US Xpress Enterprises Inc (USX) 2020 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the U.S. Xpress Third Quarter 2020 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn this call over to Mr. Brian Baubach, Senior Vice President, Corporate Finance. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. We appreciate your participation in our third quarter 2020 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 in the Investors section of our website through October 29, 2020. We have also posted an updated and more detailed supplemental presentation to accompany today's discussion on our website at investor.usxpress.com. We'll be referencing portions of this supplement as part of today's call.

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 2019 10-K filed on March 4, 2020, as supplemented by our second quarter 2020 Form 10-Q filed on August 5, 2020. 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.

Thank you, Brian, and good afternoon. On today's call, I will review our third quarter results and provide an update on our digital fleet initiative. Eric Peterson will review our financial results in more detail, and I will then conclude with a review of our market outlook. The 5 main themes that we hope you take away are, first, we continue to make progress transitioning underperforming OTR solo tractors to our digital fleet, which we have now branded as Variant. This transition remains a priority for our management team and the key to driving margin expansion.

Second, the substantial improvement in Variant's operating metrics include increased utilization, lower driver turnover and reduced costs held steady from the second quarter's levels as we grew the fleet approximately 25% during the quarter. Third, the freight market strengthened through the third quarter, which boosted revenue per mile in the uncommitted portion of our OTR fleet. We made hiring qualified drivers more challenging across our entire Truckload segment. I'm going to spend more time on this topic later because attracting and retaining the right drivers has been the single largest obstacle to improving our profitability, and we believe our digital fleet initiative will increasingly help address the issue through 2021.

Fourth, our dedicated operations continue to deliver strong performance as we continued our trend of average revenue per tractor per week in excess of $4,000 for the sixth consecutive quarter. And lastly, we have taken meaningful steps through the third quarter to improve the profitability of our Brokerage division.

To start, this is an exciting time at U.S. Xpress as we seek to transform our business to deliver not only pure levels of profitability, but also deploy an operating model that is being purpose-built to organically scale over time. Through the third quarter, we continued to scale Variant, adding approximately 100 average tractors compared with the second quarter. Variant's business model continues to prove out, maintaining a more than 20% advantage in utilization and approximately 70% reduction in driver turnover and substantially fewer accidents per million miles in the legacy Over-the-Road, or OTR, fleet.

This provides real confidence in the scalability of Variant as we work to transition an additional 400 underperforming tractors in our legacy OTR solo fleet by the end of first quarter of 2021. As we complete phase 1 of our transition, we expect improvement in our operating ratio through the first half of 2021 regardless of the market backdrop. Ultimately, we believe that Variant provides a long runway for not only margin expansion but also sustained organic growth.

I would like to take a few minutes to discuss our historical challenges with driver turnover and our former OTR student driver program in more detail because it speaks to the profitability that we are addressing and will also provide good insight into why our unseated tractors increased in the midst of a strong market. We are confident that the steps we have taken will ultimately lessen the volatility that our results have experienced through market cycles.

Over the last decade, portions of our legacy OTR division have experienced driver turnover as high as 185% in some years as our systems became unnecessarily complicated. This has caused increased [well], lower miles driven and ultimately, a reduction in our drivers' ability to earn, on average, competitive pay. As a result, we've had to spend significantly on driver recruiting, training and bonuses as well as keeping excess capacity of unseated tractors to meet this high turnover.

Our OTR student driver training program was a key source of driver supply to keep up with turnover and provided a buffer to our fleet to meet customer demand. The downside to this solution was the poor profitability of our student drivers given their cost of recruiting and retention, low utilization and higher levels of accidents per million miles driven.

Our frictionless order initiative was specifically created and designed to reduce the complexity in our systems and improve our driver satisfaction while also accelerating the velocity of our operation. Bob Pischke, our CIO, has done an amazing job digitizing our company as we continue to remove millions upon millions of manual touch points. We are beginning to reduce the level of work required by our drivers, allowing them to spend more time moving freights, which results in higher take-home pay and greatly improving their satisfaction working at U.S. Xpress.

The frictionless order initiative was also a key first step and foundation, which enabled our team led by Cameron Ramsdell to develop Variant. Further, this fleet is largely recruited, planned, dispatched and managed using artificial intelligence and digital platforms. Variant is a completely new paradigm for operating trucks in an over-the-road environment that is provided to the driver through a proprietary app-based driving experience.

Through 3 quarters of operation, Variant is producing. A key benefit of Variant is the significant reduction in driver turnover. As our drivers see their utilization and pay increase as a result of more miles driven, their job satisfaction also increases. This is an important aspect to the transformation of our business model. As we continue to transition tractors from our legacy OTR fleet over to Variant, we believe not only will our turnover continue to decline, but so will the accidents per million miles driven and resulting claims expense.

The improvement is dramatic. As an example, our average preventable accidents per million miles are more than 30% lower than our legacy OTR fleet. This significant cost is coming down materially given our business model transformation.

Turning to our third quarter results. Our third quarter Truckload operating ratio improved to 94.6% or a 450 basis point improvement over the prior year. This improvement was tempered somewhat by a higher percentage of unseated tractors in our legacy OTR fleet due to increased competition for drivers during the quarter and suspension of our student program during the second quarter, which contributed to an approximate 6% reduction in miles driven during the third quarter.

