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Edited Transcript of USX earnings conference call or presentation 1-Nov-19 12:00pm GMT

Q3 2019 US Xpress Enterprises Inc Earnings Call

Chattanooga Nov 5, 2019 (Thomson StreetEvents) -- Edited Transcript of US Xpress Enterprises Inc earnings conference call or presentation Friday, November 1, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Baubach

U.S. Xpress Enterprises, Inc. - SVP of Corporate Finance & IR

* Eric A. Peterson

U.S. Xpress Enterprises, Inc. - CFO & Treasurer

* William Eric Fuller

U.S. Xpress Enterprises, Inc. - President, CEO & Director

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Conference Call Participants

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* Brian Patrick Ossenbeck

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* David Griffith Ross

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics

* Jack Lawrence Atkins

Stephens Inc., Research Division - MD & Analyst

* Kenneth Scott Hoexter

BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials

* Ravi Shanker

Morgan Stanley, Research Division - Executive Director

* Scott H. Group

Wolfe Research, LLC - MD & Senior Transportation Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the U.S. Xpress Third Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Brian Baubach, Senior Vice President, Corporate Finance. Please go ahead with your conference, sir.

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Brian Baubach, U.S. Xpress Enterprises, Inc. - SVP of Corporate Finance & IR [2]

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Thank you, operator, and good morning, everyone. We appreciate your participation in our third quarter 2019 earnings call. With me here today are Eric Fuller, President and Chief Executive Officer; and Eric Peterson, Chief Financial Officer.

As a reminder, a replay of this call will be available on the Investor section of our website through November 8, 2019. We have also posted a supplemental presentation to accompany today's discussion on our website at investor.usxpress.com.

Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about future expectations, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risks, uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our 2018 10-K filed on March 6, 2019. We do not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to the most comparable GAAP measure can be found in our earnings release.

At this point, I'll turn the call over to Eric Fuller.

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [3]

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Thank you, Brian, and good morning. On today's call, I'll review our third quarter results and provide an update on our strategic initiatives. Eric Peterson will then discuss our third quarter financial results in more detail. I will then conclude with a comment on the market and our outlook before opening the call to your questions.

As you think about our results and even more important, as you consider our prospects as the trucking cycle turns, we ask that you keep in mind the following things. First, our Dedicated business, which accounts for approximately 35% of our revenue, continued to perform well through the third quarter. This is a steadier business with longer-term contracts that have less exposure to business cycles. I am pleased to report that we delivered another quarter of record performance as we achieved revenue per tractor per week in excess of $4,000.

Second, we grew our truckload fleet approximately 5% versus the 2018 quarter, which we attribute to offering professional truck drivers a superior combination of training, equipment, miles, respect and stability through the business cycle as well as a flight to quality amongst the overall driver population.

Third, we continue to execute our internal initiatives and invest in digital technologies that are designed to create efficiencies, lower costs and improve our offerings to our customers and professional truck drivers.

Finally, with the improvement in our dedicated business, a larger OTR fleet and significant noncontract exposure, we believe we are well positioned to capitalize on the eventual upswing in the freight market and take advantage of the operating leverage inherent in our revenue base.

Turning to our third quarter results. We continue to see excess tractor supply in the market, where overall freight volumes were relatively consistent with year ago levels. This supply-demand imbalance not only pressured our revenue per mile, but also our ability to optimize the utilization of our fleet, particularly in the noncontractor portions of our Over the Road and Brokerage operations.

For the quarter, noncontracted pricing in our Over the Road operations declined by approximately 35% from last year's record-high levels, while our spot exposure grew marginally from second quarter levels. Together with a $3.1 million decline in Brokerage operating income, the impact of market volatility overcame significantly better dedicated results and the positive impact of our internal initiatives.

As a reminder, our OTR segment, which is approximately 60% of our asset-based fleet, has historically seen approximately 80% of its freight move under contract rates with 20% moving under noncontracted or spot rates. Year in and year out, the vast majority of U.S. Xpress' spot freight is made up of incremental loads or specific projects from our customers and is not necessarily comparable to the spot market information reported by various services such as DAT.

As we discussed in our second quarter call, excess supply in the market combined with the relocation of capacity from our closed Mexico operations, drove our spot exposure to more than 25% of our Over the Road miles. Through the third quarter, our exposure to spot rates marginally increased sequentially, which was largely the result of the continued soft market trends. Additionally, pricing in the spot market continued to be under unprecedented headwinds as a result of aggressive and unsustainable pressure created by new digital entrants in the market.

Looking at our Over the Road results in more detail. Our OTR contract rates were up approximately 2.6% in the third quarter on a year-over-year basis. However, our spot rates were down approximately 35% year-over-year, which put them at an approximate 20% discount to contract.

