Schneider National - Q2 2019

Transcript

Operator (participant)

Good morning and welcome to the Schneider National Second Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. This webcast is being recorded and will be available for replay later in the day. This call is scheduled for one hour. After introductory remarks, there will be a question-and-answer period. Out of consideration for others, please limit yourself to two questions. To cue a question, please press star one on your telephone keypad. To remove your question, please press star two. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I would now like to turn the call over to your host, Steve Bindas, Director of Investor Relations. Please go ahead, sir.

Steve Bindas (Director of Investor Relations)

Thank you and good morning, everyone. Joining me on the call today are Mark Rourke, President and Chief Executive Officer, and Steve Bruffett, Executive Vice President and Chief Financial Officer. Earlier today, the company issued an earnings press release, which is available on the Investor Relations section of our website. Before we begin, I'd like to remind you that this call may contain forward-looking statements and that actual results may vary. Also, there may be references to non-GAAP measures. Please refer to the special notes related to risks and uncertainties of forward-looking statements and the reconciliations of non-GAAP measures included in this earnings release. Now I'd like to turn the call over to our CEO, Mark Rourke.

Mark Rourke (President and CEO)

Good morning, everyone, and thank you for joining the call. I will offer a few summary comments for the most recent quarter and turn it over to Steve Bruffett for more specifics on the financials and moving forward commentary. Let me start my commentary in the truckload segment. Our task in the second quarter was to first improve our basket of freight and our large for-hire standard trailer network quadrant through higher primary contract volumes versus the spot market, and secondly, tighten our overall cost position. As expected, primary contract volumes have increased. In spot order volume and miles have returned to the normalized mid-single digit range. In addition, the remaining spot volume has improved materially in contribution per order as rate per mile is up over $0.40 from Q1 levels. We are now 70% through the contract renewal seasons for our for-hire truck quadrant.

Average renewal increases in the quarter were in the low single digits from the mid-single digit levels experienced in Q1. Change is a combination of higher comps and a persistent oversupply of capacity. Our cost position has improved primarily in the salaries, wages, and benefits, and other general expense lines of the income statement. The combination of improved freight quality and cost performance led to sequential improvement in our operating margin and truckload, excluding the effects of First to Final Mile, of 400 basis points in the quarter versus our historical average improvement from Q1 to Q2 of 200 basis points. The truckload segment operating ratio, excluding First to Final Mile, was 88.4%. Let me now address this morning's announcement of the shutdown of the First to Final Mile service offering.

Following a careful assessment of the near and longer-term prospects for this service offering, including a thorough review of viable alternatives, we've made the difficult decision to execute a structured shutdown of the First to Final Mile offering over the next several weeks. While we made significant investments in the operation, the business operating results are below target, not meeting our expectation on financial performance, or improving at an acceptable pace or timeline. This course of action allows us to fully focus on our core businesses of truckload, intermodal, and logistics, and is consistent with our portfolio management and capital allocation disciplines. We believe this plan is in the long-term best interest of our company and stakeholders.

I want to express my gratitude to all the Schneider associates involved with the First to Final Mile offering and who have invested a tremendous amount of energy and creativity toward the endeavor over the past 3 years. We are looking at all opportunities to redeploy affected associates based upon role, geography they live in, and business need. Steve will cover the financial implications of this decision and how to think about it for modeling purposes. Moving on to the intermodal segment, intermodal grew revenues, excluding fuel surcharge, 12% year-over-year, with order volume up 2% and revenue per order up 11% over Q2 of 2018. The growth was achieved in what we estimate to be an industry reduction year-over-year in the quarter of between 6%-7% of domestic intermodal movements.

At the end of the quarter, we are now approximately 85% through the contract renewal book. The Q2 contract renewals increased average in the mid-single digit range. While there have been reduced volumes as a result of less supported rail lane options and an increase of over-the-road capacity levels, intermodal remains a strategic imperative for a large cross-section of this shipper community. Intermodal achieved an 88.2 operating ratio in the quarter, 220 basis points reductions from a year ago as a result of increased rail expense and lower asset turns. We believe we are well positioned with very solid execution fundamentals, increased container counts, and a highly effective company driver fleet as we head into the final ELD and Drug and Alcohol Clearinghouse implementations at the end of the year.

Finally, on our logistics segment, revenues, excluding fuel surcharge, contracted 9% year-over-year, a combination of large contract insourcing in our import-export transloading service and lower revenue per order in our brokerage offering. Brokerage order volume, though, grew double digits over the same period year-over-year, and brokerage now makes up 87.5% of our logistics revenue. The logistics operating ratio performance of 96% was essentially flat year-over-year. Continue to see the benefit of automation in our processes as our carrier self-serve feature across the Load My Truck and Orange Hub platforms realized a 9% increase in no-touch carrier assignments sequentially from quarter one. Now I'll turn it over to Steve for further commentary.

