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Earnings Transcript for USX - Q3 Fiscal Year 2020

Operator: 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 the call over to Mr. Brian Baubach, Senior Vice President, Corporate Finance. Please go ahead, sir.
Brian Baubach: 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 on the Investors section of our website through October 29 of 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 will 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 of 2020 as supplemented by our second quarter 2020 Form 10-Q filed on August 5 of 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 will turn the call over to Eric Fuller.
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. Peterson will review our financial results in more detail and I will then conclude with a review of our market outlook. The five 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 operating metrics include increased elevation, 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've made hiring qualified drivers more challenging across our entire truckload segment. I'm going to spend more time on this topic later because attracting entertaining 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've 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 continue to scale Variant adding approximately 100 average tractors compared with the second quarter. Variant 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 of legacy over the road or OTR fleet. This provides real confidence in the scalability of variants 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 one 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 their 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 decades portions of our legacy OTR division have experienced driver turnover as high as 185% in some years as their systems became unnecessarily complicated. This is called increased dwell, lower miles driven and ultimately a reduction in our driver's ability to earn on average competitive pay. As a result we have 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 the 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 utilizations 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 freight 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 in 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 three 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 models. 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 accident per million miles driven and result in claims expense. The improvement is dramatic. As an example our average preventable accidents per million miles are more than 30% lower than a 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 450 basis point improvement over the prior year. This improvement was tempered somewhat by a higher percentage of unseated tractors in a 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 would be successful rapidly attracting external experienced drivers, however, our initial ability to attract experienced drivers was unsuccessful. To address this issue we made adjustments to Variant recruiting program and are beginning to experience the pickup and hiring momentum through October as indicated on slide 7 of our earnings supplement. Our over-the-road segment experienced the 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 by 5.8% as compared with a 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 low 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 teams 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 break-even run rate as we exit 2020. Let me now turn the call over to Eric Peterson for review of our financial results.
Eric Peterson: 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 quarter. The primary drivers of improved earnings were higher rate per mile and lower claims extent. 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 fix and variable cost 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 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 eluding 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 today. 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 operating ratio for the quarter was approximately 108% but improved sequentially through the quarter. As we execute on our initiatives we expect the segment [OTR] 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 tightens and turnover in our legacy OTR fleet returned to the higher pre-pandemic levels. 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 conversion would not be linear in nature. We believe that trends are positive for our future. For example, we believe the negatives such as higher recruiting cost and legacy operations. Warranty to tractors and higher insurance premiums were mostly frontend loaded. In contrast, we believe the positives. Contract rate renewals occurring during a rise in markets, the impact of safety of client's expense related to the suspending of a student program and the continued growth of the Variant fleet all build over time and we are in the early inning. 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 cost 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 compared 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 have $386.3 million of net debt and a $154.9 million of liquidity. Defined as cash and cash equivalent plus availability under our revolving credit facility. I'm very pleased with the progress that we had made as our leverage continue to decline to three times net debt to trail in 12 month EBITDA for the third quarter of 2020 compared to 4.15 times 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 pays and extent of the economic recovery. As we discussed on our second quarter call, we reduced our planned that capital expenditures for 2020 to be in a range of $100 million to a $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 carry over. Interest expense for the third quarter was $4.4 million and we expect interest expense to be approximately $20 million for the full-year 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 1st. With that, I'd like to turn the call back to Eric Fuller for concluding remarks.
Eric Fuller: Thank you, Eric. To conclude, our third quarter results continue to validate our vision for Variant. In the long-term potential, this new business model obviously a driver at company and their industry. This model was designed and created by U.S. Xpress utilizing artificial intelligence in digital platforms to manage all aspects of the fleet operations including recruiting, planning, dispatching and management. What makes Variants optimization so effective is its ability to dynamically react to changes within its ecosystem to self-correct instantaneously. What this means in plain English, their operations are continuously being optimized which includes the utilization and ultimately our drivers stay in satisfaction. As we discussed, this is delivering a substantial growth in our performances is there and achieving an approximate 20% improvement utilization for drug. A dramatic decrease in driver turned over of approximately 70%. Improved safety, a higher level of on time service and over time a reduction in fixed cost. Looking forward, we remain on track to have the initial non-100 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 the strong financial results regardless of the cycle. Where we're going to headwind to our result over the last decade is driver turnover. We believe Variant solves this challenge and the resulted inefficiencies in cost to come with it. When we look to the fourth quarter, we expect a 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've experienced in our legacy OTR fleet. It slightly improved our profitability for the third quarter as we expect to experience improve spot in contract pricing. And we continue to scale Variant into the first quarter of 2021. We didn’t expect to experience sustainable margin expansion over the course of the next year. In regards to the market, a baseline assumption for the balance of 2020 include a general sequential economic recovery that maybe balance all times. Increasing inventory restocking, high trucking capacities and relatively benign cost inflation outside of driver related in insurance premium expenses. These conditions combine 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 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. Our economic outlook remained 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 in the Variant. We benefit the further streamlining our operation. Thank you again for your time today. Operator, please open the call for questions.
