Werner Enterprises Inc Q3 FY2020 Earnings Call

Good afternoon, and welcome to the Werner Enterprises Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. The operator will provide instructions for the question-and-answer session. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. Earlier this afternoon, the company issued an earnings release for its third quarter 2020 results and posted a slide presentation. These materials are available in the Investors section of the Company's website at werner.com. Today's webcast is being recorded and will be available for replay beginning later this evening. Before we begin, please direct your attention to the disclosure statement on Slide 2 of the presentation, as well as the disclaimers on Page 6 of the earnings release related to forward-looking statements. Today's remarks contain forward-looking statements, including those related to COVID-19 that may involve risks, uncertainties and other factors that could cause actual results to differ materially. Additionally, the Company reports the results using non-GAAP measures, which it believes provide additional information for investors to help facilitate for the comparison of past and present performance. A reconciliation to the most directly comparable GAAP measures is included in the tables attached to the earnings release and in the appendix of the slide presentation. I would now like to turn the conference over to Mr. Derek Leathers, President and CEO. Please go ahead.

Thank you and good afternoon everyone. With me today is our CFO, John Steele. The shortest and deepest recession in U.S. economic history in the second quarter was followed by a steep rebound as robust truckload freight demand with our customers combined with a stubbornly tight driver market produced strong truckload freight market conditions. I'm extremely proud and grateful for our entire Werner team responded with superior on-time service during the period with continued challenging operating conditions caused by the pandemic. Since the onset of COVID, our drivers have been on the frontlines delivering the essential products to our customers. And this is a responsibility we take seriously. Our primary focus will always be protecting the health and the personal safety of our associates, their families and communities and our customers. While there remain significant uncertainties ahead related to COVID-19 and its effect on the economy, we are increasingly confident that demand for our services will be strong for the fourth quarter and heading into 2021 owing to two overarching trends. One, driver supply constraints continue to persist; and two, many of our key customers are generating strong sales that significantly reduced their inventories. Inventory restocking will occur, and we believe this will continue over multiple quarters. We are well prepared to thrive in this type of business environment as we did in 2018 when freight was strong and capacity was tight. In the event the economy were to soften causing demand to slow, you can look to our industry leading performance in 2019 as an indicator of how we were able to respond. The strength of our diversified revenue portfolio, our 5T strategy, our relentless focus on operational excellence and our experienced management team enable Werner to succeed in any trucking freight cycle. Following a review of our third quarter financial results, I'll provide an update on our 5T strategy. I'll discuss the unveiling of the addition of sustainability as an all-encompassing component of our 5T strategy moving forward. I'll review our environmental, social and governance strategy and announce three ESG milestone goals. I'll then discuss how we are leveraging our core strengths and sustainable competitive advantages. Following that I'll update our 2020 guidance metrics and then discuss our new long-term TTS adjusted operating margin goal. For investors new to the Werner story, on Slide 4, we provide an overview of our key market size and fleet size metrics as well as revenues by segment, industry vertical and customer. In summary, Werner has a diversified fleet and revenue base that has served us well over many years and economic cycles, including 2020. Let's move to Slide 5 for a brief overview of our financial performance. In the third quarter, revenues decreased 5% to $590 million. On a sequential basis, revenues increased 4%. Adjusted EPS grew 21% to $0.69 per share. Sequentially adjusted EPS grew 12% from second quarter and adjusted operating income increased 19% to $64.3 million, while adjusted operating margin increased 210 basis points to 10.9%. One-Way Truckload freight volumes in the quarter were strong. Unlike the second quarter, the third quarter started out with relatively strong freight activity and then gained further momentum in August and September. Our dedicated freight volumes and our operational execution remained at a high level throughout third quarter. Many of our largest dedicated discount retail customers and home improvement retail customers are producing much higher than expected same-store sales growth that has resulted in lower inventory levels. We are helping these and other essential products customers begin to rebuild their inventories as their strong sales continue. We ended the third quarter with 7,710 total trucks in TTS, a decrease of 345 trucks year-over-year, and an increase of 60 trucks sequentially. Most of the sequential increase in our TTS trucks occurred in September in our dedicated fleet. At this point, I'll turn the call over to John to discuss our third quarter financial results in more detail. John?

