Schneider National - Q3 2018

Transcript

Operator (participant)

Greetings, and welcome to the Schneider National, Inc 2018 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Pat Costello, Senior Vice President of Investor Relations. you. You may begin.

Pat Costello (SVP of Investor Relations)

Thank you, operator. Good morning, everyone, and thank you for joining our call. By now, you should have received a copy of the earnings release for the company's third quarter 2018 results. If you do not have a copy, one is available on our website. Joining me on the call today are Chris Lofgren, our Chief Executive Officer, Mark Rourke, our Chief Operating Officer, and Steve Bruffett, our Chief Financial Officer. Before we begin, I would like to remind you that some of the comments made on today's call, including our financial guidance, are forward-looking statements. These statements are subject to risks and uncertainties, including those described in the company's filings with the SEC. Our actual results may differ materially from those described during the call.

In addition, any and all forward-looking statements are made as of today, and the company does not undertake to update any forward-looking statements based upon new circumstances or revised expectations. Also, non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the tables attached to our press release. Finally, this call is scheduled to go 60 minutes. After some introductory comments, we will answer as many questions as time will allow. Please limit yourself to one question and a related follow-up question. There are multiple people in queue to ask questions, and we want to get to as many as we can. I would now like to turn the call over to our CEO, Chris Lofgren. Chris?

Chris Lofgren (CEO)

Thank you, Pat. The third quarter was very good for our company and demonstrated the power of the portfolio of services. As we have said time and again, our strategy is to build a company that can resiliently perform through each stage of an economic and industry cycle. Q3 was no exception. The availability of commercial drivers continues to be tight, and the pressures on driver recruiting expenses and pay for the over-the-road business have been growing. As a result, we pulled the levers available to us and pivoted capital investment and our hiring of drivers to our Intermodal business. The Intermodal business segment had another highly successful quarter, both in terms of growth and volume, price, and the resulting revenues, as well as operating earnings.

While we would agree some truck capacity has come into the market, there are still constraints in capacity to meet demand, particularly when considering the daily volatility associated with trucks moving into and out of key markets. These conditions have allowed our Logistics business to create value through the use of our Quest technology platform and the continued advancement of tools available to serve both customers and other capacity providers. This business segment also experienced significant growth in revenue and earnings in the third quarter and also enhanced its operating margin.

Collectively, our Intermodal and Logistics businesses delivered 90% of the year-over-year growth in the enterprise revenue, not including fuel surcharge, 45% of the total revenue, again, not including fuel surcharge, and 50% of the operating earnings for the enterprise, versus a 51% of the growth in the enterprise revenue, not fuel surcharged, 40% of the total revenue, not fuel surcharged, and 31% of the operating earnings in Q3 of last year. Another example of the adaptability of our portfolio of services through market cycles. All in, our Truckload segment delivered very good results. We entered 2018 recognizing that driver constraints would bring with them increased recruiting expenses, particularly in the For-Hire Standard equipment business, and therefore, wanted to operate holding that portion of the fleet relatively flat.

In addition, our business model is based on adjusting contract rates to market versus playing significantly in the spot market. We have executed consistent with that plan, producing growth driven predominantly by pricing with strong margin performance. In addition, we have focused on exiting dedicated contracts that aren't reflective of driver-related costs and adjusting contracts that could be restructured to a win-win for the customer and our company. More importantly, both in the third quarter and looking forward into the near future, we're directing growth capital for Truckload on dedicated contracts that have sustainability and positive driver experiences, both in the short and longer term. One disappointing aspect of our third quarter performance was our First to Final Mile business. The losses here created a 300 basis point margin drag on our traditional Truckload business.

In our zeal to provide exceptional service and transits, we got too far out over our ski tips... driving a cost structure well beyond the customer's willingness to pay for the value delivered. As a result, we took a setback on the turnaround trajectory we were managing this business to, creating a two-quarter delay in our plan to get this business into the black. We have no one to blame but ourselves, and we have taken the necessary measures, including changes across management, reengineering the service and pricing models for this business as we speak. We remain committed to be a significant player in this portion of the market and continue to believe it will provide a channel for long-term growth. We will provide maximum focus and intensity to get this business up on plane and performing to longer-term targets. Mark will provide more color on this business.

Looking into the remainder of the year and into 2019, we remain relatively bullish. While we have seen slight increases to supply and a moderation in demand, there is still tightness in capacity that should continue through the fourth quarter and into next year, barring an economic downturn. The repricing of contract rates over the past 12 months and extra efforts to increase the number of drivers in our third quarter, much as we did in Q3 of 2017, sets us up well for seasonal surge and demand associated with the fourth quarter and our diversified customer base. Steve will provide you updates to our annual guidance for EPS and net CapEx spending. With that, I will turn it over to Mark Rourke to provide more detail regarding the business performance.