Early driver satisfaction at Variant led me to believe that the fleet will be successful at rapidly attracting external experienced hires. However, our initial ability to attract experienced drivers was unsuccessful. To address this issue, we made adjustments to Variant's recruiting program and are beginning to experience a pickup in hiring momentum through October, as indicated on Slide 7 of our earnings supplement.

Our Over-the-Road segment experienced a year-over-year increase in spot rates given the improving supply/demand dynamics in the market. This helped to drive average revenue per tractor per week higher about 5.8% as compared with the year ago third quarter. The challenge was an increase in unseated tractors, resulting in a 1.3% decrease in revenue miles per tractor per week.

Turning to our Dedicated division. Average revenue per tractor per week, excluding fuel surcharges, increased $54 per tractor per week or 1.3% as compared to the year ago quarter. The average revenue per tractor per week achieved in the third quarter of 2020 of over $4,000 remained in record territory for the sixth consecutive quarter. The increase was primarily the result of a 3.7% increase in revenue miles per tractor per week partially offset by a 2.3% reduction in average revenue per mile.

Brokerage segment revenue increased to $56 million in the third quarter of 2020 as compared to $46 million in the third quarter of 2019 primarily driven by increased revenue per load and to a lesser extent, an increase in load count. We incurred an operating loss of $4.5 million as compared to an operating loss of $100,000 in the year ago quarter. Improving Brokerage margins is a priority for our team, and during the quarter, we executed on a series of initiatives that have resulted in monthly sequential margin improvement since the beginning of the third quarter. Our short-term goal is to return Brokerage to a breakeven run rate as we exit 2020.

Let me now turn the call over to Eric Peterson for a review our financial results.

Thank you, Eric, and good afternoon. Operating revenue for the 2020 third quarter was $431.5 million, an increase of $3 million as compared to the year ago quarter. The increase was primarily attributable to increased revenues in the company's Brokerage division of $9.9 million, an increase of $7.1 million in Truckload revenue partially offset by decreased fuel surcharge revenues of $14 million. Excluding the impact of fuel surcharges, third quarter revenue increased $17 million to $403.7 million, an increase of 4.4% as compared to the prior year quarter.

We posted operating income of $15.9 million in the third quarter of 2020, which compares favorably to operating income of $3.3 million in the 2019 third quarter. Our operating ratio for the third quarter of 2020 was 96.3% as compared to 99.2% in the prior year quarter. The primary drivers of improved earnings were higher rate per mile and lower claims expense.

Revenue per tractor per week improved 5.8% in our Over-the-Road division and 1.3% in our Dedicated division, while accidents and overhead costs reduced as we continue to execute on our digital initiatives and fixed and variable costs control efforts. Additionally, I'm happy to report that our Truckload operating ratio improved 450 basis points to 94.6% from 99.1% in the prior year quarter.

We continue to execute on our initiatives designed to improve our profitability and some of the notable results are as follows. First, we continue to allocate capital away from the underperforming divisions in our organization to more profitable areas as we successfully grew the Variant fleet by more than 25% or approximately 100 tractors for the quarter to approximately 500 as we exited the quarter and have further grown to approximately 550 tractors in this division to date in October.

Second, we continue to benefit from the strategic decision to close our student program in our Over-the-Road division. Third, for the quarter, we were able to achieve growth in Variant without diluting previously realized operational efficiencies that we announced last quarter. As outlined on Slide 8 of the earnings supplement, this is significant as we are not seeing dilution on a per unit basis as we increase the volumes over this new model. As a result of the success, we are continuing to expand that group with the target of having a total of 900 tractors converted by the end of the first quarter of 2021 as we are effectively in the process of transitioning the majority of our legacy solo Over-the-Road operations over to Variant.

Finally, we are making recent progress towards improving the financial results in our Brokerage segment despite robust market conditions that generally pressure gross margins in this business. The segment's operating ratio for the quarter was approximately 108%, but improved sequentially through the quarter. As we execute on our initiatives, we expect the segment's OR to improve approximately 500 basis points for the fourth quarter.

During the quarter, as we continue to execute our strategic decision to allocate capital away from our underperforming legacy OTR division and into Variant, the driver market tightened and turnover in our legacy OTR fleet returned to the higher pre-pandemic level. This dynamic resulted in a faster pace of contraction of the underperforming legacy OTR division than the pace of growth in Variant, which resulted in approximately 10 million fewer miles in the third quarter compared to the second quarter of 2020 due to fewer seated tractors.

However, we remain committed to our strategy and understood in advance that this digital version would not be linear in nature. We believe the trends are positive for our future. For example, we believe the negatives, such as higher recruiting costs in legacy operations, more unseated tractors and higher insurance premiums, were mostly front-end loaded. In contrast, we believe the positives, contract rate renewals occurring during a rising market, the impact of safety on claims expense related to the suspending of the student program and the continued growth of the Variant fleet, all build over time and we are in the early innings.

For example, as we continue to build and scale Variant and reduce the number of unseated tractors, these miles will return but over a digitally-enabled platform that is yielding lower costs and higher revenues on a per unit basis. We believe that ultimately, this will have a significant impact on our ability to deliver levels of profitability on a regular basis.