Thank you, Derek, and good afternoon. Beginning on Slide 7, total revenues decreased $28 million with $20 million of the decrease due to lower fuel surcharge revenues caused by lower fuel prices. The balance of the revenue decrease was primarily due to lower logistics revenues. Our TTS revenue per truck per week increased 5.0%, up 390 basis points from the 1.1% increase achieved in second quarter. Our logistics revenues decreased 3%, a significant improvement from the 16% decrease in second quarter. Our cost management initiatives and programs continued to perform well in third quarter. While we dealt with sequential cost increases from second quarter to third quarter due to higher fuel prices and higher liability insurance premiums, we continued to more effectively manage our controllable costs with sustainable improvements through improved associate productivity, better leveraging our procurement spend and doing more with less. We are aggressively managing expenses and to date in 2020 have implemented $20 million in annualized sustainable cost savings. Adjusted operating income increased 19%. In TTS, we expanded our operating margin by 390 basis points while our logistics operating margin decreased 320 basis points. In our driver schools, the number of drivers we can train is limited by ongoing social distancing requirements, which has been a factor in the 4% year-over-year decline of our trucks. This along with a reduction in equipment leasing income contributed to the corporate and other operating income year-over-year decline of $1.6 million, or $0.02 per share. However, due to improved execution on a sequential basis, corporate and other operating income improved by $1.4 million. Our adjusted earnings per share were $0.69 or $0.12 higher than the $0.57 a share we earned in third quarter 2019. Beginning on Slide 8, let's look specifically at results for our Truckload Transportation Services segment. In the third quarter, TTS revenues decreased $22 million, mostly due to lower fuel surcharges of $20 million. Adjusted operating income was $65.2 million and increased 31% due to the expansion of our operating margin percentage. Our adjusted operating ratio net of fuel surcharge was a strong 84.5%. Turning to fleet metrics on Slide 9. For Dedicated, we grew trucking revenues net of fuel by 5% to $244 million. Dedicated average trucks decreased slightly and revenues per truck per week increased 5.8%. One-Way Truckload trucking revenues net of fuel decreased 7% to $173 million. Average trucks decreased 11% due to the challenging driver market and our ongoing focus on dedicated execution. Revenue per truck per week moved into positive territory and increased 4.4%. One-Way Truckload miles per truck increased 1.4% and revenue per total mile rose 2.9%. We analyzed the mileage production of our TTS fleet before and after the changes to the driver hours of service that were implemented by the FMCSA on September 29. As we expected, so far the increase in mileage productivity for our TTS fleet is approximately 1%. Moving to Werner Logistics results on Slide 10, in the third quarter, logistics revenues decreased 3% to $117 million. Truckload Logistics revenues decreased 15% due to 15% lower volume and flat revenue per load. Revenue per load strengthened each month as the quarter progressed. Intermodal revenues accelerated rapidly throughout the quarter, up 31% driven by a 37% increase in volume and a 5% decrease in revenue per load. Our logistics gross margin percentage decreased 440 basis points as contractual brokerage experienced an unprecedented and rapid rise in the cost of truckload capacity as the spot truckload rate market accelerated quickly throughout the quarter. Logistics had an operating loss of $0.9 million. During third quarter, we addressed many of our contractual brokerage accounts and we expect that logistics will be profitable in the fourth quarter. And Slide 11 is a summary of our cash flow from operations, net capital expenditures and the resulting free cash flow over the past five-year period. Our net CapEx guidance range for the full year 2020 has been narrowed to $275 million to $300 million. We continue to expect to generate free cash flow in excess of $150 million this year. I'll now turn the final portion of our prepared remarks back to Derek. Derek?