Mark Rourke (COO)

Thank you, Chris, and good morning, everyone. I'll offer a few summary comments about the quarter, and as usual, quickly move into the three business segments. I'll start with an update on our contractual renewal status of our book of business. As we enter the fourth quarter, our largest Truckload quadrant, For-Hire Standard, the percentage of our contractual book that has been re-rated is in the mid-90% range, and we're in the upper 90% range for the Intermodal segment's contractual book of business being updated. Considering the rate of the collective bid and pricing reset levels achieved in Truckload and Intermodal for hire networks across the broader shipment community, it has resulted in less routing guide chaos in the quarter than we experienced in the first half of the year.

Also, as Chris mentioned, in the quarter, the company's driver condition improved meaningfully as gains in retention and recruiting performance resulted in a sequential increase in capacity of over 500 drivers from Q2 to Q3, just like a year ago. The improvement was realized in both the Truckload and the Intermodal segments, with the extra recruiting expense dollars largely centered in Q3, with the benefits to be realized more in Q4 in 2019. Now, moving into Truckload. The Truckload segment, the overall tractor count, which is a combination of company and owner-operator units, was down 4% year-over-year and down 103 units sequentially from Q2 of 2018 at 11,393 units. This metric is reported as an average truck count for the quarter.

However, we finished the quarter 150 units higher than the average, primarily due to growth in dedicated and For-Hire Standard operations. The standard equipment quadrants in for hire and dedicated each increased revenue per truck per week, excluding fuel surcharge, 10% year-over-year, and the largest quadrant in Truckload, For-Hire Standard, with over 6,000 tractors, price improved 12% year-over-year as compared to Q3 of 2017, with productivity down 2%. The Dedicated Standard quadrant yields improved 9%, with productivity increasing another 1%. Last quarter, we indicated we were reshaping some of our dedicated business. The planned actions for 2018 process is complete, and that's represented in the year-over-year net reduction of 200 units, or nearly 10% in the specialty dedicated quadrant.

We did, however, add 200 new dedicated driving positions in the quarter, offsetting a portion of this planned churn. As a reminder, the objective of reshaping the exercise in Dedicated was largely to allocate capital to the most attractive configurations from a driver experience and financial return standpoint. As we expressed last quarter, the Dedicated Specialty quadrant's revenue per truck per week contracted due to customer fuel surcharge program changes, resulting in more dollars being recognized in fuel surcharge and less in line haul rates as compared to prior periods. Finally, in our For-Hire Specialty quadrant, our objectives, as Chris mentioned, the First to Final Mile service offering, have not changed. To profitably address the movement and care of over-dimensional products in B2B configurations, as well as the growing B2C e-commerce-driven marketplace.

However, our recent financial performance, coupled with a comprehensive business review, provided clear insight that a change to our business model is necessary. Our plan is to adapt our model to reduce the variability and increase the structure of the network on closely defined standards of service areas and transit levels, effectively eliminating the complexity of customization of those items by customer, by customer. This model enables an increased level of simplicity and an enhanced alignment for sales, pricing, and execution processes. To affect these changes, we have revamped the senior leadership team at the business lead level to accelerate our execution. This includes bringing in an experienced industry talent to lead this offering from a respected LTL service provider, and high service predictability, key product milestone visibility throughout the supply chain, and exceptional end customer experience are remain the tenets of our value exchange.

Therefore, the core Truckload segment, excluding First to Final Mile, had an operating ratio of 87.6 in the quarter. Now transitioning to Intermodal. We are pleased with the Intermodal segment's performance, growing revenues year-over-year by 29%, while achieving another record operating ratio result of 85.7. Order volume grew at 11% year-over-year, Q3 of 2018 to Q3 of 2017, and revenue per order increased 16% as compared to the prior year, Q3. Within that, yields improved 12%, with mix impacting revenue per order by another 4%, mostly due to longer length of haul on our transcon business. We took delivery of an additional 1,800 containers within the quarter and a corresponding number of chassis to support them.

Despite the additional containers and 14% year-over-year growth in company driver dray resources, we had more opportunity than we could serve in the quarter. Rail fluidity and our mix change within Intermodal consumed more containers, and we believe we are supremely positioned to take advantage of the peak shipping season here in the fourth quarter. Our Logistics, our Logistics segment also achieved revenue growth in the quarter of 29% year-over-year, to $269 million in operating revenue. We now have both Logistics and Intermodal on a billion-dollar brand run rate for both of those segments. Earnings performance increased year-over-year in the quarter by 37%, as margin expanded by 30 basis points year-over-year and 60 basis points sequentially from Q2. The mix continues to move higher into the spot arena.

The spot order percentage averaged in the high 50% range in the quarter, but our brokerage offering too, is set up well with agreements to support our customers with additional seasonal and surge support coverage across all modes of transportation coming into peak season. With that, I'll turn it over to Steve for final comments.