Operator: [Operator Instructions] Our first question comes from the line of Ravi Shanker with Morgan Stanley. You may proceed with your questions.
Ravi Shanker: Thanks. Good evening, everyone.
Eric Fuller: Good evening.
Ravi Shanker: So, and then it looks like you're taking here some short-term pain for some long-term gain which makes sense. I think the timing were unfortunate coming at the kind of strong point in the cycle. But just to kind of a few clarifying questions in Variant here. 1) Do you have abated timing for Phase 2?
Eric Fuller: Meaning Phase 2 meaning the second group of the 1200 trucks?
Ravi Shanker: Yes, the 1200 trucks, yes. Is that a 2021 thing or is that beyond that?
Eric Fuller: It's a 2021. So, we will probably start that starting in second quarter 2021 and that second version should be finalized by hopefully the first half of 2022.
Ravi Shanker: Okay, got it. And also you only have like 50 experienced drivers out of 900 trucks so far. But momentum is increasing. Can you share a little more detail on kind of why you had that initial sceptism 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 drivers, maybe I misunderstood that.
Eric Fuller: Yes no, we're really focused on experienced drivers. We think that with the level of turnover being in that better than 50% range in Variant, we think that we could just prioritize experienced drivers over student. And we think that student drivers, there's a lot of issue that comes to the drivers. 1) Its incredibly expensive to train them but also the quality even if you do a very robust training program, we often see that the quality of the driver and accelerate 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 fees, we believe and all I could say was a miss from my part. We felt the rabid enthusiasm from our driver population within Variant and we saw that as we went out into the market from a recruiting perspective, then we will get this interest of drivers. And realistically that didn’t happen. It probably took six or eight 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 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 could see there on our supplement slide or slide seven that it started slow but this last week we hired over 15 -- we had 15 drivers at Variant. I believe we'll hire more than that this week. And we really need to be in that 20+ range on a week-to-week basis from our hiring perspective. And I believe within the next week or two or three, we'll be there. And I think we can maintain that. We're starting to get traction and now I feel like not ever getting our name out there, we're getting traction that we kind of getting over the hump. That first six to eight weeks was a little difficult just trying to get that traction out in the market. I think we just did recognize how difficult that would be launching a new brand and a new concept and the driver acceptance. The bigger thing was, there was a lot of skepticism from the driver population that yes everybody said this but I have a hard time believing it. And so, but I think now we're starting to get some buy in.
Ravi Shanker: 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 noises related to COVID?
Eric Fuller: Yes. No, we absolutely do, could we can go back and when we started this in Q3 --.
Operator: Our next question comes from the line of Jack Atkins with Stephens. You may proceed with your questions.
Jack Atkins: Great, good afternoon and thank you for taking my questions.
Eric Fuller: Absolutely.
Jack Atkins: So, I guess and Eric just to maybe kind of think about it this way, you got 1300 or 1400 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 will generate to the organization on a consolidated basis?
Eric Peterson: 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 50% turnover, that's just one component we said that on averaging cost up to $15,000 for every driver that you have to hire. And so, if you're going from a 150% turnover to 50% turnover, you're hiring a third less driver. 2) In converting those drivers over. If you have few 100 tractors that all of a sudden increasing their utilization nearby 20%, that's at a 2/3rds variable and 1/3rd fixed modal, that group of tractors has essentially got 700 basis points more profitable on utilization of loan. And then, 3) and this is one we're really excited about is the safety matric that we're seeing if you look at our preventable accidents per million miles. This group is down to four. 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 that four accident per million mile. To put that perspective with legacy fleet, was a 12 incidents per million miles in 2019. That's 1300 tractors there and this is what's exciting but no longer having near the students and this population. Those remaining 1300 tractors are still performing much better. They're down to right under seven accidents per million miles compared to 12 with the Variant trucks are just were just outperforming time at that four number right now. So, getting those remaining tractors in all the miles, 1300 tractors with the miles over to that digital model, it's going to have a significant impact on our overall earnings.
Jack Atkins: I mean, is it something that were just kind of from a bracket perspective. Can you maybe, I think that would be helpful for both to bring in 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 six to eight quarters regardless of the freight backdrop. And so, I know you don’t want to get too for other one 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.