Steve Bruffett (EVP and CFO)

Thanks, Mark, and good morning, everyone. I'll begin with an overview of the key elements of our consolidated financial results.

Revenue, excluding fuel, of $1.1 billion down slightly from the second quarter of 2018. This was the first quarter in numerous years in which we experienced a year-over-year decline. Lower volumes in the truckload segment and in the import-export component of the logistics segment were the primary reasons. Also, we expect modest revenue declines to continue in the third and fourth quarters of this year given the tough comps of 2018. Adjusted income from operations was $84 million, and while this was a 14% decline from the record second quarter of last year, it was the second most profitable Q2 in our history. Also, this reflects a 63% sequential improvement from the first quarter of 2019, reflecting the revenue management and cost initiatives that Mark discussed earlier.

Most of the line items on the consolidated income statement followed recent trends in the second quarter, but there are a couple of items worth noting. The first is that operating supplies and expenses increased about $13 million from the second quarter of last year. Higher costs of goods sold from increased activity at our leasing unit more than explain the difference. The second item is other general expenses, which were down about $12 million year over year. Last year's second quarter contained a $6 million litigation charge, which explains about half of the variance. The remainder of the decrease was due to cost initiatives. Looking at our segment results, Mark covered truckload, intermodal, and logistics, so I'll comment on the other segment. There was a $2 million profit in the second quarter compared to a $7 million loss last year as adjusted for this litigation charge.

The drivers of this variance were increased leasing activity and lower accruals for incentive compensation as compared to the second quarter of last year. Before I leave the income statement, I want to explain how the accounting for First to Final Mile will work going forward. First, we will incur operating losses for a portion of the third quarter as the business operated as normal until today's announcement. To help you with your models, especially as you think about 2020 compared to 2019, we expect about $9 million of third quarter operating losses. This amount, added to the first half losses of $26 million, brings the 2019 total to approximately $35 million. Second, we will book estimated amounts for the cash and non-cash charges that are related to the shutdown in the third quarter. Information regarding the shutdown charges is included in the 8-K that we issued earlier today.

Beyond the third quarter, we will monitor actual shutdown costs as they are incurred and adjust as needed. We expect the majority of this activity to occur within the 2019 calendar year. However, lease activity will be monitored over a period of years, and we will have a separate line on the income statement for these items to provide transparency. Moving now to cash flows, our year-to-date cash from operations of $302 million was essentially offset by investing in financing activities. Our cash position is virtually the same as at year-end. We do expect to generate free cash flow in the second half of the year as the pace of CapEx tapers. Also, a portion of the cash is expected to be used to repay a $40 million debt maturity in November.

Looking ahead, we have updated our Adjusted EPS guidance for the full year to a range from $1.30 to $1.38. At the midpoint, this is a 14% reduction from our prior guidance, and the adjustment incorporates lower volume and price assumptions across our primary operating segments for the second half of the year. Also, estimates for the fourth quarter First to Final Mile operating losses have been removed from our updated guidance. However, the difference between actual operating losses in the second and third quarters and those that were assumed in the prior guidance more than offset the fourth quarter benefit. Regarding net capital expenditures, we are incrementally lowering our full year expectations to approximately $325 million from the prior level of $340 million. And lastly, we expect the full year effective tax rate to be 25.5%. And with that, we will open up the call for your questions.

Operator (participant)

Thank you. Ladies and gentlemen, at this time, we will be conducting the question and answer session. Again, if you would like to ask a question, please press star one on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of David Ross with Stifel. Please proceed with your question.

David Ross (Managing Director)

Yes. Good morning, gentlemen. I just want to focus on first, I guess, the trucking operations that you still do have, namely dedicated. How is the dedicated pipeline looking? The revenue per truck per week seems to be down year-over-year. Is that from a mix issue, or is that the customers not running the trucks enough because of a soft economy or weak freight market?

Mark Rourke (President and CEO)

Good morning, David. This is Mark. Certainly, we are very pleased with not only so far in 2019 on our new business closures within Dedicated, but the pipeline remains very robust. We're in the midst, really here in the second and now the third quarter, of a fairly robust series of implementations. Although they're a little bit different than our historical average, which is very much at the heart of our strategy, away from big mega fleets supporting retail, which has been our predominant over the years, to more of a specialty service area where we're doing smaller operations but generally doing things that are adding additional value-added services versus moving the product simply from point A to point B. So as such, we have a little less slip seating activity in those operations because of the way they're structured.