Net income for the third quarter of 2020 was $10.7 million, which compares to a loss of $1.4 million in the prior year quarter. Earnings per diluted share were $0.20, a modest increase from our second quarter earnings of $0.18 per diluted share.

Turning to our balance sheet. We had $386.3 million of net debt and $154.9 million of liquidity defined as cash and cash equivalents plus availability under our revolving credit facility. I'm very pleased with the progress that we have made as our leverage continued to decline to 3x net debt to trailing 12-month EBITDA for the third quarter of 2020 compared to 4.15x at the end of the 2020 first quarter. We believe our leverage will continue to improve over the next several quarters.

We are taking a conservative approach with respect to our liquidity, leverage and capital expenditures until we have greater certainty concerning the pace and extent of the economic recovery. As we discussed on our second quarter call, we reduced our planned net capital expenditures for 2020 to be in a range of $100 million to $120 million and still believe this is where we will end up, which includes a previously discussed $20 million transaction that carried over from the fourth quarter of 2019.

Through the third quarter of 2020, net capital expenditures were $95.3 million, including the $20 million carryover. Interest expense for the third quarter was $4.4 million, and we expect interest expense to be approximately $20 million for the full year of 2020.

Finally, during the quarter, we were able to renew our auto liability insurance program in a challenging market, which ultimately resulted in annual premiums increasing approximately $5 million, which went into effect on September 1.

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

Thank you, Eric. To conclude, our third quarter results continue to validate our vision for Variant and the long-term potential this new business model offers for our driver, our company and our industry. This model was designed and created by U.S. Xpress utilizing artificial intelligence and digital platforms to manage all aspects of the fleet's operations, including recruiting, planning, dispatching and management.

What makes Variant's optimization so effective is its ability to dynamically react to changes within its ecosystem and self-correct instantaneously. What this means in plain English is their operations are continuously being optimized, which improves our utilization and ultimately, our drivers' pay and satisfaction. As we have discussed, this is delivering a substantial lift in our performance as Variant is achieving an approximate 20% improvement in utilization per truck, a dramatic decrease in driver turnover of approximately 70%, improved safety, a higher level of on-time service and over time, a reduction in fixed costs.

Looking forward, we remain on track to have the initial 900 underperforming legacy OTR tractors moved into the Variant fleet by the end of the first quarter. We will then embark upon phase 2. The key is the scalability of the model, which means we can organically grow this business while maintaining these strong financial results regardless of the cycle. What has been a headwind to our results over the last decade is driver turnover. We believe Variant solves this challenge and the results of inefficiencies in costs that come with it.

As we look to the fourth quarter, we expect our driver recruiting in Variant to pick up, which we are already beginning to see through October. This increase will deliver improved results, which should effectively offset the turnover that we have experienced in our legacy OTR fleet and slightly improve our profitability for the fourth quarter as we expect to experience improved spot and contract pricing. As we continue to scale Variant into the first quarter of 2021, we then expect to experience sustainable margin expansion over the course of the next year.

In regards to the market, our baseline assumptions for the balance of 2020 include a general sequential economic recovery that may be volatile at times, increasing inventory restocking, tight trucking capacity and relatively benign cost inflation outside of driver-related and insurance premium expenses. These conditions combined with the continued shortage of drivers are expected to be supportive of the market and rates through next year, which will have to support significant increases in driver pay, some of which are already in place.

As a result, we expect contract rates in 2021 to increase on average by 10% to 15% with the driver shortage likely extending the cycle as we believe there will be up to 200,000 fewer drivers compared to the beginning of the year. While the economic outlook remains somewhat uncertain, we remain very positive given the many opportunities that we have in front of us to improve our profitability, including a further development of the frictionless order, conversions of underperforming tractors into Variant and the benefit of further streamlining our operations.

Thank you again for your time today. Operator, please open the call for questions.

(Operator Instructions) Our first question comes from the line of Ravi Shanker with Morgan Stanley.

It looks like you're taking some short-term pain for some long-term gain, which makes sense. I think the timing is unfortunate, coming at the kind of strong point in the cycle. But just 2 -- kind of a few clarifying questions on Variant here. One is, do you have updated timing for phase 2?

Meaning -- phase 2 meaning the second group...

Yes, the 1,200 trucks, yes. Is that a 2021 thing? Or is that beyond that?

It's a 2021. So we will probably start that starting in the second quarter of 2021, and that conversion should be finalized by hopefully the first half of 2022.

Okay. Got it. And also, you only have like 50 experienced drivers out of 900 trucks so far, but the momentum is increasing. Can you share a little more detail on kind of why you had that initial skepticism and kind of how you've been able to convert that? And also, I'm a little bit confused. I mean I got the impression that Variant was meant to be able to make student drivers just as effective as experienced drivers, so I'm not sure why you need experienced driver. Maybe I misunderstood that.

Yes. No, we're really focused on experienced drivers. We think that with the level of turnover being in that better than 50% range within Variant, we think that we could just prioritize experienced drivers over students. And we think that student drivers -- there's a lot of issues that come with student drivers. One, it's incredibly expensive to train them, but also the quality. Even if you do a very robust training program, you often see that the quality of the driver and accident rates and things are higher. So we would rather try to keep students out of that population, and that's part of the strategy.