Our average spot premium has been more than 20% higher than our contract rates over the last 10 years, and our spot rates have not been below contract for any of those years. As we have said and based on our history, we believe the market conditions experienced this year are not representative of a typical market regardless of cycle, and we will continue to target approximately 20% spot exposure in our Over the Road operations.

As a result, average revenue per tractor per week for the quarter declined 12.1% compared with the third quarter of 2018 in our Over the Road operations. This was the result of a 7.8% decrease in average revenue miles per tractor per week combined with a 4.7% decrease in rate per mile.

Turning to our Dedicated division. Average revenue per tractor per week, excluding fuel surcharges, increased 5.8% in the third quarter of 2019 as compared to the year ago quarter. The average revenue per tractor per week achieved in the third quarter of 2019 of over $4,000 remained in record territory for the second quarter in a row. The increase was primarily the result of a 5.6% increase in the division's revenue per mile.

As we have discussed on prior calls, we have significantly improved the execution in the Dedicated division as we manage accounts to achieve a more attractive combination of rate and utilization. We've been working on this initiative for over a year and are very encouraged with the results as we have experienced 4 quarters of consecutive improvement and believe there's opportunity for further gains.

Brokerage segment revenue decreased to $46 million in the third quarter of 2019 as compared to $65.1 million in the third quarter of 2018 on fewer loads and decreased revenue per load.

We incurred an operating loss of $100,000 as compared to operating income of $3 million in the year ago quarter. This is primarily the result of a $260 drop in revenue per load, partially offset by a $205 drop in cost per load.

I would now like to spend a few minutes updating you on our strategic initiatives, many of which center on utilizing technology to improve our processes, accelerate the velocity of our business, improve our customers and driver satisfaction and lower costs.

To further our efforts, we recruited a Chief Information Officer at the beginning of 2019, with a mandate to digitize our systems and our business. His first project has been our frictionless order initiative, with an early priority on integrating our legacy systems and utilizing existing data to reduce many of the manual decisions that are made on a daily basis.

Let me describe this first initiative to give you a better idea of the opportunity as we work through all areas of the company. If you look at an order, there are typically 15 touch points from the time the customer books the order to the time that it is billed. These touch points require manual work and at times decisions by our drivers and back office personnel. This is not only time-consuming, but also opens the door to both data entry errors and suboptimal decisions. Our goal is to fully automate most touch points and then optimize them. The end result will be a significant reduction in the level of work required by our drivers while in the cab, which should allow them to spend more time actually moving freight.

It will also make our office employees' jobs more efficient by removing routine work. As an example, let's take a look at automatic arrivals. When a driver would arrive at a shipper, he would need to submit an arrival macro, which had to be filled out by the driver. The driver would have to input what trailer they had, the bill weighting and other information, which is both time-consuming, and again, opening the door for data entry errors. What we need to do is consolidate the information into 1 system so we can auto-populate all these items, so the driver doesn't have to input any information. The problem isn't that we do not have the data, but that we did not have the data aggregated into 1 system, which our team is working on and making very good progress. In fact, we have eliminated approximately 4 million touches annualized with line of sight to another 1 million over the next 30 days.

Another important initiative with potentially far-reaching impact has been our investment in our redeveloped driver training facilities. The first of which was opened in Tunnel Hill, Georgia, in February. This program provides continuous learning opportunities for both new and experienced drivers with the goal of providing our drivers with the knowledge, skills and abilities necessary for a successful career. While still early in its rollout, we are seeing positive results from those drivers who have completed this training.

We are optimistic that over time this training will improve our drivers' satisfaction and retention, while also reducing their accident rate and the company's insurance and claims expense. Given the positive results that we are seeing, we opened a second facility in July and expect to open a third facility in the next few months.

Our plan is to continue to upgrade our training facilities across the country. As an additional safety measure, we are moving effective immediately to hair follicle testing for all of our drivers, which is up from 50% of our drivers that we have been testing through most of 2019.

I would now like to turn the call over to Eric Peterson for a review of our financial results.

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [4]

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Thank you, Eric, and good morning. Operating revenue for the 2019 third quarter was $428.5 million, a decrease of $31.7 million as compared to the year ago quarter. Excluding the revenue from the company's Mexico operations, which, as a reminder, were discontinued in January of this year, operating revenue for the third quarter decreased $18.3 million, the main driver with a $19 million decrease in brokerage revenue.

In our Truckload segment, we had 5.4% more trucks producing 4.7% less revenue per truck as success in recruiting and retention came during a period of negative market conditions.

Operating income for the third quarter of 2019 was $3.3 million compared to the $22.9 million achieved in the prior year quarter. We delivered a 99.2% operating ratio for the 2019 third quarter, which is an increase relative to the 95% operating ratio that we reported in the year ago quarter.

Our profitability declined largely as a result of the challenging market conditions, which Eric has outlined.