So that has a little bit different approach to the capital being deployed. But time to start up from profitability and overall performance of those operations are superior to our prior approach. So I feel very, very good about that. We do have some inefficiency through the startup process that we obviously will get through, and we're getting through it within a 2-3-month process. So I feel very good about that, and it'll be a continued focus. In fact, that's where we would see any increase in tractor count or capacity levels for the remainder of the year would center around those dedicated operations.

David Ross (Managing Director)

Would you consider those specialty dedicated operations to have any different contract length or terms? Are they longer-term deals than the old mega fleet ones, and are they better return on capital because it's just a smaller deal size?

Mark Rourke (President and CEO)

Yeah. I would put all of the above on that category there on that question, David. Generally, they are longer-term contracts. They're generally more stable and durable from a renewal standpoint. And in a world that could argue that's becoming more and more commoditized and the network businesses offer stable revenue, stable earnings, and very much a deeper relationship because of the services you're providing.

David Ross (Managing Director)

And then just quickly on the First to Final Mile shutdown, those 26 facilities, are they leased? Do you own them? Is there a plan for how those are going to be either repurposed or exited?

Steve Bruffett (EVP and CFO)

Yeah, David. This is Steve. All the facilities are leased, and those lease parameters range from near-term to multi-year. So it's a variety in there. And those that have the longer lease terms still that we're obligated to, we will be in the market attempting to sublease those facilities.

David Ross (Managing Director)

Excellent. Thank you.

Operator (participant)

Thank you. The next question is from Scott Group with Wolfe Research. Please proceed with your question.

Scott Group (Managing Director and Senior Analyst)

Hey. Thanks. Morning, guys. So the rev per truck in for-hire, can you help give us a breakdown of how much of that's utilization and rate per mile and then maybe share what you're seeing so far on those metrics in July and sort of how you're thinking about the rest of the year?

Mark Rourke (President and CEO)

Sure, Scott. As it relates and it was in the for-hire? That was the question?

Scott Group (Managing Director and Senior Analyst)

Yeah. The down 7 in the for-hire. Yep.

Mark Rourke (President and CEO)

Yeah. Contract pricing is positive, and so more than 100% of that is in the utility front, with one exception is we're just seeing less of the promotional or project-oriented things that we do very, very well. Overall, I think just because there's less duress and stress in the marketplace. So that generally finds its way onto the rate and price line as well. But as currently constructed there in the quarter, virtually all of that is productivity related. And as we did take a great deal of deliveries in the quarter of our replacement tractors, I think we're going to be finishing 90% through the first half of the year on the replacement front. And so we have a little bit of noise in there because of not getting everything out from a sale standpoint. But all of that erosion is in the productivity space.

Scott Group (Managing Director and Senior Analyst)

Are you assuming? I get the contract pricing comment, but are you assuming rate per mile stays positive in the second half, total rate per mile?

Mark Rourke (President and CEO)

I think it's certainly going to be, we believe it's going to be positive on a contract standpoint. The question that we have is typical seasonality in the second half of the year relative to the holiday season, the project work, all of those things. Scott, if those things don't hold to a typical seasonal pattern, price and total could turn negative. But that's more in the short-term project space versus the contract space.

Scott Group (Managing Director and Senior Analyst)

Okay. Mark, did you say anything about July?

Mark Rourke (President and CEO)

We did not. We would consider July being July. It's not a very robust period. It generally isn't, and it's playing as is typical.

Scott Group (Managing Director and Senior Analyst)

Okay. Then just secondly, there are concerns in intermodal about share shifts between players. Can you just talk about sort of volume, yield, margin expectations embedded in the second half guidance? Did volume stay positive? Did yields really good in the second quarter? Does that continue? How about margins? Any thoughts there?

Mark Rourke (President and CEO)

Yeah. I'm really, really pleased with how we've been performing in intermodal. Obviously, having a 2% volume growth in a shrinking market would suggest that we're competing effectively there. If you kind of think about this on a year-over-year basis going forward, Scott, we certainly had some lift a year ago because of the tariff activity and the pull forwards. It's a little murky from our standpoint what the whole trade discord is going to deliver in the second half of the year. Intermodal is more influenced by Asian and international imports than the rest of our business. So we would expect that all things being equal will probably be less of that pull forward activity. So that could put some pressure on overall year-over-year comparisons.

As we're 85% through the book of contractual renewals and still hanging in there nicely in the mid-single-digit range, we would expect revenue per order and the rate to be very solid between here and the end of the year.

Scott Group (Managing Director and Senior Analyst)

Just so I understand, Mark, your comment about volume, that's more about the market and comps? And so you're not talking about contract losses or anything that would explain volume weakness?