Steve Bruffett (CFO)

Thanks, Mark, and good morning, everyone. I'll begin with a quick recap of our enterprise results and provide context to the notable items. Enterprise revenues, excluding fuel, increased 13% over the third quarter of 2017, with growth percentages at our reporting segments ranging from the low single digits at Truckload to the upper twenties at Intermodal and Logistics. And as Mark mentioned, for the first time, quarterly revenues, excluding fuel, topped $250 million for both Intermodal and Logistics, highlighting the scale of these valuable components of our portfolio. Looking now at operating expenses, one of the larger variances for the quarter was purchased transportation, which was up 29%. Most of this increase was in support of the revenue growth I just mentioned for Intermodal and Logistics.

Also, operating supplies and expenses decreased 9% from the third quarter of 2017, and more than half of that decline was attributable to lower chassis costs, both duplicate and otherwise, at Intermodal. On the year-to-date income statement, other general expenses were up 48%, which at first glance, looks unusual. However, when adjusted for a 2017 benefit from contingent consideration and a 2018 litigation charge, the year-over-year variance makes more sense. Our quarterly incremental margins on an adjusted basis have been in a narrow band of 22%-25% so far this year. However, the composition of the incremental margins by reporting segment has varied as we've progressed through the year. Also, we are now measuring against tougher comparisons from the second half of 2017.

So for the third quarter, incremental margins were 6% at Logistics, which is solid performance for their business model, 33% at Intermodal when adjusted for last year's duplicate chassis costs, and 90% at Truckload on moderate revenue growth. Year to date, our consolidated incremental margin was 23%, with Truckload at 44%, Intermodal at 46%, and Logistics at 6%. Regarding diluted EPS, the $0.40 recorded in the third quarter of 2018 was a 90% increase over last year and an increase of 74% on an adjusted basis. Year to date, EPS was up 65%, and again, 74% on an adjusted basis. Wrapping up the overview of the income statement, I want to note that on an adjusted basis, our trailing 12-month EBITDA was over $650 million. Moving now to the statement of cash flows.

Year-to-date cash from operations increased $94 million compared to 2017, driven mostly by a $78 million increase in net income. Regarding investing activities, our year-to-date purchases of transportation equipment were similar to last year. However, the composition is different, as investments were being made last year to convert the Intermodal chassis fleet. This year, with the chassis conversion completed, there's been more of a focus on growing the Intermodal container fleet. On the balance sheet, our cash and marketable securities were $405 million at September 30th. That was up $125 million from year-end, and our total debt was $423 million. Moving now to some forward-looking comments. Our full year guidance for adjusted diluted EPS is $1.47-$1.53. This guidance maintains the midpoint and narrows the range from our prior guidance in July.

As a reminder, we raised the midpoint of our annual guidance by $0.06 per share in July. Our 2018 net CapEx guidance is $325 million-$350 million, which again, is narrowed from our prior guidance, but also has a slightly lower midpoint, and that's mostly due to higher proceeds from dispositions. So to recap the quarter, it was a fluid three months during which we leveraged our technology and predictive analytics to identify opportunities in fluctuating market conditions. We invested in driver capacity and in Intermodal containers to position us for the fourth quarter, and we continue to focus on our core themes, leveraging the portfolio of services, the resiliency through business cycles, and capital allocation disciplines, all enabled by our Quest technology. I will now turn it back to Chris.

Chris Lofgren (CEO)

Thanks, Steve. As many of you may have heard, we issued a press release after the market closed on Tuesday, announcing my retirement at the annual shareholders' meeting this coming April, and the board of directors' decision to promote Mark Rourke to the CEO role. Succession of key roles, including the CEO role, is something we take very seriously at Schneider and is something we manage very actively. We are blessed with a great number of highly talented executives, and the way you keep them is to provide them increasing opportunities to grow their careers. Sometimes that means being willing to get out of the way when the time is right. I've had the privilege of sitting in the CEO role here at Schneider, going into my seventeenth year. I've also had the wonderful opportunity to work directly with Mark Rourke for over 12 years.

He is a tremendous business leader, and he now deserves the opportunity to lead this great company into its great future. The board of directors, working with both Mark and me, have executed a thoughtful and extensive succession plan, where the next phase is for me to step aside and for Mark to step forward. I'm highly confident in Mark's readiness. I love this company, and I'm proud of what we've collectively accomplished during my tenure. I will deeply miss the people and the work, but I will be most proud of watching Mark, the exceptional team of leaders in place, take the company to the next level of performance. But I'm not done until April. There's much left to be accomplished. So with that, I'll turn it back to the operator for questions.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. In the interest of time, we ask that you please limit yourselves to one question and one follow-up. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd 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. One moment please, while we poll for questions. Our first question comes from the line of Ben Hartford with Baird. Please proceed with your question.