Our Over the Road fleet saw revenue production decrease 12.1% on a per unit basis to $3,479 in the current quarter from $3,957 in average revenue per tractor per week in the third quarter of 2018. This productivity degradation was partially offset by progress made in our Dedicated fleet, which saw per unit revenue production increase 5.8% to $4,011 in average revenue per tractor per week. In addition, and very similar to the second quarter, driver pay increased approximately $0.06 per mile since last year's quarter as a result of wage inflation and lower utilization.

Net loss for the third quarter of 2019 was $1.4 million, which compares to net income of $16.1 million in the prior year quarter. Loss per diluted share in the third quarter of 2019 was $0.03 compared to earnings per diluted share of $0.33 in the prior year quarter.

As our tractor and trailer delivery and trade schedules have firmed up, we have narrowed our expectations for net capital expenditures for the year to be between $100 million and $115 million compared to our previous guidance of $110 million to $130 million. We will continue to manage our tractors to an approximate 475,000-mile replacement cycle.

We ended the third quarter with $434.2 million of net debt and had $119.2 million of cash and availability under our revolving credit facility. Our leverage ratio is calculated under our credit agreement with 2.7:1, which remains well within the credit agreement requirements, and our comfort zone for managing the business based on our historical ability to manage at much higher leverage levels.

Consistent with our strategy, as stated during our IPO, we intend to delever the organization over time towards 1x. However, we expect progress will be incremental and will vary with market conditions, internal initiatives, equipment financing decisions, amongst other factors.

We believe we are currently in trough market conditions and would expect our leverage to peak in the first half of 2020 before beginning to improve thereafter.

Interest expense for the third quarter was $5.5 million, and we continue to expect interest expense to be approximately $22.0 million for the full year of 2019.

With that, I'd like to turn the call back to Eric Fuller for concluding remarks.

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [5]

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Thank you, Eric. Turning to the market and our outlook. The freight environment has remained challenging as we enter the fourth quarter due to pressure from new capacity added to play 2018 strong spot market and new digital entrants with transactional customer relationships. We expect the fourth quarter of 2019 to exhibit a continuation of negative market conditions experienced through October.

Our prior guidance of a full year 2019 adjusted operating ratio of 95.5% to 97.5% was predicated on an assumption of flat or improving market conditions versus the conditions in June and July. Instead, freight rates declined and peak season freight has been slowly developed. To provide context, if the current market environment experienced through October persist through year-end, our adjusted operating ratio for the full year would approximate 98.5%. In the longer term, we remain positive on the outlook for our industry, and U.S. Xpress', given the significant capacity we will be able to deploy against the next freight upcycle and the growing rate of capacity exit from the industry.

We believe the recent combination of falling new truck orders, growing backlog of used trucks for sale, regulatory constraints and skyrocketing insurance premiums for smaller carriers, all indicate the early stages of capacity exiting the market.

Additionally, the Drug and Alcohol Clearinghouse is expected to go live in January, which we believe will be a major event for the industry and further squeeze capacity out of the market over time.

To conclude, we continue to have significant opportunity to improve our operations and our profitability through the cycle as we execute upon our initiatives.

I remain confident in our team, our strategy and the outlook for our business. Thank you again for your time today.

Operator, please open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Jack Atkins with Stephens.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [2]

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So yes, I guess, let me just start off with kind of thinking through, Eric, your outlook commentary about the full year was approximately an 80 -- excuse me, approximately a 98.5% OR for the full year, that would imply something north of 100, maybe 101, 102 for the fourth quarter, which there's some sequential deterioration there. Can you talk about, a, is that the right way to think about it; and b, what's driving that deterioration of profitability sequentially into the fourth quarter? I know that most folks aren't seeing much of a peak, but we're hearing about at least a little bit of a peak out there. Can you just talk about that? And what can you do to mitigate some cost pressure as we head into the first half of next year?

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [3]

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Yes. Thanks, Jack. I think what we're trying to say there is that if market conditions stay consistent, exiting the third quarter and starting the fourth quarter, that would be more in that mid -- we did a 99.2% for the third quarter, so that would be a comparable result for the fourth quarter, which would approximate a 98.5% on the year.

As far as what we can do to mitigate that, our initiatives that we're looking for over the longer term primarily looking at our insurance and claims expense, we believe we are making progress there and have an opportunity on that line item. Those are more longer-term initiatives where the progress is going to come over time and not necessarily be immediate shown in the numbers from a quarter-to-quarter.

I think also on the cost side, what we're doing on the digitization of the platform, as Eric Fuller mentioned earlier, that's going to continue to take friction out of the process from order to cash of our loads, which ultimately, as those become more efficient, that's going to take cost out of the organization as well. Once again, that's a longer term initiative, where I can't show you hockey stick type results from quarter-to-quarter, but it's something that I am seeing in the number.

