look at. We have to earn that business every day, and we take that very seriously. But it's not the essential threat that people think it is.

Are you kind of even helping them grow their own business and that kind of -- if there is an issue with them doing their own thing, like do you think they might come back to you and say, "Hey, this is not working for us. Can you take this business?"

Those dialogues happen all the time, both ways, to be fair. I mean, they're a quality operator who we think highly of them. But there are absolutely times where we'll look at a building, there's multiple buildings where the split in the building is us and them in the same building. So we're operating side-by-side. We're benchmarking. We're finding best practices, we're working together. We run some of their driver training programs through our driver school network. It's a collaborative effort, and it's one that, yes, we have our eyes wide open on the fact they're growing their private fleet. But we're comfortable with how we're working with them on a go-forward basis.

Sounds good. Any questions from the audience?

It hasn't really been brought up quite yet, but I want to ask a little bit about the intermodal side of the business. You've had some announcements with some pretty key partners. Just curious what you guys are seeing there and what the kind of the growth strategy is going forward?

Yes. So our intermodal business is not nearly as large as some of our competitors. If you think about philosophically, what does Werner do? What do we stand for? We stand for working with customers on the hardest to do, most difficult part, most defensible portions of their supply chain. That's not by definition, intermodal. Intermodal is a little more of a commoditized portion of their spend. We do intermodal for customers that want us to play in that space. We have a competitive product that we believe makes sense in certain applications, but it's not a large scale portion of our portfolio. If you look at it broader and you zoom out for a second, it's my contention that with what's happening with overall supply chain design across America, higher and higher service expectations, shorter and shorter length of haul that the opportunity for growth in that space. Is not -- that's not where I want to place my chips. I'd rather us place our chips in Dedicated, e-commerce, Final Mile in places that are more of the growth engine than an area that's going to be -- have certain headwinds that are structural in nature. Length of haul continues to shrink forward, deployed inventory is a reality. It's not going away. It's only going to increase. All of that works against intermodal. And so we're proud of our intermodal offering. I'm not going to -- we're not looking to shun that in any way, but it is not part of the growth engine plan of Werner as we go forward.

Any other questions? Derek, you've obviously been one of the most active in the space on M&A. What is the outlook out there right now? Do you think sellers are waiting for the market to improve before they sell? Do you think there's opportunity to pick up good deals at the bottom of the cycle? And also, you've been active in both the asset heavy and the asset-light side of the business, kind of where do you think you might over-index on the M&A side going forward?

Yes. Well, first and foremost, we're going to always think about capital expenditures or capital deployment as organic or first. I mean we want to grow our business, invest in our business, and that's going to be our first priority. Yes, we've had 4 acquisitions in the last, call it, 2 years, which shows an openness and willingness to do them if we think they make sense. At this point in the cycle on the asset side, the struggle is always that valuations may be more in check right now than they would have been during COVID, but the quality of the underlying asset, the equipment maintenance, the care of the business in order to survive how difficult these last several quarters have been is often under invested. So that creates some cautionary tales that we want to be careful with. We've got work to do on the form we've already bought. Integration is underway and on plan, but we've still got a lot more work to do. So we've kind of consciously signaled a little bit of a time out, but we're still open and looking at deals all the time. So if something came that was additive and accretive that was doubling down on the strength of our portfolio or opening up our portfolio to new product lines that we believe are growth engines going forward, we'll be open-minded to it. But we're going to be careful for now, and we want to make sure and first and foremost, invest in the business, we want to get margins back in line with long-term expectations. And to do that, you need focus on execution, discipline and best practices within our building, so that's really where our head space is right now.

Got it. And just kind of on that topic, kind of how much of that spend is going to go into kind of proprietary technology investments and such? And second, kind of as you deploy that balance sheet kind of you were very clear over the last 2 years that you're going to be a lot more aggressive with that deployment. And I think you've seen that on the M&A side. You've seen that on the organic side. When do we see that on the cash return side as well? .

On the cash?

The cash return to investors or buybacks and?

Do you want to take that?

Yes. On the technology side, as Derek mentioned earlier, we've been investing in technology for some time now. We're kind of midway through that. And on the next quarterly call, our intention is to give a bit more color and make that a bit more tangible and specific in terms of what that nonrecurring spend has been when that goes away and when the tech enabled savings will start to be more tangible. So I think we'll give some more color around that, that will help. From a CapEx perspective, not sure this is really getting toward your question. But from a CapEx perspective, that can include technology, other investments, that's going to be an outlier this year largely reinvesting the business in the fleet. But when we think about reinvesting in the business, it can also translate to continuing to invest in our competitive advantages, technology being one of those.

Got it. And in the past, kind of pretty close to the end of the cycle, you guys have considered a special dividend kind of is that something that's on the cards that you're thinking of?

When you think about the opportunity for us to set the table for this turn, we're clearly signaling just with our -- we just recently increased our CapEx guidance. We think this is the time for us to invest in the fleet. We think this is the time for us to put our money where our mouth is. We believe that we are at the tail end of the cycle and entering into a new one. And I don't believe our plate has ever been better set for that than it is right now. Our Logistics brand is over $1 billion strong and growing. Our Dedicated business is 63% with a robust pipeline. Our One-Way is more engineered and specific between TMS Expedited in Mexico and engineered lanes than ever before. I love the opportunity as this thing turns for us to show what this portfolio can do.

Got it. And just very last one on the technology side. And you were one of the first to actually have a Dedicated EV lane for one of your customers. And so you have been making investments, obviously, on the autonomous side as well with kind of early technology plays on the asset side. Where are some of those investments going? Kind of do you still feel like you can convert on growing your fleet to be substantially EV or substantially autonomous over the next decade?

So first, I'll start with this. I mean, we are very committed to our environmental footprint, our environmental stewardship. We're going to do everything we can to meet and exceed every goal we've placed out there, including a 55% reduction in our carbon footprint by 2035. But I am not yet sold that EV is the way that we're going to get there. I just don't think -- there are clearly applications that could be dedicated, regional, local dray where EV will play a role, but the economics of long-haul EV are still very difficult to work. I think it's a highly subsidies current environment that you must assume subsidies go away over time. I think it's questionable as to the environmental impact if you go from the mine to the tail pipe instead of just focusing on the tail pipe. And I think there's a simple headwind that is nearly insurmountable in my view, relative to not just infrastructure but grid capabilities and where we're headed as a country with overall production of electricity, not to mention as you throw all this additional demand on what that electricity ends up costing that has to be in your model and your thinking. So my best answer to you would be to say that in 10 years, I guarantee you this. We will be significantly more environmentally forward in our application, but I am far from able to say that it's going to be electric as the predominant force. It could be but we're going to stay mode agnostic or tech agnostic, and we're going to continue to test across hydrogen, dual fuel, electric and renewable natural gas and then look across the entire spectrum to put the best technology where it makes the most sense.

That's really helpful, Derek. As you know, we are a big champions of technology using the space. So I'm looking forward to your next conference call and that detail you're going to share with us on that productivity curve. Thank you so much for joining us today, and see you soon.

Thank you.