Ben Hartford (Senior Research Analyst)

Hey, good morning, everyone, and congratulations, Chris, on the retirement and Mark, on the new position. Maybe Mark, just kind of thinking about 2019 and core industry contractual pricing growth expectations as it stands today, both on the Truckload side and on the Intermodal side, in the context of your comments about 3Q trends, how do you see the industry? What are reasonable benchmarks for core contractual pricing on Truckload and Intermodal? And for you guys, specifically, how do you think about net price in both modes for 2019? Thanks.

Mark Rourke (COO)

Well, good morning, Ben, and thank you for the comments. No, we haven't at this juncture issued a great deal of guidance, obviously, for 2019 yet. We still think there's room on contractual price. Certainly, the driver condition and the labor inflation associated with that, we don't think is, you know, completely mitigated. We're very mindful of the contractual work we've done this year and where that plays in the carryover aspects into the various quarters next year. We'll, I think, next time, probably give you a bit more guidance as it relates to those matters, but we still think there is a solid contractual movement yet to be had as we enter into 2019.

Ben Hartford (Senior Research Analyst)

If I could get a follow-up on that. When you think about Truckload versus Intermodal, some of the service issues on the Intermodal side, but the capacity constraints on the Truckload side, what is the kind of the average delta between Truckload and Intermodal pricing as it stands right now? And is there the opportunity for Intermodal to meet or exceed Truckload pricing growth as we think about the upcoming quarters?

Mark Rourke (COO)

Yeah, Ben, I think, you know, certainly there, there is an influence on truck pricing to where Intermodal is, but we have seen a contraction in that delta in 2018, particularly in the East, where we are competing more heavily against truck on the Intermodal product offering. And so, when I mentioned my comments that we've got room on both, contract rating in 2019, I think that certainly applies to the Intermodal segment as well. And so those-

... those deltas have shrunk, and I think they may continue to shrink a bit further.

Ben Hartford (Senior Research Analyst)

Okay, thank you.

Chris Lofgren (CEO)

Ben, this is Chris. Thank you for your, you know, kind words when the announcement came out. I appreciate that very much.

Operator (participant)

Thank you. Our next question comes from the line of David Ross with Stifel. Please proceed with your question.

David Ross (Managing Director)

Yes, thank you. Good morning, gentlemen.

Chris Lofgren (CEO)

Good morning.

David Ross (Managing Director)

On the Intermodal side of things, you, you talked about the, you know, discount to truck shrinking a little bit in the East. On the demand side, how would you characterize, you know, demand on the West long haul versus Eastern short haul? And then what are you seeing in terms of any pre-shipping as it relates to tariffs and how that's impacted the Intermodal demand?

Mark Rourke (COO)

Yes, this is Mark, and I'll offer some thoughts there. You know, we really haven't seen any level of change of demand throughout the whole year in Intermodal, east, west, or otherwise, and obviously, we are now starting to see the peak season hit, particularly in the import locations of Pacific Northwest and Southern California. But we're busy across the board, when we grew volume, I think 11% on a market that we assessed that grew about 4%. So we're taking market share, and we expect a very, very solid fourth quarter as it relates to the seasonal elements of that. So, very bullish on our Intermodal offering.

David Ross (Managing Director)

And then just to follow up, as you extrapolate that into next year, do you expect a similar amount of container growth or capacity growth at Schneider on the Intermodal side?

Mark Rourke (COO)

Our plan does have some, container and chassis growth next year, but, but obviously, over the last, 12-18 months, we have amped up, our box count. We took, 1,800 in the third quarter. We have about 600 left to take, if all the shipping activity goes out as, planned into the port location, and then we'll give further consideration to next year. But we think we've have, room to grow because of those investments that we've made here and the growth of the fleet in 2018.

David Ross (Managing Director)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question.

Ravi Shanker (Managing Director)

Thank you. Good morning, everyone, good luck with retirement, Chris. Mark, congratulations, you have big shoes to fill, but I think you have big feet as well, so it's all good.

Chris Lofgren (CEO)

Thank you.

Ravi Shanker (Managing Director)

Gentlemen, so can I just ask you kind of for your thoughts on peak season? Because, I mean, we're certainly not seeing it kind of show up in a meaningful way in the data. And I think you guys have said maybe you're seeing something than I am and maybe not kind of in the overall business. Kind of where are we in the peak season demand, kind of as you would have expected it, because I think there certainly was an expectation for maybe an earlier and fairly robust peak season this year.

Chris Lofgren (CEO)

Ravi, this is Chris. Again, thanks for your nice comment. As human beings, we get really conditioned, you know, sort of by the current and kind of a short history behind us. And I think if we were to really step back and look at where the market is and where it's performing today, you know, it's a very positive market. We came into fourth quarter last year with a number of things that really had impact, the two hurricanes, clearly, the EOBR mandate moving at us quickly, and frankly, you know, coming out of a market that was pretty challenging relative to price.