I think the biggest thing is that deterioration in the market conditions and our exposure to the spot market primarily in our Over the Road fleet, which has been the headwind on our current earnings, which we believe to be temporary in nature based off the prior cycles that we've managed through.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [4]

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Okay. Got you. But I mean I guess, just to make sure I understand, Eric, the guidance or the outlook commentary, I guess, to be more specific correctly, the 98.5%, does that assume any sort of seasonal uptick into the back couple of months of the year? Or does that assume that the September, October levels just persist on through? I'm just trying to figure out what's assumed in that 98.5% number?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [5]

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Yes, yes. If we go back, September, we saw a little bit of life in the market. I would call it kind of seasonal life, starting to feel a little optimistic about where the market was headed. October, unfortunately, felt a lot weaker than what we would like a normal October to feel, so I think that probably put a little bit more cautious approach to our outlook.

I still see, as you mentioned earlier -- we still see that there is going to be a peak. I think it's a very muted peak. And I don't think it's going to be anything like we've seen probably the last couple of years. But I do think that there are some peak opportunities, and we are seeing some projects and pop-ups and things like that. So I think the -- really, the guidance was based on the fact that if things did not see any type of improvement as we go into November and December. Unfortunately, at this point, I would -- I'll tell you, we're not seeing improvement that's worth noting, but we still have some cautious optimism that with some of our dialogue with our customers that we will see a little bit of pickup relative to the peak season. And so that's kind of where -- that's the reason we're being a little cautious in how we approach this guidance for the fourth quarter.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [6]

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Okay. Got you. One last one, and I'll turn it over. But when we look at the fleet sequentially within the OTR business, it was up, I think, 174 trucks on average, 2Q to 3Q. Can you talk about the fleet plans there? Why not maybe look to shrink that fleet or keep it stable? Why are we growing that one sequentially in such a challenging market because I would guess that the OTR business is probably -- if the consolidated company is a 99.2, OTR is over 100.

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [7]

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Yes, yes. Yes. Admittedly, the OTR group is really giving us a lot of headwinds at this point. But if we go back and look really over the last 20 years, and I would even throw 2008, 2009 into this conversation, you typically only see a few quarters of rates that where spot rates are running counter to contract rates, and we're now running 3 to 4 quarters, where we've been in that scenario. So we believe that the upside opportunities, if we look over a long period of time, are far greater with larger truck count as opposed to keeping our truck count reduced. And so from our approach, we think it's prudent when there is opportunity to grow truck count to do so because we think coming out of this cycle, there will be a lot of upside opportunity for us.

And one other thing, Jack, I did want to mention also is Dedicated. We also -- we saw some -- a good bit of growth in Dedicated, but we also anticipate additional growth in Dedicated over the next couple of months. We do have a number of accounts that we have already sold that are going in over the next 90 days that will allow us to continue to grow our Dedicated.

So we feel very optimistic about Dedicated opportunities. And so our ability to grow with it Over the Road and then shift those drivers and trucks into Dedicated also leads us to go ahead and grow that fleet now.

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Operator [8]

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Your next question comes from the line of Scott Group with Wolfe Research.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [9]

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Just so I understand that last point, are you going to take the trucks then out of Over the Road and put them into Dedicated as these contracts begin?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [10]

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We would. Now if there's an opportunity to grow both with our belief that the market has troughed and that there will -- the market will turn in a relatively due time, we would take the opportunity to grow both. But our first intention would be to move those drivers and those assets out of Over the Road and into Dedicated.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [11]

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So -- and what does this mean for CapEx, and I understand this year, but what's the preliminary thought on cash CapEx for next year?

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [12]

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Yes. We're going to stick to the equipment cycle, Scott, at $475,000, and we're still going through what's going to be leased and what's going to be owned. But I think obviously when you're going to look at our earnings, we're going to be prudent. And to the extent we have more cash earnings and better results, you'll see a higher percentage of that will be with debt financing compared to leases.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [13]

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Okay. And then I just want to clarify what you guys are saying about the fourth quarter so we all have the right expectations. So are you saying -- I guess, Eric Peterson, you made a comment that fourth quarter OR should be similar to third quarter obviously that wouldn't get you to a 98.5% just so -- I'm not sure, should we be getting to 98.5% for the year or should we be modeling fourth quarter OR similar to third? I just want to make sure we understand what you're trying...

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [14]

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Yes, yes. We're saying approximately a 98.5%, so I meant to the extent that you're in that mid -- similar results in the fourth quarter compared to the third. That's going to approximate at 98.5%. I think to your point, it might be slightly lower.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [15]

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Okay. And then the rate per mile in Over the Road, down 8% and utilization down 5% in third, how are you thinking about those 2 metrics in the fourth?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [16]

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Yes. I mean we still anticipate some peak season rates that will boost that up a little bit. But I think at this point, we probably anticipate similar results.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [17]

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Okay. And then just lastly, depreciation took a bit of a step up, I'm guessing, is that more just on losses on sales? Can you give us a number on that and how we should think about residuals loss on sales going forward?