With the recruiting piece, we believe -- and I could say it was a miss on my part. We saw the rabid enthusiasm from our driver population within Variant, and we thought that as we went out into the market from a recruiting perspective that we would get this influx of drivers. And realistically, that didn't happen. It probably took 6 or 8 weeks. And to be fair, as we were out recruiting externally, we didn't get a lot of traction initially. So we had to spend a little bit more time with marketing, leveraging our current drivers to go out and kind of speak to other drivers, do some marketing, do some testimonials. And as we did that, we started to get some traction.

And you can see there on our supplement slide on Slide 7 that it started slow. But just last week, we hired over 15 -- we hired 15 drivers in Variant. I believe we'll hire more than that this week. And we really need to be in that 20-plus range on a week-to-week basis from a hiring perspective. And I believe within the next week or 2 or 3, we'll be there, and I think we can maintain that. We're starting to get traction. And now I feel like now that we're getting our name out there, we're getting traction, that we've kind of gotten over the [home]. That first 6 to 8 weeks was a little difficult just trying to get that traction out of the market.

And I think we just didn't recognize how difficult it would be launching a new brand and a new concept and the driver acceptance. The biggest thing was there was a lot of skepticism from the driver population of, "Yes, yes, yes. Everybody says this, but I have a hard time believing it." And so -- but I think now we're starting to get some [buy-in].

Got it. And just lastly, the initial results look really good. But are you convinced? I mean do you have data that convinces you that this is real and not just kind of noise related to COVID?

Yes. No, we absolutely do because we can go back. I mean we started this in Q3, Q4 of last year. The results that we were seeing even with 25 and 50 trucks is comparable to what we're seeing with 500. And so there -- we're not -- we haven't seen any kind of degradation or any kind of change in the statistics. In fact, the statistics stayed pretty even pre-COVID, through COVID and then through this last quarter. And so we feel pretty confident that those numbers are real and they're consistent. I mean if you look at what we're doing, I mean, it's significantly different than how our legacy fleet has operated. And we believe that all the elements of that really does drive a better product.

Our next question comes from the line of Jack Atkins with Stephens.

So I guess, Eric, just to maybe kind of think about it this way, you've got 1,300 or 1,400 trucks in the legacy fleet left to convert over. If you were to get that group of trucks down to a 50% to 60% sort of annualized turnover, can you help us think about the savings that, that would generate to the organization on a consolidated basis?

Yes. I think it could be significant. You're exactly right. I mean if you look at those trucks and you get them down to 15 -- 50% turnover, that's just one component. We said that on average, it can cost up to $15,000 for every driver that you have to hire. And so if you're going from 150% turnover to 50% turnover, you're hiring 1/3 less drivers. Number two, in converting those drivers over, if you have 1,300 tractors that all of a sudden increasing their utilization by 20%, that -- at a 2/3 variable and 1/3 fixed model, that group of tractors essentially got 700 basis points more profitable on utilization alone.

And then third, and this is one we're really excited about, is the safety metrics that we're seeing. If you look at our preventable accidents per million miles, this group is down to 4. And as Eric said, we've been seeing the same result with 25 trucks, 50 trucks and even today, running approximately 550 tractors in this division. We're still seeing 4 accidents per million miles.

To put that in perspective, this legacy fleet was at 12 incidents per million miles in 2019. That's 1,300 tractors though, and this is what's exciting. By no longer having the students in this population, those remaining 1,300 tractors are still performing much better. They're down to right under 7 accidents per million miles compared to 12, but the Variant trucks are just -- they're just outperforming them at that 4 number right now. So getting those remaining tractors in all the miles, 1,300 tractors worth of miles over to that digital model is going to have a significant impact on our overall earnings.

I mean is there something -- just kind of from a bracket perspective, can you maybe -- I think that would be helpful for folks if we can kind of maybe think about the potential magnitude because, I mean, it seems like these are awfully big numbers that could be showing up here over the next 6 to 8 quarters regardless of the freight backdrop. And so I know you don't want to get too far out on a limb here, but is there anything you could share with us in terms of just to help us quantify the potential savings when you sort of put all those buckets together, just rough numbers?

Yes. I mean if you look at it and you want to say that represents approximately, say, 1,500 tractors is about 25% of our fleet in round numbers, and the numbers I went through are probably 1,200 basis points of earnings. So that's -- overall, that's 300 to 400 basis points on the consolidated results.

Okay. Okay. That's helpful. And I guess just maybe just for my follow-up question, last one for me. When you think about the business and sort of how it should trend as you go from the third quarter to the fourth quarter, I think if we go back a quarter ago, [we thought] we could improve operating ratio as we move through the year, quarter-to-quarter. Obviously, there are some challenges in the 3Q because of driver turnover in Brokerage.

But is there a way to kind of think about what -- how we should be thinking about operating ratio improvement sequentially given the improvements in Brokerage, given the rate improvement that you guys have been starting to realize in the business? I know that would be offset by driver wage inflation and things like that. But can you maybe frame that up for us in terms of how we should be thinking about the sequential change?