And so I think Mark has a nice view as to kind of what's going on, and in some cases, how this is shaping both our experience, our competitors' experience and the shippers' experience in the market. But I, you know, I think we should just all kind of reflect that, you know, this is still a very good market condition, and we think fourth quarter will be like fourth quarters within that. So Mark, why don't you, you know, kind of share your insight as to what we're seeing and what we believe is kind of behind what shippers and carriers are feeling, vis-a-vis what kind of expectations might be?

Mark Rourke (COO)

Maybe just a couple things to add there, Ravi. You know, when we look at the extent of the reset level of the rate structures, not only here at Schneider, but in the industry, you know, you certainly are now seeing, I think, just much higher acceptance rates because the board has been reset. The shippers are happy getting the coverage, the carriers happy to accept, and so all the secondary and tertiary chaos that was going on earlier in the year, I think, have subsided with those resets. With that said, there are still pockets that are more robust as we sit here today in the early fourth quarter than others, particularly around, as I mentioned earlier, the import centers are seeing what we would consider typical peak season.

The demand by mode for Intermodal and for our team service to expedite product inland is growing, and we expect to be incredibly robust as we would normally expect in the fourth quarter. And so, you know, to us, it seems fairly average in that respect, or fairly, I should say, expected in that respect.

Steve Bruffett (CFO)

This is Steve. I would just add, you know, there are numerous strength indexes in the external space. You have one of them. We also have an internal strength index that we monitor pretty closely, as you might imagine. And so we've looked back over the last several years to look at the specific dates in the fourth quarter when strength began to appear in our internal index. And those dates really range from October fifteenth to November seventh over the past number of years. So we're right in the middle of where we would expect to start to see some upward trajectory in that strength index.

Ravi Shanker (Managing Director)

Got it. That's helpful color. And just to follow up, Chris and Mark, I think you guys sounded just as smart as anyone with the First to Final Mile, kind of step back this quarter. Are, are you confident this is a one-off, and it's gonna be kind of back to normal service or better than normal performance the next quarter? I think you said that you, you took a couple of quarters, you're gonna take a couple of quarters longer to get to that final target. But, are, are you fully confident you're gonna get there? And kind of, at what point do you guys decide that this is maybe not worth the effort?

Chris Lofgren (CEO)

Well, I will tell you, there is a great deal of intensity and focus, and it's the one place that we have certainly big opportunity to, you know, with kind of focused leverage to improve the enterprise performance. I think we have stepped back and really taken a look at, in some cases, I think we, with all of our, you know, with all of the best of intentions, we're running out to create a champagne and caviar offering for people who would really like a good beer and a good brat. And I think we're gonna focus the orientation on creating value, creating a, you know, a level of standard and predictable service at a price point that is competitive. We believe there's opportunities out there.

We think the assets that we acquired have many, many, many uses and many points of leverage for us, both in that business and across the enterprise. But we're to a place where, you know, we think we understand how to get there, but this isn't something that we're gonna, you know, spend 24 months and wonder. So, made some real important changes. I think we have some deep insights. There's a lot of heavy lifting to be done. As long as we're seeing the progress and the direction where we believe this business can go and should go, that's gonna be good. But if we don't see the ship turning and getting where it needs to go, we're not really into hobbies here.

I don't think this is gonna be one, but if it turns out, I'll have hobbies in my retirement, but not here.

Ravi Shanker (Managing Director)

Very good. Thank you, guys.

Operator (participant)

Thank you. Our next question comes from the line of Chris Wetherbee with Citigroup. Please proceed with your question.

Chris Wetherbee (Senior Research Analyst)

Yeah, hey, thanks. Good morning, guys. And, yeah, Chris, congrats on the retirement, Mark, and yeah, congrats on the new role. It's been a pleasure working with you guys and look forward to more to come. Wanted to pick up just on, Steve, your comment about the strength index, and, and just make sure I was clear with what you said. Have we seen that sort of pick up in activity as we stand here, I guess, about a week left in that sort of historical band where you normally see it? Or are you suggesting that we're still in the middle of that, and so in the next week or so, you'd expect to see a pickup?

I'm just trying to make sure I understand sort of the lay of the land as we're sitting here, because you had some comments about deceleration. I just want to make sure I, I completely understood that.

Steve Bruffett (CFO)

Sure. This is Steve, so I'll follow up on that. Well, what we're saying is that we are in the middle. If you look at a lot of the external indexes, we've followed a similar trajectory with our internal one. Where we sit today, we would expect to see the upward bend in that curve coming up within the next week.