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [18]

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Yes. I would say that putting some equipment that we took out during the third quarter, there were some losses there that really drove that depreciation up by a couple of million dollars. But on a go-forward basis, yes, I would expect that number to be lower than what we experienced in the third.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [19]

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Do you think we should start to move depreciation lower again starting in the fourth?

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [20]

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Slightly.

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Operator [21]

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Your next question comes from the line of Ravi Shanker with Morgan Stanley.

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Ravi Shanker, Morgan Stanley, Research Division - Executive Director [22]

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Just a couple of follow-ups here. One is, just going off your response to the first question, I'm still having a little bit of difficult time understanding why the right strategy here is kind of staying where you are and waiting for the market to turn rather than kind of trying to go where the market is, where -- which seems to be something that some of your peers are doing. I understand what you're saying about if the market comes back hard, you're going to be in a great place, which you will be, but the market may not come back for a while just given the macro we are in right now, and so kind of what does that scenario look like?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [23]

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Right. Yes. So I mean we are working diligently to move our Over the Road asset either into Dedicated opportunities or into consistent contract freight that will give us more consistency, both on the utilization side and on the rate side. And so we believe we can accomplish that while seeing some truck count growth.

Again I understand the approach -- I would say that our network and we've run numerous scenarios, is our network is not built to where if we were to shrink the fleet that we could improve our profitability through shrinking and part of it is an infrastructure issue. And so if we look at our overall fixed costs from our infrastructure, putting more revenue and more miles over that infrastructure is a better model for us. And so for us, we believe that if there's opportunity to grow truck count, that it's prudent to do so.

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Ravi Shanker, Morgan Stanley, Research Division - Executive Director [24]

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Okay. And maybe a follow-up to that is, I mean I hear what you're saying on repositioning the truck fleet and such, but are there more decisive cost actions that you guys can take? I mean you're doing a lot of good things on tech, which is great, but I mean is there any other like big cost items? I know you spoke about the long-term cost initiatives, anything in the short term we can do to predict the OR?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [25]

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We are -- we've taken down. So if you look at -- I think one of the bright spots for us is we look at our overhead and our SG&A within our operations group. And though the truck count -- the truckload group, though the truck count has grown, we've been able to maintain that head count, and so we're not having to increase head count in order to handle the additional trucks. So I think that's significant and that will lead to better results down the road. We are also continuing to focus on our insurance costs. That is a major area that's getting a ton of attention within the company. And we've seen some positive results in that area. In fact, we haven't had the level of catastrophic accidents that maybe we had had in the past. And so we believe that, that will continue, especially as we move into hair follicle testing and have a better quality driver that's coming in the door. So we feel really optimistic there.

And then the frictionless order process that we're really focused around automation and optimization, I believe that this next 2 quarters is where we're really going to start to see the impact. We've been working on it for about 3 quarters now. And a lot of it was, what I would call, kind of rudimentary stuff, just trying to maybe do some things that maybe we deferred or hadn't done in the past. Now we're really focused around some things that I think will really start to bear some significant results in our financials.

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Operator [26]

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Your next question comes from the line of David Ross with Stifel.

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David Griffith Ross, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics [27]

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Eric, I want to talk a little bit about drivers. Are you seeing any pay pressure this year?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [28]

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We're not this year with the driver situation. I look at it as a couple of things. I mean obviously, we're focused around changing things within the company to make us easier to deal with, that frictionless piece, I think, is really starting to help us get a little bit more traction from a driver perspective, particularly in recruiting. But also what we're seeing in the market broadly is more of what I'd call, a little bit of a flight to quality, as the market continues to feel weak, then you typically see drivers move to the larger carriers, where there's more stability and we're seeing that as well. And so -- that we're not feeling any pressure to increase wages in order to bring drivers in.

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David Griffith Ross, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics [29]

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And with the extra trucks and the decline in utilization, is it just hard to get them the miles because their pay, in theory, is down year-over-year now?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [30]

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So if we look at where we were, if we were to go back and look at our Over the Road group 2 quarters ago in roughly the same operating environment, our utilization was comparable. So we do not believe that we're seeing a significant degradation in utilization related to truck count growth. We think that -- and again, because of the irregular route network, it is difficult to be affected on one way or the other, so we are able to continue to bring in revenue that's getting the same amount of utilization. So if you look at on a truck by truck basis, I don't think that the drivers necessarily are making significantly less. And in fact, I'd say probably around the same. And so that hasn't affected that. And I -- and we don't think that will affect us going forward either.

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David Griffith Ross, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics [31]

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And then on the hair follicle testing, do you anticipate any material incremental cost from that before you get any benefit?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [32]

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I mean minimal. I mean obviously, right now, the government still requires us to do both hair follicle and urinalysis, which is unfortunate, and we are still trying -- we're part of a request with a number of other carriers to get that lifted so we can do just hair follicle, but at this point -- but I think those costs are not significant.