Sure. Yes. So we're still working through some issues. So there's still a little bit of that overhang that we're dealing with in Q4. But we are starting to see some momentum in Q4 relative to our recruiting initiatives and our growth within our Variant fleet. Also, if you look at our Brokerage group, we're trending -- in fact, this last week, we had our first week of breakeven within our Brokerage group in nearly a year. And so we are trending towards a breakeven. I think we'll be close to that exiting the year. I don't know that we'll have that for the quarter. I think there'll still be a little bit of noise for the quarter from a Brokerage perspective, but we're starting to trend towards more of a breakeven.

And so I feel really good about the things that we've been focusing on in Brokerage, and I think we have the fix in place and it's just going to take a little bit of time for that to continue to play out. If you look at the overall fleet, Dedicated's still running strong. So our biggest opportunity is really that conversion. So I think that if you look at it from an earnings perspective, I think we'll see sequential improvement, but I still think that we're in the early stages of recognizing the full impact of all of this transformation.

Our next question comes from the line of Ken Hoexter with Bank of America.

Maybe you could just give us a quick refresher on what it takes to convert the fleet and given the success, why you can't go maybe perhaps a bit faster here.

Yes. So the conversion at this point, so we moved over 450 to 500 trucks that were internal drivers. So we converted drivers over into this model, and there's a specific type of driver that we're looking for. They have to be a little bit more digitally native. They have to be willing to operate in a little bit more of an environment where they -- there isn't as much handholding. And so it does take someone who has some experience in the industry.

And so it's a specific type of driver. And so we converted about 500-or-so internally, but then we needed to go externally to start to drive growth further. And that traction, from a recruiting perspective, didn't happen as fast as we would have liked. And like I said earlier, it's -- launching a new brand, launching a new model and then trying to explain the drivers why it's different and how it's different was a little more difficult than I think we appreciated. But I think now we're -- we now have momentum, and now we're past that.

So you -- on page -- or the chart 7 where you had the turnover, you were just talking about the 48 drivers in 10 weeks for Variant and you're at a 50% turnover rate. But I presume that's an annual rate. That means you've just had a handful of maybe a couple of drivers that have turned over. Is there -- have you done a postmortem with them as to what was wrong, I mean, just given there was a couple of them to -- or is there anything to figure out about why that turnover is there [as we look at] driver turnover?

Sure. Right. We have been, and one of the best indicators is we have yet to see on a large scale any kind of issues related to us or the fleet. When we go and do postmortem with some of the U.S. Xpress drivers, there's a lot of negativity. There's a lot of, "Hey, this happened, this happened. I'm frustrated. I didn't get enough miles," whatever. Those are not the kind of things we're hearing from our Variant fleet. Some of them are churns that we make, whether it be safety-related or things like that.

On the other hand, typically, when drivers are self-selecting to leave, it's usually a personal reason. They're going off the road for -- they want to be with their family or trucking is not for them. They decided to go to construction or whatever. So for the most part, that's the reason we're seeing attrition. It's either involuntary or if it's voluntary, it's something that wasn't related to us. It was more a personal issue for the driver.

Last for me. Just to clarify, Variant, are you coming out with a new branding for the tractors? Or is this just a name brand internally? And then my other question is -- go ahead.

Well, I'd just say on the branding piece, it's driver-only-facing brand, but it is a completely new brand. The tractors are gray. They're not red. We believe this model is so different and so unique from our legacy brand that we thought it was necessary to have a completely new brand out there in the market. So we are recruiting for this brand specifically. There's a different -- I mean, there's -- everything for the driver is completely different. How they interact with the office, how they do their day-to-day, the type of tractor they're in, the color of the tractor, the whole works.

Okay. Last one for me, the miles. I just want to understand. Is this solely because of lack of drivers that we're seeing miles down? Is that just, I guess, given the need for utilization with inventory levels so low? Or is that an unseated tractor count? Is there -- or is it just the drivers? Or what is...

Yes, it's mostly unseated tractor count due to the driver situation. We did -- we have seen through the last probably 90 days some issues with some of our shippers where detention times are going up. It's taken longer to load tractors and unload tractors, and I think it's due to labor shortages at a lot of our customers. And so we are hearing that and feeling that on a regular basis, which may have a little bit of an impact. But I think the biggest impact was the driver situation and the fact that we have more unseated tractors than we normally would carry.

All right. Wonderful. And you include that in your numbers, right? You count all tractors even if they're unseated, right? It's not like...

Yes.

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

So maybe just to follow up there. So utilization down 1 in the third and rates up 7. What do you think is a good expectation for both of those in the fourth?

Probably similar results, maybe a little bit better results from a utilization perspective. We are currently addressing some rates on the contract side. Likelihood, if they -- if those rate improvements go in, it's in the back half of the quarter. So it probably doesn't greatly impact the quarter, though I would say peak season has the potential to drive spot rates higher than we saw in Q3. So I would say a little bit of improvement on the rate end and maybe some small incremental improvement in utilization.

So when do we actually see utilization inflect positive?

Once we start getting some positive net growth in our truck count. I think we can probably see that into Q1. I think this quarter, we're still working through that. But like I said, the last couple of weeks, we're starting to see the appropriate momentum there, and we believe we're kind of over that hump. We're definitely past the stage where we're losing seated truck count. We've stabilized. We can start growing our seated truck count back, and I think that we'll probably see that hopefully at some point in Q1.

Just to be clear, so are you talking about grow the unseated -- grow the seated count or grow the reported truck count that we see?