Chris Wetherbee (Senior Research Analyst)

Okay. So you haven't seen it yet? Okay, got it. And then just as a follow-up to that, in the context of the First to Final mile and what we're seeing from, you know, peak or the maybe slower development of peak, incremental margins, you know, have been good, broadly speaking. Just want to get a sense as we move forward with some of the challenges of First to Final mile, you know, some of the seasonality or lack thereof, you know, how generally we should be thinking about that. You know, rate environment is still quite good. Just trying to get a sense of, you know, maybe the trajectory of the business. Are we in sort of a leveling off type of period now that maybe persists for a couple of quarters?

I just want to get your sense of how that looks.

Steve Bruffett (CFO)

Yeah, it all, of course, depends on what you're comparing to. And I noted in earlier comments that as we get into comparing to, say, the fourth quarter of 2017, which was our most profitable quarter in our history at that point in time, and remains that those incremental margins will likely moderate a bit. But we've been running in the mid-20s to upper 20s so far this year as an enterprise. And perhaps that settles in to the mid-teens or so as we move forward, but we do expect additional leverage in the model as we go forward.

Chris Lofgren (CEO)

Chris, this is-

Chris Wetherbee (Senior Research Analyst)

Okay.

Chris Lofgren (CEO)

This is Chris. You know, the one thing again with our approach, we spend a lot of time working with our customers, trying to move our book of business and our engagement in their supply chains and transportation needs, you know, at the contract level. Takes a little bit more effort and a little longer time to get it, but it also is sustainable. And so a lot of that work we carry into, you know, 2019, which has positioned us well. So you know, I think it's within that spirit that we kind of go, okay, a lot of that work has been done.

The customers have said, "Look, here's what we'd like you to do, and here's what we're willing to pay for it." And so, you know, I think that carries us into, you know, the first quarter and maybe even into the second quarter without dramatic efforts, you know, as we would have seen starting in fourth quarter of last year and, you know, kind of every single quarter of this year. So I think that's a perspective that you need to kind of carry into thinking about modeling us for 2019.

Chris Wetherbee (Senior Research Analyst)

Okay. That, that's a very helpful perspective. I appreciate it, and again, congrats, Chris and Mark. Thanks.

Operator (participant)

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

Todd Fowler (Managing Director)

Great. Thanks, and good morning, everyone. This probably follows on the last line of questioning, but just the comments around having the growth capital being directed right now at the Dedicated and the Intermodal segments. It sounds like maybe the retention on the driver side has improved a little bit. The rates have gotten maybe back up to a better or more acceptable level. With the expectations we move into 2019, should we still expect the capital to be dedicated or to be focused on Dedicated Intermodal, or do you shift back into one of the other quadrants from a capital allocation standpoint?

Mark Rourke (COO)

Good question. This is Mark. Certainly, while there has been, and we had some success in the third quarter on the driver front, it did come with the corresponding expense to achieve that. But certainly our thoughts relative to the labor is still gonna be very tight, very much in demand, and so increased focus on our mind is on those work configurations and driver experiences, both in the work that they do and the customers they interact with, is paramount, and we believe certainly Dedicated and Intermodal give us that edge, and that's exactly where we believe our growth will entail, particularly as it relates to the driver and our capital spend.

Todd Fowler (Managing Director)

It sounds like no significant change going into 2019 versus what we saw in 2018?

Steve Bruffett (CFO)

Yeah, I think that's. We're refining and finalizing our CapEx plans for 2019, but generally speaking, it's more of the same, where we would invest in Intermodal containers, as we see the opportunity to do so, and other organic growth opportunities are first and foremost in our prioritization.

Todd Fowler (Managing Director)

Okay. Actually, Steve, I do want to follow up on that. So, just thinking strategically, you know, where are you at from the standpoint of looking at anything externally? Then from a capital allocation standpoint, beyond, you know, the organic growth opportunities, what, what are you guys considering at this point?

Steve Bruffett (CFO)

Yeah, I mean, we're we say capital allocation disciplines, and that we do try to enforce the discipline part of that. And so we do have interest in looking externally, as we've openly acknowledged, but we are selective in what we would pursue and, probably on the fairly conservative side of that spectrum. So not everything's gonna fit, and we're looking for things that leverage our capabilities, our core capabilities, our technology, our ability to deal with complexity, customer stickiness is an important criteria in what markets we're serving. So when we look at that combination of factors, that all comes together in how we prioritize our efforts.

Todd Fowler (Managing Director)

Okay. Thanks for the time, and congratulations to both Chris and Mark.

Chris Lofgren (CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Brian Ossenbeck with JPMorgan. Please proceed with your question.

Brian Ossenbeck (Managing Director)

Hey, good morning, and thanks for taking the question. And again, congrats to Chris and Mark on the new roles in life. It's been a pleasure working with you both. Just to maybe ask a different question here, there's been a lot of activity on the regulatory side. You've got hours of service coming up for comment, you've got some exemptions on ag hauling, personal conveyance, the push for younger drivers. How do you see that impacting the industry? Are these headlines that are going to translate into something substantial from a capacity perspective, or are we just seeing sort of the end result of a big tightening in capacity and, you know, just like anything in government, will take a little while to get to resolution?