Eric Peterson: Yes. I mean, if you looked at it and you want to say that represents approximately by 1500 tractors is about 25% of our fleet round numbers. And the numbers I went through are probably 1200 basis points of earnings. So, that's overall that 300 basis points to 400 basis points here on the consolidated results.
Jack Atkins: Okay. That's helpful, thank you Eric. And then I guess just maybe just one follow-up question, last one from me. Then when you think about the business and sort of how much of trend as you go from the third quarter to the fourth quarter. I think if we go back a quarter, though the sellers we can improve operating ratios as we move through the year quarter-to-quarter. Obviously, there are some challenges in the 3Q because the driver turned over in brokerage. But is there a way to kind of think about what how we should be thinking about operating ratio improvements sequentially given the improvements in brokerage, given the rate improvements that you guys have been starting to realize in the business. And I know that will be offset by driver wage inflation and things like that. But is could you can you maybe frame that up for us in terms of how we should be thinking about the sequential change?
Eric Peterson: Sure, yes. I mean, it so we're still working through simple issues. So, there is still a little bit of that overhang that that we're dealing with in Q4. But we are starting to see some momentum in Q4 relative to our recruiting initiatives in our growth within our Variant fleets. 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 have been nearly a year. And so, we are trending towards a breakeven. I think we'll be close to that in exiting the year. I don’t know they will have that for the quarter, I think there still be a little bit of noise for the quarter from a brokerage perspective. But we're starting to trend towards more of a brainy breakeven. And so, I felt 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 going to take a little bit of time for that continue to play out. If you look at the overall fleet dedicated 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 improvements but I still think that we're in the early stages of recognizing the full impact of all of this transformation.
Jack Atkins: Okay, got it. Thank you, guys.
Operator: Our next question comes from the line of Ken Hoaxter with Bank of America. You may proceed with your question.
Ken Hoaxter: Hey great, good afternoon Eric.
Eric Fuller: Good afternoon.
Ken Hoaxter: Maybe you could just give us a quick refresh on what it takes to convert the fleet and given the success why you can't go maybe perhaps a bit faster here.
Eric Fuller: 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 the specific type of driver that we're looking for. They have to be a 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 hand holding. 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 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 in a way launching a new brand, launching a new model and then trying to explain to drivers why it's different and how it's different. Was a little more difficult than I think we appreciated. But I think now was we now have momentum and now we're past that.
Ken Hoaxter: So, on page where it should seven where you have the turnover, you were just talking about the 48 drivers in 10 weeks for Variant. And you had a 50% turnover rate. But behind there's an annual rate is something due to kind of handful of maybe a couple of drivers that have turned over. Is there been a postmortem with them as what was wrong, I mean, just given over the couple of them to or is there anything to figure out why that turnover is there? Or the best driver turnover.
Eric Fuller: Sure. Right. We have in, 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. We go and do a postmortem with some of the U.S. Xpress drivers. There is a lot of negativity. There is a lot of hey this happened, this happened and I'm frustrated, I'm not getting enough miles, whatever. Those are not the kind of things we're hearing from our Variant fleets. Some of them are terms that we make, whether be safety related or things like that. On the other hand, typically with drivers are self-selecting to leave, it's usually a personal reason. They're going off the road for they want to meet 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 will see an attrition at 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.
Ken Hoaxter: Okay. Last from me, I just want 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.
Eric Fuller: It wasn’t kind of branding piece and it says driver-only safety 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 brands 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 that there is a different, I mean, there is all everything for the driver is completely different. How they interact with the office, how they get how they do their day-to-day, the type of tractor they're in, the color of the tractor the whole works.
Ken Hoaxter: Okay, that's great. Now, lastly for me is that the miles, I just want to understand the, is it 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. So, is that and see the tractor count is there or is that just the drivers or where is wrong?
Eric Fuller: Yes. It's mostly unseen in tractor count, this is the driver situation. And we did, we have seen through the last probably 90 days some issues with some of our shippers where the tension times are going up. It's taking longer to load tractors and unload tractors. And I think it's due to labor shortages at a lot of our customers. Then so we are hearing that, feeling that on a driver basis which may have a little bit of an impact. But I think the biggest impact was the driver situation and in fact that we have more unseeded tractors been we normally would carry.
Ken Hoaxter: Right -- thanks. And you include that in your engine numbers, right. And so it's you kind of call tractors even if they're unseated, right, it's not like --?
Eric Fuller: Yes.