Yes. No, grow the seated count because as we grow the seated count, obviously, that impacts our utilization. So yes, grow in the seated count. I -- we have no plans at this point to grow the net amount. In fact, we probably will try to take down that net number to an extent because of the unseated.

Right. And then I don't know if this is a silly question or not, but there's a lot of talk about the old fleet and Variant. But what's the typical driver turnover for a new driver versus an experienced driver? Forget if they're on Variant or not, just what's the typical [turnover]? I'm guessing -- yes.

Yes. So when we were doing the student program prior, we -- our turnover was running north of 200% for students, probably closer to that 150-ish range for experienced. So the student turnover was significantly higher.

So I guess, I'm -- like you're -- so it sounds like even on the old fleet or sort of the legacy fleet, whatever you want to call it, there was a 50-point spread in driver turnover. I guess I'm not really sure what's so different about that than Variant.

Well, because we're only hiring -- we only have experienced drivers within our solo legacy fleet today. We're running still north of 150% or so. So if you look at the student population that we had prior going in, it was still a smaller percentage of the overall. And so the net was -- and in some quarters, we had run as high as 170% and 180% turnover partially with that mix of, say, 150 experienced and 200-plus of students. But we're still seeing north of 150% today in our legacy population.

Okay. And then just last thing, real quick. Eric Peterson, I thought I heard something about 500 basis points of margin improvement at Brokerage. Was that a sequential comment, so like a 103 OR? Or is it closer to the breakeven? I'm just not sure.

Yes, averaging for the fourth quarter, we're saying we did a 108 in the third quarter. And the comment was that we'll be 500 basis points better than that sequentially in the fourth, so that would be a 103. And as Eric mentioned, last week in that division, we are at a 100 even.

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

You talked about converting some of your drivers into Variant, but then needing to go external. So as you go external, what happens to the drivers that had been driving in the underperforming Over-the-Road fleet?

Yes. So over time as attrition takes place -- and that was kind of somewhat what happened this last quarter. We had a couple of decisions to make as we saw that we were not getting traction on the front end with Variant. We had kind of deprioritized recruiting for our legacy fleet because obviously, our long-term plan was to move drivers into this new fleet. We kind of had a semi check early in the quarter, saying, "Hey, we're not getting traction. Should we go back and start recruiting for this legacy fleet?" And where we landed was that eventually, we're wanting to get out of that fleet in whole anyway.

And so we decided that wasn't the right decision, that we needed to stick with our strategy of recruiting for Variant, not recruiting to that legacy fleet. And so that's why we saw the truck count drop, but we still think that was the right decision. And over time as attrition takes place, as we bring in new drivers, we will bring them into the new digital fleet and not into the old legacy fleet. And so over time, the amount of tractors that we have in that will obviously shift over into Variant.

Do you have the current OR for the Variant fleet?

No. Right now, we're focusing on the product, and the product is increasing the utilization and lowering the overall driver turnover. So in effect, we're standing up 2 infrastructures, one for the digital and one for the legacy. That's something that as we get further in this transition, we'll be able to discuss.

Yes. I think -- I was going to say, David, one thing is, yes, exactly what Eric said, is we're doubling up costs in a number of areas in order to grow and build this. And so our landing pad long term at maturity, we think we can be as much as 1,500 to 2,000 basis points better than the legacy fleet. But there's an investment period, and we're in the middle of that investment period right now.

So if that's the case, that's way better than even the non-underperforming Over-the-Road tractors. So wouldn't all 30, 50 move to Variant?

So yes. So our strategy, obviously, is we're focused on those that I would say are losing money today. But we're always going to be looking at that tail and obviously trying to improve -- kind of our capital allocation strategy is to improve our earnings through allocating capital to the more profitable group. So we would make a decision at some point in, say, late 2021, do we then convert the rest of those tractors over. Or at that point, does it make sense to start into a growth strategy because we have a scalable model? And if the market -- if it makes sense from a market perspective, then we may look to grow in that fleet.

Or I guess as you talk about Variant recruiting and planning and managing and dispatching, if it's operating as well as you say and that much better, is there anything you can just learn from what's going on with the AI to have your people operate more efficiently or do things differently in the legacy fleet so you actually get the benefit there even before you would ever convert?

To an extent. So we've done some of that. We've learned some things and tried to apply it to our legacy business. But at the end of the day, the amount of transactions that take place and the amount of touch points that take place in a day-to-day running a fleet of that size, a computer with artificial intelligence can do so much more than a person from a manual perspective. And so I think there are some things that we can learn, but the full benefit is really the digital model really helps us to recognize that full benefit.

And last question just for Peterson on the -- like a financial [knit]. With the insurance renewal, was there any change in the deductible or in your excess coverage that went along with the premium increase?

Yes. We did lower our overall [tower]. But as far as the deductible amount, it stayed at the $3 million.

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

Eric Fuller, can you just talk about if you're hearing any real changes on the RFP, the bid cycle, if there's going to be something different this time? I'm sure there's more mini-bids out there. You said you're working on some of those right now. But is this just one of those things that we hear about when capacity is tight and the cycle is closer to a peak or at least doing very well? Or do you think there's actually going to be some structural change either through technology or through the capacity constraints we're seeing, that people just want to transact differently? Anything on that front would be helpful.