Mark Rourke (President and CEO)

What volume weakness are you referencing?

Scott Group (Managing Director and Senior Analyst)

Well, you're saying that second half volumes, you have tough comps related to tariffs, so volumes could be lower. I just want to understand, is that a market and a comp comment, or is that a comment about some market share losses on contracts?

Mark Rourke (President and CEO)

Well, as I mentioned, we're 85% through the renewal. We have wins. We have losses. We have on both sides of that equation. My comments prior were predominantly around what was lifting the intermodal volumes a year ago.

Scott Group (Managing Director and Senior Analyst)

Okay. Makes sense. All right. Thank you, guys. Appreciate the time.

Operator (participant)

Thank you. The next question is from Ravi Shanker with Morgan Stanley. Please proceed with your question.

Ravi Shanker (Transportation and Airlines analyst)

Thanks for morning, everyone. So I think the decision for the final mile, I think, makes a lot of sense to us. Can you just—I mean, given all the noise, can you just help us understand what clean TLORs will look like in 3Q and 4Q and heading into 2020 once you strip out the First to Final Mile business again? I'm not so much looking for guidance on TL margins as much as just the math on what it looks like ex First to Final Mile.

Steve Bruffett (EVP and CFO)

Yeah. This is Steve, Robbie. Just looking at the second quarter, for example, we had indicated in our earlier comments what the truckload segment margin was excluding First to Final Mile. There was about a $10 million degradation year-over-year in First to Final Mile earnings in the second quarter. But when you adjust for that, it does make quite a difference in the comparison of the truckload segment to the prior year. Rather than being down 31%-32% on an adjusted basis, it was down more like 14%. And so it just depends on your assumptions about First to Final Mile going forward, if they were going forward, as to what that drag would look like. But obviously, there'll still be some cost associated with that in the third quarter.

Then we think the waters will be pretty clear pretty clean by the time we get to the fourth quarter in the truckload segment.

Ravi Shanker (Transportation and Airlines analyst)

Understood. That's really helpful. And I mean, that, I think, isolates only the First to Final Mile impact. Are there any knock-on effects of this? I mean, clearly, you guys ran the business in different ways in the time that you had it. Kind of once you've kind of freed up the assets and the people kind of are there, knock-on effects on the core TL business from this?

Mark Rourke (President and CEO)

Robbie, I don't know if I captured the question accurately.

Ravi Shanker (Transportation and Airlines analyst)

Meaning, will you be redeploying the trucks and the assets and the technology that may be used in the First to Final Mile business in the rest of the trucking business? And kind of is there going to be any kind of impact on truck count or people in the core TL business from this?

Steve Bruffett (EVP and CFO)

Oh, okay. I understand better this, Steve. We're in a unique position where we can actually repurpose a fair amount of the equipment that's currently deployed in the First to Final Mile operations. And we will go through a thorough process to assess which is the best equipment to keep in our truckload operations. It's predominantly with tractors. But there will, at the end of the day, be roughly 800 tractors and 2,000 or slightly more trailers that come out of the business as a result of that that will optimize our age of fleet and configurations as appropriate, looking across the pool of assets. And naturally, on the people side, unfortunately, there will be people that will be coming out of the organization. In total, the exact amount will be determined as we sort through the broad business need as we go forward.

Ravi Shanker (Transportation and Airlines analyst)

Okay. Understood. And just lastly, the insourcing decision by the customer in the logistics business, I don't think that's necessarily a surprise kind of given the headlines from earlier this year. But can you just put some color and context around that? Kind of what drove that decision? Was it a full customer insourcing? Was it just two or three facilities? And just kind of bigger picture, do you see this as a one-off development, or do you think it's the start of a bigger trend where kind of large customers will increasingly look to insource logistics?

Mark Rourke (President and CEO)

Yeah, Robbie. This is Mark. That decision happened earlier in the year, so now we're just into kind of the overlap comparison periods here. It was a single customer, single facility change, but consistent with some of the customer thought process, particularly the very large retailers relative to what is a core and what will be outsourced. I would consider it in general a one-time, but certainly on trend.

Ravi Shanker (Transportation and Airlines analyst)

Great. Thank you.

Operator (participant)

Thank you. Our next question comes from Thomas Wadewitz with UBS. Please proceed with your question.

Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)

Yeah. Good morning. Wanted to ask you a comment a little bit more on the intermodal side. I know you, Scott, touched on that a bit, but just wanted to make sure I understand it. So your kind of view on second half, is that intermodal is likely to be down, or is that where you just to make sure I understand that comment? It sounded like that might be the case, but it wasn't clear.