What are you guys expecting on that front?

Chris Lofgren (CEO)

Brian, this is Chris. I'll give you my view and have Mark follow on. Yes, the government, even when they decide that they're gonna move, it takes a while for implementation. That said, when they finally implemented this EOBR, I mean, there's still things going on. But in general, I would give the DOT and FMCSA, you know, pretty high marks in terms of when they moved, getting it done. I think there is no doubt, there's an effort to try to get younger drivers. Again, that may work. It's just, it's challenging. You want somebody who is proficient and professional behind an 80,000 lbs vehicle moving with passenger vehicles. Clearly, the vehicles-...

are getting more and more safe in and of just their capabilities to know what and who is around them, and so that may open up that possibility. I think a lot of this around the hours of service, my hope is, given that there is electronic data, and this data is then being shared, that we can get to an hours of service that really understands the work, the driver's life, and says, how do we have the driver be productive, but be safe and productive at the same time? And I'm hopeful to the extent that they're going to make changes that this broader database, and if they will take a similar kind of approach, we'll land in a good place, and then we can stay there.

Because it is disruptive, to the industry, you know, changing hours of service. It has a huge impact in terms of how we think about, freight, price, markets, all of those kinds of things. And so, I would like them to do a ready, aim, check windage, aim again, and then fire if, if we're gonna go through that. And my hope is that, kind of given the, the ELD thing, maybe that's what'll happen. In the end, my view is it's gonna be incremental. It isn't going to be earth-shattering change in terms of, capacity and a workforce. The workforce is gonna change by, you know, raising pay, by the whole industry carriers and shippers recognizing that the driver has to be productive.

And, you know, those—that is where I think the greatest opportunity lies, and I think we're, we're, in many cases, just on the front of it. Mark? You just—you written to me like

Mark Rourke (COO)

It's pretty comprehensive. You know, there's no doubt, though, that the regulatory apparatus has slowed down with the new administration and get into some level of burn-in period. And the only real negative for capacity, but good for society and safety, is the national drug database that you know could be coming at us here in 2020, which gets after the habitual drug use. And then you saw the other item, some approval to get after hair follicle testing, which we believe is superior in its ability to identify and weed out the habitual drug user. So those are the probably two that's gonna put the additional crimping on capacity going forward, but probably for a very good reason.

Brian Ossenbeck (Managing Director)

Okay, I appreciate all the details on the answer. Maybe just a quick follow-up on the rail service impact. You mentioned it was clearly a headwind in the quarter. Just wanted to see if that was improving sequentially. I think in the past, you gave us some context of how many loads were kind of left on the board in terms of capacity that was just constrained or box turns that were lower than expected. So can you kind of quantify that and give us a bit of sense for expectations going forward? Thank you.

Mark Rourke (COO)

Yes, certainly, you know, what we're, I think, are seeing more is just the congestion in the terminals now. And, particularly our western partner has got some excellent plans on automation and some things that I think are gonna be very, very helpful to the throughput around the terminal constraints, and so we're very much looking forward to their investments there. But, certainly in the short run, we would estimate we could have done, reasonably, another 6,000 orders through the quarter, based upon the fluidity slowdown and some of the impacts on that congestion, both within the boxes we had available and the demand that we could have deployed there.

But certainly our eastern partner is, as we expected, improving and obviously still dealing with making some adjustments to their network that we've got to work through, but they're listening and looking at the opportunities to do exactly what they want to do, and which they need to do, is improve the overall execution and speed of their network, which we absolutely are behind. But we just want to make sure we get a chance to have some input and some influence there to make sure we can do that in the best way possible for the customer and us as a carrier community.

Brian Ossenbeck (Managing Director)

All right, Mark, thanks a lot. Appreciate the time.

Chris Lofgren (CEO)

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

Tom Wadewitz (Senior Equity Research Analyst)

Yeah, good morning. You know, Chris and Mark, also congratulations to you. I think it's worth noting for both of you that you know, you've presided over some pretty big changes at Schneider. I think in terms of you know, big focus on improving profitability over the years and then also the you know, the IPO. So it's you know, been great interacting with both of you guys, and wish you the best.

Chris Lofgren (CEO)

Thank you, Tom. Appreciate that.

Tom Wadewitz (Senior Equity Research Analyst)

Let's see. When we think about 2019, is it reasonable to expect margin improvements across the board? Or how would you think about, you know, it seems like you're expecting more contract pricing gains. I guess within truck, you've got this, you know, if you move to break even in the First to Final Mile business, that would be pretty meaningful, a boost to margin. But how would you just kind of broadly think about margins in the different businesses in 2019 and, you know, kind of opportunity for improvement?