Yes. I think that we will see some structural changes in RFP process over the next 3 to 5 years. I wouldn't say that this year is the year where that really is a significant difference. I think this year, everybody is really focused from a shipper perspective around trying to capture capacity, doing everything they can to capture capacity because of concerns about capacity that are going to be ongoing into 2021. And so I would say that's going to be more the focus than doing anything transformational around the RFP process.

So I will say that I think over the next 3 to 5 years -- I mean, some of this had been pushed by digital brokers and new entrants into our market. I do think that the expectation around technology and technology alignment between the carrier, the provider and the shipper, that expectation has gone up significantly and I think that will continue to increase. And so I think as we go forward over the next 3 to 5 years, I think the expectation is going to be more of a digital engagement. And I think that will probably change a little bit of the traditional RFP process.

Okay. Got it. A couple more on Variant. Just wondering, when you go to the old trucks to the new ones, I think it's red would be gray and you've got different capabilities, of course, in the new ones, is there a used truck overhang? Or how are you managing any sort of residual risk that might be there as you transition from one to the other?

No. I think if you look at our general trade cycle, essentially, what happened is when a red truck gets traded out, a gray truck comes in. So it's really not going to change the amount of used equipment that we have on -- that we have that we're -- that have to offload. So essentially, what we're not doing is we're not parking the entire red truck fleet out of cycle, selling it all and bringing in gray. We're sticking with our normal trade cycle.

Okay. Got it. The other part, when you think about recruiting for the new platform, I get that it's very different than the current legacy fleet at U.S. Xpress, but how much of an edge [or like that] do you think you have on your peers? What are you hearing from some of these other experienced drivers that you're going after? I'm sure they've got a lot more attention and focus and offers on them in these last couple of weeks and more so in the future. Are you getting the sense that someone else could replicate this? I guess what are the common reasons you hear that you get turned down from someone that you're trying to pursue with this new model?

Yes. I think the biggest thing is skepticism, right? I mean if you look at -- if you were to go out and look at all the advertisement that's out there from a trucking perspective is there's a lot of noise. And everybody kind of advertises kind of the best-in-class type stuff. And so when we're out there talking about our utilization and talking about how we treat drivers, there's a lot of, "Yes, yes, yes. Everybody says that." And so there's a little bit of, "Hey, you've got to prove it to me."

One really distinctive piece about this model over the long-term is we're also applying the same strategy of technology to recruiting. And so we are going over time to minimize that traditional recruiting piece as much as possible and really leverage the drivers because we think that that's really where the value of kind of convincing somebody that there is a -- that this is new and it's different and it's innovative. That's where we're going to get the real value, and we're actually starting -- on the early days of seeing traction to that.

And I think one of the things that excites us the most is one of the big limitations to scalability is the fact that even if you're running a low turnover, you're still going to have a lot of churn and that churn obviously requires a lot of replacement drivers. And you've got to have a large infrastructure of recruiting, and then you've got to have a large advertising budget to drive apps into that recruiting department.

We think that this model over the long term, and we're in the early days, like I said, of rolling this piece out, we think that, that solves a lot of those issues and actually will allow us to scale in a much less costly manner and actually scale quicker. So not only is this an operational play from a technology perspective, but all aspects of this model leverages technology.

Okay. And do you feel like there's any sort of competitive offering out there in the market at this point? Maybe not branded or advertised the same way, but have you run into any of that as you're trying to recruit?

I have no doubt that some of our better-in-class peers are applying some of this same type of technology to their legacy fleet. I think the difference is we have completely redesigned the business model from cradle to grave. And it truly is significantly different in how it operates, and I think the drivers see it and feel it. And so I think that while there will be some incremental improvement by applying different and new technology, I do think that our model, the cradle-to-grave type solution of kind of a greenfield approach, I think, is unique. I don't think anyone else is doing that out in the market, and I think that we'll get a better benefit because of that approach.

All right. Last quick one for me, back on the Brokerage margin. You mentioned a few things you're doing to help get that moving in the right direction, month-over-month improvement. What sort of initiatives have you put in place? I would assume that just based on commentary from peers and just how the market's moving that you would see margin improvement anyway. So what above and beyond just the market conditions have you seen make an impact here into the fourth quarter in Brokerage?

Sure. So we put some -- a new management into our Brokerage group around kind of Q1 of this year. We're starting to get some significant traction around that change. And so that's starting to bear fruit and improve a lot of our results, our operations, our margins. Also, we are shifting a little bit of our model where I think we were overexposed to contract business within our Brokerage group. And obviously, when a market turns significantly like it did, then that having too much exposure to contract is negative. And so we're trying to emphasize more spot business, trying to go out into the market and be a little more opportunistic from that perspective. And so that's helping us to drive better gross margins, which will drive better profitability as we go forward.

Our next question comes from the line of [Nick Farwell] with Arbor Group.

I'm curious how this demand cycle appears, if it does, much different than more recent economic recoveries. For example, the impact of the huge inventory replenishment cycle, is that skewing demand in some unusual ways? Or are there other ways you can characterize this period of recovery versus, say, the last 2 or 3?

Yes. I think from a demand perspective, it's a very unique environment. So you've got -- you really kind of have the haves and the have nots. One, you look at retail. Retail is booming. We see the retail sector, their demand is really high, while you see maybe industrial and some of the other sectors are actually below where they were pre-COVID. Retail has not only rebounded where they were pre-COVID. They're actually outpacing pre-COVID.