Steve Bruffett (EVP and CFO)

Yeah. This is Steve. I think that sitting here today, we think there is a likelihood or possibility that we have negative volume comps in the second half of the year, not significantly negative. But given the path traveled last year, principally, is the reason for that comment. The rate environment has been relatively stable in the intermodal space, and our team's done a great job there. And we're largely through that book of business for this calendar year as well. So I think we'll have a constructive story on the rate side. Volume, we'll have to see how it plays out with seasonality and so on. But there is a possibility that it could be slightly negative.

Mark Rourke (President and CEO)

Yeah. We feel really well positioned on the flows, Tom, and the box count, particularly around the seasonal imports. If that is robust, then I think we'll feel some volume growth. If that stays on kind of the sluggish path that it's been on, then maybe not. But we feel we're really well set up to take advantage of the market.

Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)

Okay. Good. I appreciate that. What's your broader look on the freight market? I think we've heard a variety of perspectives. There generally seems to be some optimism that there'll be a seasonal pickup and a peak season. But I guess in terms of your view on freight in peak season and also how we might think about this downturn in freight, it seems like it's been maybe more rapid to the downside compared to 2015, 2016. And I wonder if you have a sense of how that might play out in terms of improvement, that it might improve more quickly, and maybe you get positive rates next year. But just kind of peak season view. And then also, is this kind of a V-shaped downturn, or might this be a two-year downturn like we saw in 2015 and 2016?

Steve Bruffett (EVP and CFO)

There's a lot to unpack in there, Tom. My personal view on this is that the information availability for both the shipper and the carrier community is so much more prevalent today on what's going on in the supply chain and just the sources of information for folks to make decisions. And so as a result of that, I think these cycle changes happen more rapidly on both the up and the downside. And I think certainly, as I look at this cycle, sitting here a year ago with the spot conditions the way they were, there was a lot of incentives for carriers, particularly small to midsize carriers, to bring on additional capacity around the margins because of those spot rates. And those same influences today are much different. And so those same capacity, that same marginal capacity that came in, I think can just as quickly depart.

We're certainly seeing some data points. If you take the owner-operator community as a subset of that small carrier world, the last several weeks, the incoming volume to our program inquiring about our owner-operator availability here has spiked considerably. So that, I think, just another statement of duress that's occurring. In this case, that was the owner-operator example. And I think certainly in a smaller carrier world who came into this looking for the spot rates the way they were could be very much in the same position. So I think, again, this industry doesn't take. We don't need 10% and 15% swings. We need 2% and 3% swings to change the dynamic. And I think we could be on the cusp of that.

Certainly, we have some external things occurring with the ELD final implementation and the Drug and Alcohol Clearinghouse coming into play early next year. So it wouldn't surprise me that we would see some tightening as we go down the stretch. If we get some seasonal kick, maybe we'll be in a quicker recovery than is typical, which is generally what, a 15-18-month slog if you look back historically. We might be operating in tighter cycles than that.

Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)

Okay. Great. Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Jack Atkins with Stephens. Please proceed with your question.

Jack Atkins (Managing Director and Senior Research Analyst)

Hey, guys. Good morning. Thanks so much for taking my questions. Mark, I guess my first question's for you. We heard C.H. Robinson yesterday on their conference call talk about the need to maybe get more aggressive in terms of their actions in the market to drive volume growth in an effort to support their own business. I heard that and kind of interpreted that as perhaps a bit of a negative with regard to broader pricing within the truckload market. I'm just curious sort of your bigger picture thoughts on sort of where we're headed from here as it relates to pricing, contract pricing within the truckload market as we look out through the remainder of this year and some early thoughts into next year?

Mark Rourke (President and CEO)

Yeah. And as I mentioned, we have maybe 30% more to go relative to the contractual book if we're talking contract prices. That, based upon the comps for what renewed a year ago, later in the year, and the current condition, it would not surprise me for those to be in the flat to slightly negative category. As it relates to the spot world, I think some of those tensions by company is depending upon your spot versus contract mix. And certainly, our business felt, particularly in the month of June in the brokerage business, a bit of a squeeze, certainly more than we would normally expect in June on the net revenue per order. But things have rebounded nicely here in the month of July and back to a more "normal" condition. Again, I think that's because we're slightly less contract-oriented than some of the other big players there.

My personal view is we may be getting closer to the bottom here relative to where we stand on this whole supply capacity mix. A bit of tightening of capacity in the second half, I think, would certainly bode well for this being the bottom of the contract rate condition.