Ken Hoaxter: Okay. Thanks Eric, I appreciate that, thank you.
Operator: Our next question comes from the line of Scott Group with Wolfe Research. You may proceed with your question.
Scott Group: Hey thanks, afternoon guys.
Eric Fuller: Good afternoon.
Scott Group: So, maybe just a follow-up there, just a follow-up there. So, utilization done one in the third and rates up seven. When you think it's a good expectation for both of those in the fourth?
Eric Peterson: And it probably similar results, maybe a little bit better results from the utilization perspective. We are currently addressing some rate on the contract side, likelihood if they those rates improvements go in. It's in the back half of the quarter, so probably doesn’t greatly impact the quarter. Well, I would say peak season has to potential to drive spot rates higher than we saw on Q3. So, I'll say a little bit improvement on the rates and maybe some small incremental permit utilization.
Scott Group: So, when do we actually see utilization inflict positive?
Eric Peterson: Once we've started getting some positive net growth in our truck count. I think we can probably see that into end of 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 passed and stayed where we're losing to see the truck count. We stabilize, we can start growing or see the truck come back. And I think that we'll probably see that hopefully at some point in Q1.
Scott Group: Just we can. So, are you telling that that grow the unseated count or grow that seated count or grow the reported truck count that we say?
Eric Peterson: Yes. No, grow this seated count. Because as we grow the seated count, obviously that impacts our utilization. Yes, is grow in the seated count. We've both plans at this point to grow in that the net amount in fact we probably will try to take down that and that number to an extent because of the unseated.
Scott Group: And then, I don’t know if this is a silly question or not but if really talk about low fleet Variant. But what's the typical driver turnover for a new driver versus an experienced driver. Forget if they're ongoing in an office. What's the typical?
Eric Peterson: Sure.
Scott Group: I'm guessing, yes?
Eric Peterson: Yes, so when we were doing this seated program, we our turnover was running north of 200% per students. Probably closer to that 150'ish for experienced. So, the students turned over were significantly higher.
Scott Group: So, I guess I'm like you're, so it sounds like even on the old fleet, was it 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 kind of sure what's so different about that than Variant.
Eric Fuller: Well, because we're only having, 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 to run as high as 170% and 180% turnover partially with that mix and say 150 experience and 200 plus of students but we're still seeing north of 150% today in our legacy population.
Scott Group: Okay. And then just last thing real quick, Eric I thought I heard something about 500 basis points of margin improvement at brokerage. Was that a sequential comment so like a [indiscernible] or is it closer to the breakeven? I'm just not sure.
Eric Peterson: Yes averaging for the fourth quarter. Yes we're saying we did a 108 in the third quarter and the comment was that will be 500 basis points better than that sequentially in the four. So that'd be a 103 and as Eric mentioned last week in that division we're at a 100 even.
Scott Group: Thank you guys.
Eric Fuller: Thank you.
Operator: Our next question comes from the line of David Ross with Stifel. You may proceed with your question.
David Ross: Yes, good afternoon gentlemen. You talked about converting some of your drivers into Variant but then needing to go external. So you go external what happens to the drivers that had been driving in the underperforming over-the-road fleet?
Eric Fuller: Yes. So over time as attrition takes place 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 de-prioritized recruiting for our legacy fleet because obviously our long-term plan was to move drivers into this new fleet. We kind of had a sanity 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 at that eventually were 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. So that's why we saw that 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. So over time the amount of tractors that we have in that will obviously shift over into Variant.
David Ross: Do you have a current OR for the variant fleet?
Eric Fuller: 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 two infrastructures one for the digital and one for the legacy. That's something that as we get further in the transition we'll be able to discuss.
Eric Peterson: Yes I think exactly what Eric said is we're doubling in order to grow and build this and so our landing pad long term better than the legacy fleet but there is an investment period.
David Ross: So if that's the case even the non-underperforming over-the-road tractors --
Eric Fuller: 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 a kind of our capital allocation strategy is improve our earnings through allocating capital to the more profitable groups. So we would make a decision at some point and 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.
David Ross: Or I guess as you talk about Variant recruiting and planning and managing and dispatching if it's operating is 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?
Eric Fuller: 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 it take [audio gap] place and the amount of in a day-to-day running a fleet of that size a computer with Artificial Intelligence can do so much more [audio gap] that we can learn but the full benefit is really the digital model really helps us to recognize that full benefit.
David Ross: And last question just for Peterson on the finance like a financial [indiscernible] with the insurance renewal, was there any change in the deductible or in your excess coverage that went along with the premium increase?
Eric Peterson: Yes, we did lower our overall, lower our overall tower but as far as the deductible amount it stayed at the $3 million.