Thank you, John. Moving to Slide 13, I'll update you on our 5T strategy. First, I will review the 5Ts, which over the past few years created structural and sustainable improvements with our modern and more efficient fleet, high quality professional drivers and strong management execution. During the quarter, we received further validation that our 5T strategy is working. In August, Werner received two Quest for Quality awards from Logistics Management in the truckload dry freight carriers and 3PL categories. Over 4,500 shippers participated in this long standing industry evaluation. Werner achieved the second highest overall ranking of all large public dry freight carriers. 2020 marks the fourth consecutive year Werner has earned Quest for Quality awards. Our first two Ts, our trucks and trailers are characterized by young average fleet ages of 2.0 years and 4.0 years, respectively. All Werner trucks are equipped with advanced collision mitigation safety systems and automated manual transmissions. Through the first nine months our accidents per million miles declined 18% year-over-year. The tight driver market further intensified in the third quarter as the improving freight market caused increased competition for a finite number of experienced drivers that meet our hiring standards. At the same time, social distancing and other safety procedures combined with the state licensing cutbacks due to COVID are reducing the number of driver training school graduates. The FMCSA estimates that there were 100,000 fewer truck driver CDLs issued in the first half of 2020 compared to the same period in 2019. Our driving school network is one of the largest in the industry and is producing highly trained new drivers while following COVID safety protocols. In our terminal network, social distancing and other safety procedures are enabling Werner mechanics to safely maintain our trucks and trailers. We're also utilizing enhanced technology to orient and train our drivers at our terminals. We continue to invest in upgrading and modernizing our IT infrastructure and data security. We've recently completed installation of 85% of our trucks with our new in-cab untethered telematics solution. This innovative handheld solution, EDGE Connect, provides Werner drivers with smart workflow, best-in-class navigation, improved safety features and reduced manual data entry. And finally, I'm excited to announce that today we're unveiling the addition of sustainability as a core component of our strategy. While Werner has long had a dedicated focus on this important imperative, over the last several months our executive team has come together to discuss and mobilize around our organization-wide sustainability strategy. Going forward we will outline our ESG approach more comprehensively, communicate our ongoing progress and further identify areas for improvement to deliver value for all our stakeholders. In addition to dedicated internal resources to support this effort, we will be transparent and hold ourselves accountable on our progress towards the performance milestones we outlined. Slide 14 outlines how we are architecting our strategy around the overarching sustainability elements: environmental, social and governance. While corporate adherence to ESG principles is becoming increasingly important to investors and associates, I'd like to emphasize that the ideals of environmental stewardship, support for our local communities and strong corporate governance are nothing new to Werner. We've decided, however, that formalizing our approach and unleashing our Werner talent on this important area will lead to even greater positive outcomes than what we've delivered to date. What is new is that we will be applying a laser-like focus on ESG to develop sustainability into a recognized and durable competitive advantage. We have tremendous opportunity if we put all our talent behind this effort and we will. Turn into Slide 15. Today, we are announcing three milestone goals that support our commitment to be a leader in corporate social responsibility in our industry and beyond. The environmental milestone we are targeting is a 55% reduction in our fleet's carbon emissions by 2035. With an average truck age of two years, we will continue to refresh our fleet with the most advanced technologies as they become commercially available. This could include electric vehicles, alternative fuels such as hydrogen or something else entirely. We're not committing to any one technology, but instead plan to achieve our goal by remaining at the leading edge, with the most efficient, eco-friendly and reliable equipment available. The social milestone we are targeting is the establishment of three additional associate resource groups by the end of 2021. And the governance milestone we are targeting is to have a formal diversity leadership position established by the end of first quarter of 2021. Please turn to Slide 16, as a proof point that our commitment is real and very much present in how we operate. Two weeks ago we appointed Carmen Tapio to our Board of Directors, with her term beginning on November 10th. Carmen is the Owner, President and CEO of North End Teleservices here in Omaha, where she is also active in local community organizations, including the Greater Omaha Chamber of Commerce Board of Directors. Carmen serves as the Diversity and Inclusion Council Chair, as well as the CEO's Commitment to Opportunity Diversity and Equity Council Chair. One of our governance goals is to continue to refresh and diversify our Board of Directors, both in terms of experience and skills and race, ethnicity and gender. Carmen, with her capabilities in technology and operations, as well as extensive experience addressing diversity matters will provide valuable perspective. I want to welcome Carmen to our Board. In the coming weeks, we will publish a comprehensive overview on our sustainability efforts today, where we are on our ESG journey and what you can expect for Werner going forward. We plan to be a leader on this front for our associates, our customers, and our shareholders. Now let's turn to Slide 17 and our core strengths and sustainable competitive advantages that continue to support our strong, consistent performance. Starting with strengths. Our diversified truckload transportation portfolio of dedicated, one-way truckload and logistics levels out trucking cyclicality and positions Werner to perform well in both strong and more challenging freight markets. Our size and scale as a top five truckload carrier, top five dedicated carrier and sizeable logistics provider gives Werner stakeholder relevance and economies of scale. Within One-Way Truckload, nearly half our revenues come from our industry leading and high service Mexico cross border and team expedited business units. The implementation of the USMCA on July 1st provides North American trade certainty, in a period of COVID uncertainty. We expect shippers to expand the near-shoring of their supply chains in Mexico and the U.S. in the next few years. We were well established in Mexico, and we are positioned to support our customers through this near-shoring transition. Maintaining a new and modern truck and trailer fleet enables us to stay at the forefront of safety and fuel efficiency enhancements, while limiting maintenance issues that can lead to service delays. And driver talent is a hallmark at Werner. Our large and industry leading 13-location driving school network enables us to vertically integrate the development of new drivers who are safely trained the Werner way. Our leading recruiting position with former military and women drivers is also a Werner strength. These core strengths produce our sustainable competitive advantages. We focus on partnering with growing companies that are winning in their verticals. They value Werner's high on-time service levels to take cost and inefficiency out of their supply chains. Our advanced Werner Edge technology platform enhances the experience of our stakeholders. Our performance driven, experienced leadership team encourages excellence in everything we do. And we work hard to speak with one transparent and consistent voice to all our stakeholders. Lastly, Werner maintains a strong and durable financial position that is sustained by strong free cash flow in an industry leading revenue per truck per week. Looking to Slide 18. Here's a comparison of prior annual guidance to third quarter actual results as well as our fourth quarter outlook. Our fleet declined in the first nine months of 2020 by 4% due to the COVID uncertainties and challenging driver market. During the third quarter, we grew our truck fleet sequentially by 60 trucks with 180 truck growth in dedicated and 120 truck decline in One-Way Truckload. Our fourth quarter outlook is for more modest fleet growth, and we expect this to occur in our dedicated fleet. For the full year, we expect our truck fleet will end up at the bottom end of our annual guidance range of down 3% to down 1%. The used truck sales market began to improve in the third quarter amid better demand, which resulted in improved equipment gains of $3.9 million. We are reinstating guidance for equipment gains for fourth quarter to a range of $2 million to $3 million based on expected sequentially lower used truck sales. We expect net capital expenditures for fourth quarter to be in the range of $88 million to $113 million. In late July when we forecasted One-Way Truckload revenue per total mile for the second half of 2020, we did not assume that freight demand would strengthen as much as it did in August and September. As a result, we exceeded our forecast in the third quarter. We've established year-over-year One-Way Truckload revenue per total mile guidance for the fourth quarter in the range of 3% to 5% growth. This guidance assumes a continued strong peak season for fourth quarter of 2020. We expect our effective tax rate for fourth quarter to be in a range of 25% to 25.5%. We expect the average age of our truck and trailer fleet to remain at or near current levels. In the first four weeks of October, freight demand trends in our One-Way Truckload unit have remained strong. We believe there are several factors that will limit truckload supply for the foreseeable future. These factors include fewer new drivers entering the industry due to COVID safety issues that limit driver school training and state CDL licensing; fewer eligible drivers as the drug and alcohol clearinghouse database continues to build; aging truck driver demographics; and an extremely challenging truck liability insurance market. Werner remains well-positioned with a superior team and active talent pipeline that will continue to yield strong and sustainable results. We believe the runway for demand looks good for fourth quarter and heading into 2021. Inventory restocking will likely occur over multiple quarters. The economy continues to recover. This should lead to much better contract pricing opportunities in the bid season in the first half of 2021. Turning to Slide 19, we have reevaluated our long-term TTS adjusted operating margin percentage goal through the freight cycle. As a result of this review, we are establishing a new long-term average TTS adjusted operating margin percentage goal net of fuel of 13%. We believe this average operating margin is achievable based on our improving financial performance and noting our growing dedicated fleet mix, our substantial essential products freight mix with winning customers, our cost structure that is two-thirds variable and one-third fixed, and our experienced and capable leadership team. Based on our current assumptions and expectations for what we believe will be a strong freight market in 2021, we believe our adjusted TTS operating margin net of fuel in 2021 will meaningfully exceed this 13% long-term goal. With that at this time, I'd like to turn the call over to the operator to begin our Q&A.