But then you also look at the haves and have nots within the retail segment, and you've got some retailers that are booming. In fact, we have some larger retailers that are seeing 20%, 30% type of year-over-year increases in their volumes. And so these are big significant increases, while we have other retailers that are off as much as 50% or 60%. And so I think those retailers, more smaller, regional retailers or niche retailers or clothing retailers are definitely hurting, while more of the big box retailers are booming. So you've got that aspect.

I think the other big piece, and I actually think it's a bigger piece of this cycle, is really the supply cycle where you have over 30,000 drivers in the Drug and Alcohol Clearinghouse. You had at least 100,000 less CDLs issued to date than you did last year, and then I think we'll have more drivers going to the Drug and Alcohol. And I actually think that due to the fact that the school -- some of the schools have shut down and those that haven't shut down are running in social distancing that I think you'll probably have another anywhere from 40,000 to 50,000 less CDLs issued on the back half of this year.

And so likely, we will exit 2020 with about 200,000 less drivers in the market than we entered 2020 with. That is significant, and that deficit is not going to come back in the short term. We're not going to be able to build back that deficit partially because the schools don't have the capacity. And so I think that that's going to prolong this cycle more than anything.

And is there a regional aspect to that? It doesn't sound like it. Like gateway versus internal, just to be very gross and geographic comment?

You might see some lumpiness here and there given certain weeks and stuff. But for the most part, I would say it's really universal across the whole network.

And then my last question is Dedicated versus Over-the-Road, especially long-haul teams or otherwise. Can you talk a little bit about rates in those 2 sectors of your business?

Sure. Yes. I mean, Dedicated, there you're going to have a lot more stability. Typically, we're working on 3- to 5-year contract. And so that stability is not going to be as volatile when you see this, like, this market turn like it has. And so I think you'll see probably a normal course of rate increases that are necessary and then some that are related to driver pay in Dedicated because the driver situation is getting very competitive. And so I think you'll see some increases to support driver wage increase.

On the OTR side is where we're getting just increased volatility. The spot rate is -- the spot market is spiking probably higher than I've seen in a long time. There's a lot of volatility in that market. The contract rates, I think, are going to have to go to a fairly significant change really for the big reason is we went through 2 bid cycles where we had flat to negative rates. And you had quite a bit of cost pressure along with those negative bid cycles. And so there is a catch-up that has to happen here. And I think we'll probably see it through this bid cycle.

So the last question is in the Dedicated, as you're rebidding and obviously looking at different contracts, to what degree are you and others in the industry embedding surcharges for driver pay, availability of capacity and other such factors that are reflective of the unknown capacity and demand environment much beyond, say, the next 3 to 6 months? When [you say] Dedicated are at least 2 to 3 years, you mentioned 5, I didn't know that, but somehow you have to take into account for capital reasons making commitments of capacity and drivers at a time when it's -- you just -- you have no clue what it's going to be like 18 months [from now] and much less 3 year or 5 years.

Well, thankfully, we have good relationship, solid, long-term relationships with our customers on the Dedicated side. And so as we see these types of situations, usually -- in almost in every case, we're able to go to that customer, discuss what we're dealing with, talk about how we feel we need to address it. And if driver pay is an issue, then we go to them. In a lot of cases, we make that driver pay decision in conjunction with the customer. We talk about the market. We talk about the region it's operating in and the competition we're dealing with. And we'll go to the customer and show them all the facts and say, "Look, we need to give a 10% rate increase in this market." And usually, we'll get -- we'll ask the customer to kind of make us whole from that perspective. And as long as we've done our work and we show that the increase is necessary, then usually we don't get a lot of pushback.

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Eric Fuller for closing remarks.

All right. Thank you. One thing I do want to address. If you look at this quarter, I actually believe that there's a lot of positive things from this quarter. You look at our insurance costs. You look at the fact that we were able to continue to grow in our digital fleet without degrading our statistics. There's a lot of really positive things that happened in the quarter. And that's not to say that we're not disappointed by the end results. With the kind of momentum we saw on the rate side, we would have liked to have had a little bit better of a kind of a bottom line.

But at the end of the day, this is really the long game, and we're really focused around our long-term results and trying not to get too caught up quarter-to-quarter. I mean we could have easily knee jerked in mid-June and reinstituted the student training program and done a couple of other things to try to get our truck count -- our seated truck count back up. We don't believe that would have been the right decision. And at some point, we would have had to go back and fix that problem.

So we're really focused on the long term, and we think that we're on the right path. And again, as we even mentioned in the last quarter, these type of things aren't linear. We're talking about a massive transformation. And so there's always going to be some peaks and valleys in that process. We're fully capable and aware of that situation and what we're going to be dealing with over the next couple of quarters. But we feel really confident that what we are setting up is the right structure for the future of U.S. Xpress, and we're really excited about it.

One other thing is we continue to pay down debt. And so as we look at our leverage, obviously, we believe we will exit this year with significantly less leverage than what we had had in the past. We're excited about continuing to pay down debt and continuing to set this company up for the future. So with that, thank you and look forward to doing it again next quarter.

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time.