Jack Atkins (Managing Director and Senior Research Analyst)

Okay. Okay. Thank you for that color. And then, Steve, just a follow-up question on the FY19 guidance. What does the guidance assume in the second half of the year in terms of peak season? Are you assuming a normal peak, a weaker-than-normal peak? Just sort of any color around that would be helpful. And then just a quick follow-up to that. When we think about FY20, on the First to Final Mile business, what's your current expectation for any operating loss associated with that just related to the leases that'll be ongoing in FY20? Just so we can have sort of an apples-to-apples number. Thanks again.

Steve Bruffett (EVP and CFO)

Okay. Sure. The first part of that is what type of seasonality is assumed in our full-year 2019 EPS guidance. And my response to that, I guess, is we have assumed that there's seasonality, albeit a bit below average. So we would expect third to have some moments, and the fourth would be our strongest quarter as is typical, but not the degree of seasonality, for example, that we experienced last year, but a bit more muted effect. How that plays out, we'll see. It could change. We could be a month later in the year feeling completely different about things. But given the path traveled to date this year, we've assumed a more muted overall environment. To the second part of your question, it's about full-year 2020, I believe, and maybe the rest of this year regarding leases.

The way we'll account for that is in the confines of the third quarter, we will make a one-time entry that estimates the net lease exposures that we have regarding the shutdown of the First to Final Mile facilities. And then over time, we'll monitor our actual results and adjust those as needed. But hopefully, they should be relatively small adjustments to that lease profile. But the charge predominantly will be booked as one entry in the third quarter.

Jack Atkins (Managing Director and Senior Research Analyst)

Okay. Great. So just to be clear, you're not expecting any First to Final Mile barring any changes to your assumptions that you're about to take in this charge, you wouldn't expect any First to Final Mile losses in 2020. Is that the right way to think about that?

Mark Rourke (President and CEO)

Correct. That's correct. Yeah. We really believe will be minimal in the fourth quarter.

Jack Atkins (Managing Director and Senior Research Analyst)

Okay. That's great. Thanks again for the time.

Mark Rourke (President and CEO)

All right. Thank you.

Operator (participant)

Thank you. Our next question is from Chris Wetherbee with Citi. Please proceed with your question.

Chris Wetherbee (Managing Director of Head of Transportation and Shipping Research)

Hey. Thanks. Good morning, guys. Maybe just a pickup on that. I don't want to belabor the point here, but just want to make sure that we're clear. In terms of what you've already booked in terms of losses on the First to Final Mile, I think it was in the $12-$13 million range in 2Q and then about $10 million in, excuse me, $12-$13 million in 1Q and $10 million in 2Q. There's probably something in the third quarter, and then it goes to minimal in the fourth quarter. Is that the right way we should be thinking about that?

Steve Bruffett (EVP and CFO)

Yeah. Let me be even more specific for you there. First quarter was 13. Second quarter is 13.4. We're estimating 9 in the third quarter and would estimate virtually nothing, very small, if any, in the fourth quarter.

Chris Wetherbee (Managing Director of Head of Transportation and Shipping Research)

Okay. And so that's the number. Those numbers are what's embedded in the guidance for the full year from an EPS perspective.

Steve Bruffett (EVP and CFO)

Yes.

Chris Wetherbee (Managing Director of Head of Transportation and Shipping Research)

And then virtually nothing in 2020 is the current expectations?

Steve Bruffett (EVP and CFO)

That's correct.

Chris Wetherbee (Managing Director of Head of Transportation and Shipping Research)

Okay. Okay. That's helpful. Very clear. Appreciate you walking me through that. I guess in terms of details, just wanted to go to the for-hire fleet and get a sense of how you guys think about that as we move through the back half of the year just sort of in the context of what has been a bit of a weaker environment and then the productivity on the trucks. Should we expect a sort of gradual increase here? Do we assume it stays flat? Just get a sense on what you're thinking on that for-hire fleet going forward for the rest of the year?

Mark Rourke (President and CEO)

Thanks, Chris. I think at this juncture, what our strategy would be to put more of our trucks as we get in the second half of the year in the dedicated configurations versus the for-hire. So I think you'll actually see a slightly lower number in the for-hire space and some of that driven by having most of our replacement capital delivered here in the first six months of the year. And so we'll kind of work through all of that very rapidly here. And we have so far in the month of July to get all that slack out of the system. And so I would anticipate a slightly smaller number in the for-hire space.

Chris Wetherbee (Managing Director of Head of Transportation and Shipping Research)

Okay. Okay. And that's in 3Q that shows up?

Mark Rourke (President and CEO)

Correct.

Chris Wetherbee (Managing Director of Head of Transportation and Shipping Research)

Okay. Great. Thank you very much for the time. I appreciate it.