The operator will now begin the question-and-answer session. Our first question today will come from Bascome Majors with Susquehanna. Please go ahead.

Yes. Good afternoon. Derek, I was curious about your comments on restocking. When you speak with your customers, what sort of signals are they giving you? The duration of that capacity need and their willingness to perhaps pay up to make sure that capacity is secured. And perhaps beyond that, how are you managing the business to satisfy those customers, but not be over-capacitize when inventories reached target levels and demand moderates closer to the baseline?

Yes. So good afternoon, Bascome. Good question. So when you think about — so the conversations today, our inventory levels especially if you slice it further and look at retail inventory levels are really at historic lows. And those data points are confirmed as we speak with our customers every day as it relates to restocking. There will be a need for restocking more urgently as it relates to, still trying to get freight in before peak and during this peak season. But a lot of those conversations have really lent themselves around how long this restocking will likely take to get back to normalized levels. Many of our larger customers are thinking in terms of multiple quarters of restocking, well into 2021 to get inventories back to a more balanced equation. As it relates to overbuilding or overproducing capacity to meet this peak, clearly we're showing discipline not to do that. We're going to have to make sure and swap the assets that we have. We have to make sure and do more with less wherever we can, but we also have to bring the portfolio to bear. And so when we're talking to customers, we're not only talking about how we can bring that portfolio to them for this peak season to augment or offer additional sources of capacity, but how our expectation moving forward is that we have better discipline around purchasing across the portfolio and with more diversity of their spend or their wallet share with Werner. All of those conversations are going well. I think we all understand the predicament that we're in and that it's going to be a tough peak. But we'll get through it together.

And Bascome, this is John. To back that up the data for our four largest brick-and-mortar retail customers, based on their year-to-date revenues, they're almost a third of our total year-to-date revenues due to the growth they've had. Their same-store sales in the most recent quarter were up 15%. Their inventory per store during that same period was down 8%. That's a massive gap and they expect their same-store sales to remain strong. They're continuing to have challenges with their suppliers and getting merchandise. So we're pretty confident that that inventory restocking will take multiple quarters to be resolved.

Our next question will come from Jordan Alliger with Goldman Sachs. Please go ahead.

Yes. Hi afternoon. Derek, question for you on your total miles per tractor per week, which I think was up, I think it's 1.4% in the quarter. Just sort of curious, I would have thought maybe that would be a little higher given the demand surge. Is that a function of just the driver availability issue and how do you think about that going forward?

Well, I think there's a few moving parts in that and John may weigh in as well, but first off during COVID, team capacity's tougher to come by than normal. And I'd probably lead with that as my answer. I mean, it's real hard during COVID to get folks to want a team and our team count is under duress as a result of that. We're doing a lot of creative things to build teams, but health and safety has to come first. And so that really impacts your ability to get more miles on the existing asset. The second thing is if you look at our utilization rates overall and compare it to most publicly traded competitors, we do a very high — we're at the higher end of that spectrum as it relates to productivity. So simply put incremental gains are tougher to come by, but we're going to continue to work to get them. Overall, we're pretty proud of the work during the third quarter with what we were able to do on productivity. We did get a little help as we mentioned, but not as much as some of the publicly reported data points around the hours of service changes. We think some of those we simply don't take advantage of; we don't believe they are appropriate to do so. Adverse weather conditions is a slippery slope. Some of the air mile radius work is something that we're not going to engage in. We just believe the liability that comes with some of those decisions far outweighs the reward. So overall, we've got eyes toward increasing and doing more incremental gains on the productivity front, but the biggest thing that will change the game for us is when comfort comes back into the concept of two drivers in one truck.

Hey Jordan, and last quarter we were down 0.3% miles per truck. So we moved up 170 basis points this quarter to get to 1.4. And that hours-of-service change was very late in the quarter when that happened.