David Ross: Okay. Thank you.
Operator: Our next question comes from the line of Brian Ossenbeck with JPMorgan. You may proceed with your question.
Brian Ossenbeck: Hey thanks. Good evening. Eric Fuller, can you just talk about if you're hearing any real changes on 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 we hear about when capacity is tight and a cycle is closer to a peak or at least doing very well or do you think there is actually 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.
Eric Fuller: Yes I think that we will see some structural changes in the RFP process over the next three to five years. I wouldn't say that this year is the year where that really is a significant difference. I think this year everybody's really focused from a shipping 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 three to five years and some of this has been pushed by digital brokers and new entrants into our market. I do think that the expectation around technology and a lot of technology alignment between the carrier or the provider and the shipper is 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 three to five years, I think the expectation is going to be a more of a digital engagement and I think that will probably change a little bit of the traditional RFP process.
Brian Ossenbeck: 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 [indiscernible] you got different capabilities of course and 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?
Eric Fuller: Now I think if you look at our general trade cycle essentially what's happened is when a red truck gets traded out a great 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 to 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.
Brian Ossenbeck: 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 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 got a lot more attention and focus and offers on them in these last couple 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 [indiscernible] model?
Eric Fuller: 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 advertising that's out there from a trucking perspective is there is 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 and there is a lot of yes, yes, yes everybody says that and so there is a little bit of hey you 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 there is 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. 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 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.
Brian Ossenbeck: Okay. Do you feel like there is 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?
Eric Fuller: I have no doubt that some of our veteran 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 now 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 the grave type solution of kind of a greenfield approach I think is unique. I don't think anyone else is doing that out on the market and I think that we'll get a better benefit because of that approach.
Brian Ossenbeck: 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 and what sort of initiatives have you put in place that I would assume that just based on commentary from peers and just how the market 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?
Eric Fuller: Sure. So we put some new management into our brokerage group around at 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 and margins. Also we are shifting a little bit of our model where I think we were over exposed to contract business within our brokerage group and obviously when a market turned significantly like it did then that having too much exposure to contract is a 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.
Brian Ossenbeck: Okay. Thanks guys for the time. Appreciate it.
Eric Fuller: All right. Thank you.
Operator: Our next question comes to the line of Nick Farwell from Arbor Group. You may proceed with your question.
Nick Farwell: Eric, thank you for taking the question. 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 executing demand in some unusual ways or are there other ways you can characterize this period of recovery versus say the last two or three?
Eric Fuller: Yes, I think from the demand perspective it is a very unique environment. So you've got, you really kind of have the haves and the have-nots. So one you look at retail retail's 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 but they are actually outpacing pre-COVID but then you also look at the haves and have not 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 there is some 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 clearing house, you had at least a 100,000 less CDLs issued to date than you did last year and then I think we'll have more drivers go into the drug and alcohol and I actually think that due to the fact that the schools -- some of the schools have shut down and those that haven't shut down are running in social distancing then 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 when we enter 2020 that is significant and that deficit's not going to come back in the short term. We're not going to be able to build back that deficit it's partially because the schools don't have the capacity and so I think that that's going to prolong this cycle more than anything.
Nick Farwell: 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?
Eric Fuller: You might see some lumpiness here and there given certain weeks and stuff but for the most part I would say it's really a universal across the whole network.
Nick Farwell: 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 two sectors of your business?
Eric Fuller: Sure. Yes I mean dedicated very you're going to have a lot more stability. Typically we're working on three to five year contracts 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 and 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 is 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 two bid cycles where we had flat to negative rates and you've 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.
Nick Farwell: So the last question is in the dedicated as you're re-bidding the constantly 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 three to six months when you dedicated or at least two to three years you mentioned five 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 much less three or five years.
Eric Fuller: 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 and 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 and 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 that the increase is necessary then usually we don't get a lot of pushback.
Nick Farwell: Thank you very much. I appreciate it.
Eric Fuller: Absolutely.
Operator: 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.
Eric Fuller: All right. Thank you. One thing I do want to address if you look at this quarter I actually believe that there is a lot of positive things in this quarter. You look at our insurance costs. You look at the fact we were able to continue to grow in our digital fleet without degrading our statistics. There is 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 result. 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 and quarter-to-quarter, I mean we could have easily knee-jerked in mid-June and reinstituted a student training program and then a couple of other things to try to get our truck count or see the 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 is 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 in the past. We're excited about continuing to pay down debt and continuing to set at this company up for the future. So with that thank you and look forward to doing it again next quarter.
Operator: Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time.