Operator (participant)

Thank you. Our next question is from Brian Ossenbeck with JPMorgan. Please proceed with your question.

Brian Ossenbeck (Managing Director)

Hey. Good morning. Thanks for taking my questions. I just wanted to ask you about the expectations for intermodal container fleet size and the service offering, especially in the context of what sounds like improving rail service. Specifically, it looked like you added a service yesterday coming out of California. So maybe you can comment on that as well. Why now? What is it offering? Do you think you need to add more lanes in the next year or so?

Mark Rourke (President and CEO)

We'll take the first part of that, maybe centering around the box count. As we finish the year, I would expect us to be slightly down from today's count or where we finished in the second quarter. Not a great deal, but slightly down. And really, the leverage point there is that we do have some disposals that we could execute or if the market would allow some additional volume that we could have a little bit of flexibility there. But we believe we are about at the box count that we need to be and for the foreseeable future. Some of the mixed elements that we're doing on Transcon's consuming a bit more boxes. So we're very mindful of how we expect our mix to play out and making those decisions. But we believe we're about where we're going to be on the next several-quarter front.

As it relates to just the overall options in the marketplace, I think we're seeing a bit more dialogue with some of the railroads relative to finding ways that they can certainly achieve their objectives that they're going after on running an effective railroad, but also looking for those areas that where additional volume may be able to be secured on the train. And so you saw a little bit of that maybe in the West. I think there's perhaps some other opportunities in some other parts of the country for a similar approach. So we're in a constant communication and discussion with our partners to look for those opportunities. And we will continue to do that for the second half of the year.

Brian Ossenbeck (Managing Director)

Okay. So in that case, it sounded like maybe the rails were a little more amenable to adding some capacity or some different offerings, or was this more of a joint thought process and venture?

Mark Rourke (President and CEO)

Yeah. I don't want to speak for the railroads. Certainly, I think one of the things that we can add value to our relationships is to bring the commercial opportunities and use kind of our insight into the marketplace to help our partners think about where those opportunities may be. It's generally a very collaborative approach and ones that we're in constant dialogue about.

Brian Ossenbeck (Managing Director)

Okay. Just a high-level question as a second one for First to Final Mile. Obviously, you've been working on it for a while. You had management changes. You did some acquisitions. It made a few strategic shifts along the way. Was there something that really changed in the end market that triggered this decision, or was this more of kind of a combination of factors and the opportunity cost and just the challenge of implementing it over the last couple of years?

Mark Rourke (President and CEO)

Well, we certainly went into this with the objective of addressing the growing e-commerce trend in consumer purchasing and how that was even extending itself beyond into the overdimensional goods, which was really our focus. And you're right. We knitted some things together, both from what we were doing prior and some acquisitions to help bring that national scope to play. But obviously, after a three-year endeavor there and from the standpoint not resonating from a cost to serve and a volume and a density standpoint, that we felt that we were on a glide path and any reasonable horizon for that to be accretive to what we were trying to accomplish here with this organization, we made the decision we made. So it's a confluence of factors. We'll play in e-commerce in different ways across our portfolio.

We're just not going to play it in the way we've been kind of focused on this service the last three years.

Brian Ossenbeck (Managing Director)

Okay. Thanks, Mark, for the thoughts.

Operator (participant)

Thank you. Our next question comes from Ken Hoexter with Bank of America Merrill Lynch. Please proceed with your question.

Ken Hoexter (Equity Research Analyst and Managing Director)

Hey. Good morning, Mark, Steve, and team. I just want to revisit some of the things you said before in terms of sounding positive in the big takeaways. In the outlook, you noted your rates are up and maybe seeing some volume declines. Maybe, Steve, can you talk a bit about your high and low-end outlook from that kind of truckload perspective?

Steve Bruffett (EVP and CFO)

Yeah. I think our high and low are built more around uncertainty around the seasonality and just to what extent that volume aspect shows up. I anticipate that we have largely baked in the rate activity across truckload and intermodal in particular. So that's our view of it is that we have decent insight given how far we are into the contractual renewal space this year, and that's where the predominance of our volumes come from. I think it's more about seasonality and volume side.

Ken Hoexter (Equity Research Analyst and Managing Director)

So less about rate fluctuation given you've got that locked in and more just about where volumes on that side trend?

Steve Bruffett (EVP and CFO)

Yeah. And the associated productivity that goes with the volumes.

Ken Hoexter (Equity Research Analyst and Managing Director)

Okay. On the follow-up, you noted a change in customers in Dedicated. Is that e-commerce market shift? Is that you fundamentally changing your target audience? I think, Mark, you were talking about that in the beginning.