Got it. Thanks. And then just one quick follow-up as you think ahead to next year, obviously the spot rates are very good. Presumably the contract market's going to heat up in the first part of 2021 any initial thoughts on how that may shake out in terms of contract pricing?

You know, there's been a lot public commentary from others about where they see contract rates going. Directionally we're aligned with comments that have already been made. We know that the current capacity situation lends itself to a really strong setup going into 2021. We will both in dedicated and in one-way, be working with our customers to take rate as appropriate. We also know there are certain headwinds that are out there. There will be a headwind relative to insurance premiums that we've talked about in our last quarter. And those will continue as we go forward. And those need to be recouped through driver wages or something that is a market reality, although our turnover is down and our driver morale is up and I'm actually really proud of the position we're in today. We're not naive to the reality, it's a competitive marketplace. So we're going to have to take rate for that as well. What I will tell you is that we've done a lot of analysis on various rate scenarios and various cost scenarios. And in the end of all of those, one thing that is true is we see the opportunity for margin expansion, while taking into account the headwinds from insurance and risk costs, driver wages and other items. So where it ultimately lands, I'll just tell you we're committed to get what's appropriate and what the market will bear because we need it to make the reinvestments back in the fleet that are going to be required in the coming year.

Right. Thanks so much.

Our next question will come from Ravi Shanker with Morgan Stanley. Please go ahead.

Good afternoon, gentlemen. So back in 2018 you guys did really well with project business, especially in the back half of the year. What are you seeing right now in terms of the pipeline for project business in 4Q and in 2021? And how much of a boost could that be to the business?

Yes. So the project pipeline is strong. Most of that work and those negotiations are predominantly settled. Now, it's just a matter of whether there'll be any surprise to the upside; that's more likely than the opposite. We feel good about what we've been able to put in place this year. It's not surprising with capacity being as tight as it is that we're able to go out and lock-up projects at a premium rate as appropriate to be able to provide that level of service. A couple of things that'll play out as the quarter develops. One is what I mentioned earlier: teams make up a big part of any project solution, and we're working diligently on some programs to build more teams as we go into the final innings of peak — or the middle innings, I should say, at peak. We're making progress there that bodes well for some margin opportunity, because those are even more in demand than solos at this point. As it relates to 2021, I think the real uptick in 2021, first off we're going to have a stronger setup than we've seen even leading into 2018. This setup is better. It's been longer in duration and it's been more consistent than the 2017 setup leading into 2018. And secondly what I'm really excited about is we see in most years even medium-to-strong years second quarter opportunities for project freight that always, that kind, that kind of have happened year-in and year-out. And it's been a couple of years since that second quarter project opportunity has been as robust. I would suspect based on the crystal ball today and everything we see looking forward second quarter next year is shaping up to be another one of those opportunities for quite a bit of project activity in that quarter as well.

Great. And just a follow-up, very encouraging to see the ESG targets that you guys set especially the e-part. But I think 2035 is a long way off. So is this just a marker in the ground? And do you guys feel like you're going to be doing the heavy lifting towards the end of the decade into early next decade? Or are there steps you're taking in the next two or three years, maybe even right now to kind of make incremental traction towards these targets?

Great question, Ravi. The answer is both. The reality is we're always focused on this and it was a pretty interesting eye-opening exercise for us to realize how far along we really are in some of our commitments. So think about first: major fleet in America to go to automated manual transmissions and have 100% implementation. Think about our commitment to aero packages across our entire fleet and what that's done to our carbon footprint. I believe it's four consecutive years we've received the highest possible EPA SmartWay designation as it relates to our environmental sustainability. We'll keep doing those incremental things and keep our nose to the grindstone to be at the leading edge. The problem in the next five years though is the danger of the slippery slope between leading edge and bleeding edge when a lot of these technologies are not fully tested and most importantly, not commercially viable yet. So we'll test and we'll have prototypes, and we will have all kinds of different initiatives already underway as we are currently doing today. But we had to put a marker at 2035 versus something sooner because there's too many question marks about where electric lanes versus hydrogen go, what's the rollout, and is there an appetite for the level of infrastructure investment needed nationwide for hydrogen to be a reality? If not, what kind of advancement can be made on battery range and weight? At what point does the environmental community really start to focus more on battery sustainability long-term i.e., how it's produced? Where are the rare earth metals coming from? What's the carbon footprint of the initial construction and design and build of those vehicles? So we want to be cautious but aggressive at the same time. Our commitment, I will say loudly, is we will be a sustainability leader. How we get there is still TBD. If a technology choice was clear today I would set the goal earlier than 2035, but it's not clear and we will be deliberate and thoughtful about the path while remaining a leader in sustainability.

That makes sense. I'm going to ask you one quick one. You started a trial dedicated service for a customer in California running EV trucks only. Can you remind us kind of has that kicked-off? What have the early learnings been like? How has it been so far? Thanks.

Yes. It's kicked off and the early learnings are valuable. We're learning a lot every day. I want to be a little careful because anytime a trucker talks about some of the obstacles to EV, it's always, it can be framed as somehow being a denier of the possibility of this technology. I'm all in on the reality that electric will happen. I believe hydrogen will happen. But there are real obstacles in the short-term, so that truck and that fleet are having the same type of obstacles that you read about. Range is still limited. Wheelbase issues exist and the trucks are still heavier than we'd like for widespread commercial over-the-road application. But with that said, progress is being made. So we're supportive of that progress and we're going to be a partner in that progress with our OEMs, because we believe a cleaner future is out there to be had, and we want to make sure and lead as appropriate through that transition.