Outside of that, we believe, because we are a little bit later than some of the other peers who saw a significant degradation in their truck count when they went to hair follicle, we believe that we won't see as significant of a reduction, if a reduction at all, in our truck count relative to hair follicle. And also keep in mind, we've had about half of our drivers' hair follicle tested up to this point. So it's not like one of these other carriers that went from 0 to 100, 2 or 3 years ago and saw a huge hit. We believe that we can maintain our truck count. But I will say that part of our strategy on boosting up our truck count was anticipation of hair follicle testing. So if we do see some slight degradation in our recruiting classes, we're doing it with a higher number of trucks versus being at a lower number and then seeing a degradation from there, and we thought that was a better strategy as well.

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Operator [33]

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Your next question comes from the line of Brian Ossenbeck with JPMorgan.

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Brian Patrick Ossenbeck, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [34]

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So just to cap off that last train of thought, it sounds like the Over the Road fleet, you've upsized maybe a little bit in terms of putting more dedicated tractors from there on the road in the future. Obviously, you've got to be on the cycle to play into that as well, and then maybe a little bit of the headwind from hair follicle testing going to 100%, depending on how that plays out. Could you -- if there's any other buckets in there, please add to them. But could you kind of rank order those in terms of the size, how much Dedicated is growing, for example, is that the biggest factor here? Or is it really more of your view on the cycle and wanting to be in the right place at the right time?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [35]

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Yes. I mean look, our long-term strategy is still to grow Dedicated and have a higher concentration of Dedicated. We're still running roughly in that 35-ish percent. We'd like to see it be closer to 50%. So we are focused around growth there. Our line of sight of growth within Dedicated is probably -- we can see anywhere from 5% to 10% growth over the next quarter, quarter and a half, within that group. And we're continuing to be aggressive out in the market to try to bring other opportunities in within Dedicated because I think that's going to be very impactful, regardless of where the cycle goes, right?

The hair follicle testing is something that will give us a benefit longer term. I think that once you have a higher quality of driver for a period of time, then you start to see less accidents, less catastrophic accidents. Definitely, you usually see less turnover, you see better service. So we think it all really interplays. But is it one of those deals where we would get an impact day 1, absolutely not. I look at that probably as more of a longer tail on the impact.

But as it relates to cycle, we still, long term, want to focus on building that dedicated up to, say, 50%. But then also we are still committed long term to keeping our spot within that 10%. So trying to get back to that level on a total revenue basis and stay there regardless of cycle is our long-term strategy.

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Brian Patrick Ossenbeck, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [36]

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Okay. So when you talk about Dedicated going to 50% over time and being more aggressive, perhaps, in the near-term for the pipeline, can you just put some context around that in terms of what else you're looking to grow? How big the pipeline is here relative to the last quarter or so? And then if there's any other verticals, geographies, end markets that you're looking at in terms of other growth opportunities?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [37]

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Yes. I mean so Dedicated opportunities, I would say, a lot of opportunities within our current customer base. I think the interesting thing last year was there was a number of customers that opened up their carrier base within Dedicated. They seemed to have retracted in large part that strategy and gone back to trying to do a lot with a few and those few that kind of understand their business and can perform at a high level. So I think that benefits us because of our large presence within Dedicated.

So we think we can see some decent growth within the current customer base. There's also some opportunity for us in some other verticals within Dedicated, specific more towards different types of products. So not like -- I'm not saying we're going into last mile or anything like that, but into other types of products, whether it be maybe different types of electronics or consumer products and things like that. We've been very heavy discount retail and grocery up to this point. We will continue to prioritize that. But I think there's other opportunities.

So I would say, pipeline-wise, interesting enough, it definitely is -- the pipeline from an overall opportunity standpoint, is down significantly. But like I said, what we're seeing is better opportunity because there's less carriers in those opportunities as well. And so from a growth perspective, I think we feel just as bullish now and dedicated as we probably did 12 months ago.

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Brian Patrick Ossenbeck, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [38]

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Okay. Maybe one for Peterson, if you can just give us context on raising the leverage ratios for the credit facility? I know you gave some color earlier about where you think the ratio will top out in the first half of the year. It looks like you got some headroom already, but you took that up a little bit further at the end of September. So maybe you can give us a little more context as to why you felt that was needed, if there was an abundance of caution and maybe how close you think you're going to be to the new ceiling given your guidance for the first half topping out?

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [39]

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Yes, thanks. And to everyone, just a reminder, we did amend our credit facility. We'd like to -- we have great financial partners, U.S. Xpress, on our term loan, and we're continuing -- we're continually monitoring the market conditions. And as the market conditions have deteriorated, we thought it was prudent to go ahead and adjust the financial covenant requirements in the facility. Regarding where that could go and where that could peak in the second half -- or in the second quarter of 2020, as I mentioned, it's really going to depend on the market conditions. And so that's something that we're going to monitor closely and keep our eye on it. And I'd like to remind, we've never been in breach of a financial covenant because of the -- because of our strategy with our financial partners to try and stay ahead of that.