Mark Rourke (President and CEO)

Yeah, Ken. Yeah. That's exactly right. And so more specialty-type services, whether that be on what we're doing, for example, in the ag space, delivering chemicals to the fields, to various other places where we're doing things beyond just DC-to-store type operations in a typical retail configuration. We could be on and offloading ATVs. We could be doing a whole series of other value-add services around supporting the customer's go-to-market strategy. And in general, those things are not 100 truck operations. They're much smaller operations, but they have less need for surging. They have less need for just fourth-quarter support. And so we like the overall return profile. We like the stickiness profile. And really, over the last 18 months in particular, it's always been part of the portfolio, but over the last 18 months, the mix is starting to shift more directly to those.

That's our approach going forward. We're not anti-big customer retail. We're just pushing more of our forward focus that direction.

Ken Hoexter (Equity Research Analyst and Managing Director)

Is that anything due to how large customers I know Walmart's insourced a bunch of business? Is that due to changing those larger customers, how they're sourcing their needs?

Mark Rourke (President and CEO)

Not particularly. It's more what's the ability to sustain returns based upon the cost to serve, capacity acquisition, length of contract. All of those things kind of come into play. But I wouldn't say it's just about insourcing, although obviously, there's certainly some folks who are more aggressive than others in that space. It's more the end markets that we're serving.

Ken Hoexter (Equity Research Analyst and Managing Director)

Just a number of questions, Steve, just minor. I know you changed some historical stuff. Are you providing, I think it was some in the Dedicated Specialty For-Hire Specialty. Are you providing historicals for the next couple of quarters on the web or anything else we can kind of normalize growth for that?

Steve Bruffett (EVP and CFO)

We have adjusted if it's the revenue recognition thing that we cited last quarter. We have a schedule by quarter, by segment for those types of things. We can work with you offline on any questions you have about our operating statistics and how they're reported.

Ken Hoexter (Equity Research Analyst and Managing Director)

All right. Thanks for the time, guys.

Operator (participant)

Thank you. The next question comes from Todd Fowler with KeyBanc Capital Markets. Please proceed with your question.

Todd Fowler (Director)

Great. Thanks. Good morning. Mark, in your prepared comments, you were talking about some cost leverage or some improvement on the cost side. I forget exactly how you phrased it. And Steve, you went through a couple of the other expense items in your comments, but salaries and wages looked pretty positive here in the quarters or percent of revenue. And I know that there would be some variability with the miles that were driven, but is that kind of a clean number on the salaries and wages side? And is that what we should expect from our run rate going forward? Or were there any other moving parts here in the quarter in that line item?

Steve Bruffett (EVP and CFO)

Yeah. It is down, I think, 9%, something like that quarter-over-quarter. There are some factors in there. Productivity is one of them, but there's also incentive compensation for the broader part of the organization lands in that line item. And we were above our targets last year, and we're below our targets this year. So there's that dynamic housed within that line. There's also – this is a lesser order of magnitude, but the shift between company driver and owner-operator dynamic, the mix between those two, as we have slightly more of our mix in owner-operator this year than we had in the second quarter of last year. So that plays into that line as well.

Todd Fowler (Director)

Okay. That makes sense. Steve, can you comment maybe directionally how much the incentive comp is on a year-over-year basis just so we have an idea from a modeling perspective?

Steve Bruffett (EVP and CFO)

We haven't gotten into that level of detail, but that's where that one would show up, so.

Todd Fowler (Director)

Okay. Okay. That's fair. And then can you just remind us on your rail relationships with your intermodal partners, what's the timing of the contract renewals, and when was the last time those would have been updated? Just trying to get a sense of what you might be looking at from a cost inflation standpoint with your rail partners as we move into 2020. Thanks.

Steve Bruffett (EVP and CFO)

Yeah, Todd, we don't disclose and we're not permitted to disclose items around our rail contracts. But you're right. We generally try to enter into multi-year structures so that for both sides, we have kind of durability, and we're focused on the long term on the market. And we're in the midst of that, but fortunately, can't share what the specifics are.

Todd Fowler (Director)

So, Mark, I understand maybe you can't talk about magnitude. Can you talk about when the contracts actually renew, or you can't comment on that part either?

Steve Bruffett (EVP and CFO)

Yeah. I can't comment on that part either. Sorry.

Chris Wetherbee (Managing Director of Head of Transportation and Shipping Research)

Okay. No. Fair enough. Okay. Just thought I would try. Thanks for the time this morning.

Steve Bruffett (EVP and CFO)

Thanks, Todd.

Operator (participant)

Thank you. We have reached the end of our question-and-answer session. Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation, and you may disconnect your lines at this time.