Awesome. Thank you.

Our next question will come from David Ross with Stifel. Please go ahead.

Yes. Good afternoon, gentlemen. Want to focus, I guess first on the dedicated segment and revenue per tractor per week was up a nice 5.8%. Wanted to dive in a little bit and see how you got there. Was that just the dedicated trucks were running more miles per week because the customers are that busy? Was it a mix issue or were there significant rate increases?

Yes. There were a few things. One, obviously when everybody's that busy and we have the need to add trucks to fleets it also usually offers an opportunity for us to talk about pricing. That's a piece of it. There's a piece that simply comes along with busyness overall of the customer: even with the existing fleet base, if it doesn't change in size, you sweat the assets a little bit more which has a piece. But honestly, one of the biggest pieces is just our ongoing efforts to be best in class on backhaul. When we go out and sell a value proposition to our customers, we talk to them about revenue shared backhaul opportunities, and we really want to deliver on that. It becomes a bit of a tailwind and being able to deliver on that when capacity is as tight as it is and freight is as abundant as it is. So you're able to go out and secure more backhaul, increase revenues, share a piece of that back with your customer, lower their overall cost while increasing your overall yield. It's one of my favorite things about running a dedicated fleet: if done well, backhaul is something that everybody wins.

Is this something that Werner Logistics is responsible for or they...?

They play a role. I wouldn't say they're fully responsible for it. They certainly play a role. We collaborate across divisions and talk about how to best use a limited number of assets and a tight driver market so that some of that backhaul certainly comes from them. But we also work with third-party logistics providers and even customers directly. When freight is abundant, you have more backhaul opportunities to be able to fill those empty lanes because they are prescriptive: that load has to pick up at a certain time, go back to a defined geographic area, and meet timing requirements without disrupting the head haul operation of that dedicated fleet. When freight is more abundant, you make better matches. It's logistics planners working with the dedicated teams and supported by the tech we're investing in that's helping us as well.

Excellent. Thank you.

Our next question will come from Brian Ossenbeck with JP Morgan. Please go ahead.

Hey guys. Good evening. Thanks for taking the question and for the extra color on the hours of service. Appreciate that. Derek, one for you. We've heard and it's probably just a sign of the times the marketing type, but it feels like we're back to talking about shippers of choice, areas of choice as well. So do you think there's really anything that's going to change from an annual request for proposal perspective? Is there something in the technology side that might make it less frictionless or how do you expect behaviors will change from this cycle? And did you really see any change from the last one that we just went through, feels like not too long ago?

Brian, that's a great question. I do believe there's incremental, iterative changes that happen when you go through tighter cycles. If you think about step-level changes between shipper and carrier collaboration, they tend to happen more in tight environments. That's not indicative of shippers not caring at other times, it's just they have more urgency in tight markets. Things that may get a cold shoulder at other times are more fully embraced by the rest of their leadership team when they know they're in a tight market. So I think we have opportunity for gains on flexibility items that carriers prefer as it relates to working with shippers. I think you'll see some of those incremental gains, which will improve driver satisfaction and turnover and productivity when executed properly. In tight markets, we've got to go beyond the rate. Rate is one of the levers. The rate environment is going to be robust — that's pretty clear to everyone. But what else can we do? How do we further align our network? How do we build density in engineered lanes? How do we build better driver lifestyles when freight is tight? All of that leads to a better, more sustainable design when we come out of the other end, because when that change occurs, we want to be even further equipped and better ready to weather it. From our diversified portfolio to the customer mix to our long-term view with customers, all of that bodes well for winning even if the cycle changes, but we certainly don't see it happening in 2021.

Okay, got it. Thank you. Just a quick follow-up on the Dedicated in the backhaul, is that — it sounds it's easy to match when freight is tight. So how do you manage the spot market risk or overlay when you look at those contracts? Is it still profitable and just maybe less so if freight goes down? Is that shared equally? If it goes down same as it is on the way up, how did you manage and kind of plan for that cyclicality overlay on Dedicated as it were?

A couple of thoughts. The hardest part on filling those Dedicated backhaul lanes is getting visibility to all of the freight that's out there. There are opportunities that you can't get visibility to because they're already owned by somebody else. When the spot market is more robust, it provides visibility, but that visibility is only as good as your ability to digest it into a system and a tech stack that can then optimize against it. Our ability to pounce on it, secure it, close it and implement it matters. Once a backhaul sticks as part of a Dedicated solution, it's hard to unseat because even if the market loosens later, that Dedicated backhaul rate is attractive to that shipper as long as we're meeting service requirements and it's filling the lane. They're going to want to hold onto that capacity in that form because if they were to place it in the open market, the pricing would likely be higher. These are iterative step-level changes that have pretty good stickiness even as the cycle turns and that's part of why we like our mix between Dedicated and One-Way.

Yes, that was great detail. I appreciate that. Thank you, Derek.

Our next question will come from Ken Hoexter with Bank of America Merrill Lynch. Please go ahead.