Our strategy really hasn't changed since the IPO. We'd like to march the organization to a 1x levered organization, but we realize right now that's longer term and that's going to depend on the market conditions and how successful we are in our initiatives. But obviously, the market conditions are going to play a large part in that. So we'll continue down that path. And where that number peaks, I was going to say, is largely dependent on where the market's going to be, and that's something that I don't think anybody has a perfect line of sight to right now.

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Operator [40]

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Your next question comes from line of Ken Hoexter with Bank of America Merrill Lynch.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [41]

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I guess after listening to this, I'm still confused a little bit on the -- why you're increasing the tractors so much in the quarter. I get that you want to be primed. But I guess going back to Ravi's comment on if the conditions continue a bit longer, why not maybe react to the market? And then I guess just a follow-up on that. If you're expanding the fleet and you're anticipating that there's going to be some negative reaction from the hair follicle testing, even though you're going from 50% to 100%, why would you expand the fleet in face of what would be a decline in driver assets? Why wouldn't you want to be reducing the fleet in preparation for losing some capacity there?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [42]

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Yes. So I think a couple of things. One, we do have a business in Dedicated that is already sold and just hasn't started yet. So as we onboard those opportunities, we will move those trucks out of Over the Road. We -- when we're building Dedicated opportunities and a lot of these opportunities can take a little while to staff up, so by going ahead and staffing early will allow us to go ahead and be at full capacity quicker than probably, typically, we would anticipate. And so we view that as a positive with the opportunities that we have in the pipeline. And so I think that's one piece. I think the other piece is...

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [43]

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But, Eric, can I just jump in there because what I guess -- I mean we've heard so many questions on this. When you have other peers that are operating at 15 percentage points difference, I mean if you were at that point, I guess, you could say, okay, I can expand because it makes sense, but at a 99% to 100% OR wouldn't -- I mean if you've got the risk that you've got more of this spot pressure and it's pressuring your margins, why not decrease your exposure to that market and move? I get that you want to be prepared, but there's always the ability to add capacity if the market calls for it when things are changing.

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [44]

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Yes. I mean like I said with the Dedicated piece, it's really about having the capacity. These Dedicated opportunities are onboarding over the next 90 days. And so being able to shift trucks out. But I think the other big piece is this hair follicle testing is -- if you go back and look historically at our peers that went to hair follicle testing, some saw as much of a drop as 5% to -- some as high as 10% in their truck count for a period of quarters after they went to hair follicle testing. So if we were to reduce our fleet and then go to hair follicle testing and take a huge hit, then that would be a significant hit which our overall revenue, and we believe our cost infrastructure, would suffer. And so by being able to boost our truck count now in anticipation and try to mitigate that loss of potential revenue and loss of coverage of our fixed cost infrastructure we believe is the right strategy, as we go to hair follicle testing.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [45]

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I mean that's even more confusing to me because then you're stuck with even more tractors if you're losing drivers, if you're expanding your fleet as opposed to fewer tractors at risk and with a 99% OR, you figure you'd want to try to minimize that, no?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [46]

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Yes. So 2 different situations, right? So what the -- when we look at the assets, we look at the physical truck assets, we have very little concern that if we saw a degradation that we could reduce the fleet, that is not the problem. With our trades and with the number of trades that constantly come up, we could -- we can pull back some additional orders and additional new tractors that we're bringing on and naturally bring that truck count down. So it's not an asset issue, it's a driver issue.

So allowing us to have the drivers is the reason that we would do that. The asset play is very fairly easy to manage, and we can reduce the number of tractors as it's actually occurring by just reducing the number of trucks we take or by increasing the number of trades that we put out into the market.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [47]

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Okay. So is that kind of timing any leases or operating leases or CapEx going into the end of the year? Is there kind of a timing into peak season that we should look that you could adjust at a faster speed?

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Eric A. Peterson, U.S. Xpress Enterprises, Inc. - CFO & Treasurer [48]

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Yes. Really, just to add to that last answer from Eric, if we look at the financial impact of this incremental truck count, I think a point that Eric made earlier on the call as it relates to SG&A and our overhead, is that we were able to add this truck count without increasing our fixed cost. So the incremental trucks are actually accretive to our earnings, even in the challenging market with it primarily 2/3 variable, 1/3 fixed cost infrastructure.