Hi, good evening Derek and John. Great update and an impressive new outlook in terms of your margin target, but let me just pick on one thing first. Where is the disconnect in the market with net orders climbing to caution, I guess, the market somewhat believes that the peak is here yet you and others continue to suggest that there's room to — there's legs in the story. So what's the misunderstanding, really the driver availability in the market? Maybe you just extend your thoughts on what really the constraint is and your thoughts on the driver market and the extension of tightness in the market into next year.

Sure, Ken. A few things. Net orders are one gauge on the dashboard. They're climbing from an all-time low base and are not back to 2018 levels. You have to put that against other gauges. BLS transportation data shows year-to-date capacity down 4.8%; ATA's recent update shows roughly 3.9% year-over-year capacity decline depending on segmentation. Our own data shows our truck fleet down about 4%. Most publicly traded competitors that have reported have been negative year-over-year in fleet, excluding acquisitions. Everywhere you look, fleets are down. Yes, you might see some creep into orders, but we're not at replacement levels. OEM production was impacted by COVID and we're ordering to make sure our fleet doesn't age because we committed to keeping it fresh for drivers. Also, COVID remains a risk: outbreaks at plants can disrupt production quickly. On drivers: the FMCSA estimate of 100,000 fewer CDLs is real, there are constraints from the Drug and Alcohol Clearinghouse, and an aging driver demographic. There's not a large army of immediately available qualified drivers. Driver availability is the overall constraint. It's not something you can simply spend your way through. We will not lower standards just to fill trucks.

Great insight. I appreciate that. Let me dig into your outlook then on the follow-up. Your margins now target that mid 13%. Can you just give maybe a little bit more thoughts on that? Is that really just price given what you see in the market because of the tightness and the driver constraints? Or are there things that with your programs that you're launching, whether it's the 5Ts or something else on the cost side? What's the driver of that and how quick do you aim to get there?

Price is certainly one of the levers. But the cost controls and the cost culture we're building are still in the middle innings. We have more work to do and more cost to take out. We believe we know where the opportunities are and we're working on them every day. It's not a single line-item; it's comprehensive. We won't rely solely on pricing. We expect insurance to be higher and driver wage pressure to continue, so those headwinds must be recouped. We're turning the corner on depreciation as an item that was a headwind while working through used equipment sales. We think there's room for P&L support there. We have improved performance recently: our 10-year average truckload operating margin net of fuel is 11%. In the last three years we've improved to around 11.7%, year-to-date this year we're at 12.6%, and the most recent quarter we were at 15.5%. With our mix of Dedicated and One-Way, cost improvements, and logistics fixes, we're confident 13% is achievable over the long term and that we will do significantly better in 2021.

And Ken, one thing I'd add. Our 10-year average truckload operating margin net of fuel is 11%. In the last three years, we've improved that to 12.6% and that included the truckload recession in 2019. Year-to-date this year we're at 12.6% and then the most recent quarter we're at 15.5%. So with our mix of Dedicated and One-Way, the cost improvements we made, we're confident that 13% is achievable over the long term and we'll do significantly better than that in 2021.

Thanks, Derek. Thanks, John. Great job.

Our next question will come from Tom Wadewitz with UBS. Please go ahead.

Yes, good afternoon. I wanted to see Derek, if you could offer some thoughts on how the current setup for 2021, the current environment is compared to 2018. I mean, it seems like there are a lot of similarities, but are there some things that you think are different — good or bad? Do you think driver pay increase and will need to be similar? So what was pretty high driver inflation in 2018? Just wanted to see if you could offer some thoughts on that comparison.

A few things. First, the strength of the market has been longer preceding the entrance into 2021 than it was in 2017 going into 2018. Conversations and reality around headwinds to driver availability are more pronounced and understood across the shipper community. The economy is not yet fully open; the product economy is doing well, but overall economic inclusion is not where it was in 2017 — that represents upside if COVID progress continues. As it relates to driver wages, the starting point is much more elevated today. A U.S. truck driver in some segments can make mid-sixties in year two, and in Dedicated often more. So you don't have as many alternatives pulling drivers away. The constraint that's very real and systemic is you cannot produce as many new entrants in a socially distanced world. Driving schools and programs have lower productivity due to social distancing and some institutions being closed. Combined with retirements and aging demographics, it sets up a different tightness you can't just buy your way through. You have to retain the drivers you have and take care of them.

Do you think there is a level of increase in pay where you get more of a response in the market in terms of pulling more people in? I don't know if there are still drivers that have CDLs but haven't re-entered the industry that have been on unemployment for a while or doing other things. It sounds like constraints obviously in the training pipeline from COVID. But do you think there will be a certain level of increase that you reach that you actually draw more labor in?

Any time wages go up and you make a job more attractive, you'll bring some folks back into the market. But I don't believe there's a big army of folks on the sidelines waiting to re-enter this tight market. Owner-operators and company drivers are already being recruited and hired because it's a strong environment. The constraint is the production of new drivers: social distancing has created roughly 60-70% productivity compared to previous levels in many driving schools. So you're not getting as many graduates. Combine that with aging demographics and retirements, and you have a tightness that isn't easily solved by wage increases alone. You must retain and take care of drivers you currently have.

Right. Okay, that makes sense. Thank you.

Our next question will come from Chris Wetherbee with Citigroup. Please go ahead.

Yes. Hi. Thanks and good afternoon. I wanted to pick up on the comments around the margin outlook in TTS and so 13% I think is the range and then significantly higher or substantially higher than that in 2021. You have a number on the slide. You have 16% on the slide there. I guess I wanted to get if you want to give us a view for what you think you can do in 2021 that would be fantastic; if not maybe you could just sort of conceptualize some of the things that would allow you to reach towards that type of target as we think about next year. We talked a lot about rate, we talked a lot about driver pay. So I think there's some pushes and some pulls there, but can you talk a little bit about next year and whether 16% is maybe the right number for TTS?

Chris, we'll stop giving 2021 guidance on the third quarter 2020 call. But I will tell you that if you look at third quarter 2020, we're already in advance of the range that we just published as a new long-term range through the cycle. We don't expect to give ground from where we're at today. And we actually feel we have a clear line of sight as to how we can improve and advance some of the ground that we've currently gained. It's going to come from things we've already talked about. The headwinds are insurance and drivers. The tailwinds are cost controls, rate support from customers as capacity gets tighter, a better blend of Dedicated and One-Way than we had in 2018 and the setup for that blend working together better. We also have a clear line of sight to fixing logistics, which will help overall operating performance even if not directly TTS margin. So yes, we think we'll be above the 13% range and it's my expectation that we will be above the current operating range. Anything more specific we'll save for later in the year.

Okay, understand. That's helpful. And then I guess lastly a little follow up here on the mix of trucks you're at the 60:40 Dedicated, One-Way Truckload. Are there any new thoughts about how you think about that mix into 2021? And might some of the constraints that we're talking about from a capacity standpoint influence that as well? So any thoughts around that 60:40 mix going forward on the tractors?

We're a little over 60/40 today. We want to meet our customers where they're at, but they have to compete for assets. We have a finite number of quality drivers we can hire, train and retain. As we staff trucks, they will be competed for based on long-term returns through the cycle. If Dedicated customers value the product and want to grow it, we'll have that conversation. One-Way is more cyclical and can cause cycle problems that are less apparent in Dedicated. Until we get further into bid season, I'm not ready to predict major change in the mix, but we did indicate that fourth quarter growth will be focused in Dedicated versus One-Way, so you could see the percentage go up a bit. We evaluate on a truck-by-truck, deal-by-deal basis and won't put trucks into Dedicated if it reduces long-term return.

Okay, helpful color. I appreciate the time. Thank you.

Our last question today will come from Allison Landry with Credit Suisse. Please go ahead.

Thanks for sneaking me in and good afternoon. I just wanted to quickly ask one question. BLS for contract rates in 2021, but specifically thinking about Dedicated versus One-Way, and maybe just based on what we saw coming out of the 2017 tight environment, do you think that there are similar factors that may sort of keep that gap more narrow as we go into 2021 between the two segments when thinking about core rates? Thank you.

Sure, Allison. The current Dedicated product is as covetable today as it has been at any point in its history. Our execution there is really hitting on all cylinders. Our customers understand and want more of that product. Given all of the above, we are not seeing a big giveaway by having trucks in Dedicated. We will continue to have advancements in Dedicated backhaul, which represents a yield opportunity. We'll continue to add trucks to fleets that are better performing and customers are growing with winning models in their verticals, which gives us opportunity for yield improvement. It won't all necessarily be cleanly and obviously just through rate per mile, but there's a lot of opportunities for us to help our customers, support them and maybe even lower their overall costs through backhaul while increasing our revenue per truck per week. I think 2018 was a shining example that Dedicated doesn't leave money on the table just because we have trucks in that unit. 2021 we'll reiterate that story as we get through the year and prove what we're capable of. Ultimately the trucks have wheels and if we need to move and shift that mix because of opportunity or an undervaluing customer, we'll make those tough decisions, but we'll work with customers in the coming months and have many dialogues.

Okay. Thank you so much for the color.

This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Derek Leathers to provide closing remarks.

Thank you, Cole. In closing, I just always want to thank everybody for spending time with us today. I know you're very busy. We appreciate you being on the call. My closing thoughts are that we've laid out a story today that hopefully resonates to make people understand this supply issue is real. The driver market is constrained. It's not one that you can spend your way through. It's one that you've got to attract and retain the best drivers you already have and get through this peak. Peak is upon us. Volumes are strong and project opportunities are out there. We think that sets up for a very strong 2021. Our service excellence is ongoing. It's paying dividends. It's showing through in the financials. I've always believed if you hire the right people, give them the right tools, but most importantly set the right type of expectations, they will live up to or exceed them. And we're going to continue to focus on that going forward. We're in the middle innings on the cost story. We're going to keep working on cost and driving costs out of our network anywhere and everywhere we can and we think there's opportunities to do that. And in closing, I would just say that we are excited about doing everything I just said with an eye toward sustainability like never before. It's really something we're excited about. We're building a structure. We've got a report coming out in a couple of weeks that will further outline and define our ESG initiatives. I'd ask that you take the time to read it when it comes out, and we'll be happy to answer questions on it as well. So, thank you all for being with us and thank you for supporting Werner.

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