And so I would say that in a down market where the volumes and the rates are suffering a little in the Over the Road, that those incremental trucks help offset some of those headwinds and actually become a tailwind. And also if you look at our strategy, we're looking long, and we understand where we are in the market right now. But if you look historically on the cycles and how long the rates in the spot market have stayed lower than the contract, we believe, if we follow historical cycles, that we should be coming out of this in the next couple of quarters.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [49]

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Okay. Just maybe switching to another topic for a quick second. You've -- you kind of highlighted in the spot that given the -- I think, Eric, you mentioned early on that the brokerage exposure for the spot really pressured rates. Is there something you can do to work your spot exposure away from the brokerage market, maybe on your own sales force on current customers? Anything you can do to decrease that exposure, I guess, not necessarily on the spot rate, but maybe on your exposure to the Brokerage segment?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [50]

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Yes. So -- and we look at spot as not brokerage. So spot is, how we define spot would be anything we don't have a long-term contract with. So spot could come from one of our major direct -- or one of our major customers and it just not have a rate. And the reason we call that spot is because that's usually predicated on the supply-demand at that specific time at which we quote that order. Most of our spot, as we define it, does not come from brokerage. So just to clarify.

But we are working towards getting more contracted business. We've made -- over the last 9 months, we've made some pretty big changes -- or 12 months, within our sales group, and I think it was about 12 or 14 months ago, we made a change within our Chief Marketing Officer. And so that's really starting to show some significant improvement. We also opened up an inside sales group that is on the phones, going after smaller customers, something that U.S. Xpress has not traditionally done, which is focused on that tail of small, small customers, people that may have a $10 million or a $20 million spend.

We typically focused on the kind of the mega shippers. And so now, we've built the group around trying to bring in smaller shippers and help to fill gaps. We're seeing some pretty significant wins. That group just launched within the last 90 days. So they wouldn't be really in this last quarter's numbers, but we're starting to see some wins from that group. And I think over the next couple of quarters, we're going to be able to fill more of the trucks that are going out in the spot with some consistent contract business through that program.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [51]

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Just -- so when you said the pricing on the spot was under unprecedented headwinds created by new digital entrants, I just want to clarify, you're just talking about the entire spot market pricing, not just your exposure to these digital entrants?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [52]

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Yes. I mean if you look at the digital brokers that are out there, they are shoving rates through the floor and it is unsustainable. They are taking negative gross margins to try to grab market share and apparently they have unlimited cash, they don't have to make any money. And so these guys are very aggressive in the market. And they are creating this situation, in my opinion. I think without those type of brokers in the market, you would not have this market behaving like it does because I think if you look at the normal supply-demand situation, it's not as bad as the market makes it look because of how these digital brokers are aggressively trying to buy market share.

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Kenneth Scott Hoexter, BofA Merrill Lynch, Research Division - MD and Co-Head of the Industrials [53]

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So with that comment, though, I'm just looking at what's happened with J.B. Hunt noting that they're willing to spend money and lose operating income for the next 12 to 18 months, I think they said. You've got Uber Freight, Convoy, Amazon, all coming out and staying on, but yet you're saying we expect the market -- that we're prepping ourselves for a rebound very shortly, wouldn't you in light of the unlimited capital that you just mentioned, believe that you should be cutting the fleet to prepare for maybe a longer cycle on the market pressure there?

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [54]

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Yes. So I think you've got 2 situations. Yes, you have these digital brokers that are pushing rates to what we would call unprecedented levels. But on the flip side, they are also pushing out their own capacity. Because of the rates that they are taking in the market, they are pushing these small marginal carriers out of business in a quicker fashion than we believe we've seen in a long time as well. And so I think that even though they are aggressive in the market from a price perspective, I think they're also really hurting themselves in the back end because they're killing their own capacity.

So we still believe, with everything that we're seeing in the market, that this thing will self-correct in a relatively short period of time. And I think that scenario, it will probably speed that correction. And then at some point, I mean you look at it, you also see -- I don't think this endless supply of cash and never having to make money is going to last forever. And I think this whole WeWork thing obviously was kind of the beginning of that, and I think we're starting to see that from venture capital and from private equities, this capacity to just never make a profit, I think that world is changing a little bit.

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Operator [55]

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Ladies and gentlemen, we have reached the end of the question-and-answer session. And I'd like to turn the call back over to management for closing remarks.

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William Eric Fuller, U.S. Xpress Enterprises, Inc. - President, CEO & Director [56]

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Great. All right. Well, we appreciate everybody on the call. One thing I do want to -- that didn't come up on the call, I just want to mention, as we go into 2020, we do have the Drug and Alcohol Clearinghouse that goes into effect in January. We still believe that is going to have a significant impact, and in fact I would say a much larger impact than what may -- some of you may have anticipated. And so we think that's going to have -- probably going to push this market towards -- back in a favorable position for the asset guys in quicker fashion than maybe would normally occur because of this regulatory situation. So just want to bring that up.

But anyway, I appreciate everything, and we'll talk to you guys in a few months. Thank you.

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Operator [57]

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This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.