Chris Lofgren (CEO)

... Well, Mark's looking at me like, well, you know, you're not gonna be here to deliver the whole year. But I think that, I think as you just kind of a general construct thinking about 2019, 2018 was fairly prolific in terms of what the shipping community experienced in terms of moving rates. It was driven by the fact that many or all of us in the carrier community did move driver-related expenses pretty significantly as well, in some cases, starting even back in 2017 to have to do that.

I think that - and so as a result, I think if you're gonna go, Oh, we're gonna get another turn on 2018 and 2019, I've never seen that happen in this industry, and because I think a lot of things did get addressed, and we're in a place that's pretty strong. I think, again, we'll see movement in driver expenses that will have to go into the marketplace and be able to recover. So I think as long as the economy doesn't make a big turn, I think there, you know, there's gonna be pricing activities that happen. But I think if - I just can't imagine, and we don't have anything in history that would say we would duplicate what happened in 2018 in 2019.

And so I think you probably go back in history and have some pretty good models to kind of think about what would happen, you know, until there's the ultimate economic slowdown. And if we were really good at predicting that, we would probably have a different division in our enterprise that was doing a lot more speculation. So, you know, Mark or Steve, I don't know if you want to add to that.

Mark Rourke (COO)

Yeah, Tom, I think we have, you know, as I look at where the opportunities are for us, you called out one clearly in First to Final Mile. We have the ability, through the things that we're working on, to make that a very, very positive comp condition, and we're focused on doing that, obviously. I think we have room in our Dedicated reshaping that we've done, which was all enhanced around or all focused on the driver experience and getting in a position where we have the appropriate returns for the services we're providing. So that is a place that we are believing that we'll have improvements in 2019. The irregular route networks, the large networks, maybe we don't have as much, certainly, as Chris points, a year-over-year pop to those same degrees.

But when we look at the whole portfolio, we're not sitting here thinking that we are maxed out in truck, Intermodal, or Logistics, and we have improvement opportunities, and particularly maybe more driven by growth in some of those segments than expansion of margin. But we can increase our earnings profile with our more asset-light functions, and regardless, in some respects, regardless of where we are in the market cycle.

Steve, anything?

Steve Bruffett (CFO)

No, it's exactly what I was gonna say, what Mark said there at the end, whereas that's the beauty of having this portfolio. We have some margin improvement opportunities within it, but we also have just earnings dollars growth, opportunities from top-line expansion in our, less driver-intensive businesses. So it's a good combination.

Tom Wadewitz (Senior Equity Research Analyst)

So, okay, that's, that's good. If I could maybe just follow up on that a little bit. What, what's the conviction level that—like, is it, is it good to say base case on first to final, we get to break even next year? Or would you say, "Hey, you ought to still model a, a loss on that?" And then on Intermodal, where you've had the most dramatic improvement, maybe to your comment, Chris, is that, would you say, think about a flat Intermodal margin next year, or is that, is that too cautious?

Steve Bruffett (CFO)

This is Steve. I'll weigh into that a little bit. This First to Final Mile, for example, when Chris mentioned earlier about a couple-quarter delay in achieving profitability with that, given where we are today and the amount of work we need to do to retool that business, I'd be hesitant to say, like, on a full year basis, that there's profitability. What we're signaling is we expect to achieve profitability sometime during the year, and that's likely in the second half of the year. That's our objective, and that's what we're striving for with a lot of earnest activity. So that's how I would respond to the First to Final component of that.

In Intermodal, given the step-up in margin that we achieved this year through a variety of initiatives and investments, you know, it's more of a organic growth story there going forward, in my opinion, and maintenance and fine-tuning of those margins rather than robust expansion of those margins.

Tom Wadewitz (Senior Equity Research Analyst)

Okay, great. That makes a lot of sense. Thank you for the time.

Operator (participant)

Thank you. Our next question comes from the line of Allison Landry with Credit Suisse. Please proceed with your question.

Allison Landry (Senior Transportation Research Analyst)

Hi, good morning. I just wanted to echo congratulations, you know, to you guys, similar that everybody else has been doing during the call. I wanted to ask on Intermodal, with your Western rail partner, have you seen anything that, you know, maybe suggests that there's potentially some testing of Precision Railroading going on there, or, you know, even implementation? Just curious if you've seen any changes.

Mark Rourke (COO)

Morning, Allison. I don't wanna speak, you know, for them or perhaps their strategy. If you're asking -- as you ask for our opinion on that, as you look at their network and what they've done over time, they've always been very, very disciplined relative to how they think about opening additional ramps and slowing the train down or making it, if you look at the, you know, the tenets of Precision Railroading, which is long trains going long distances, I think, their current network is highly aligned to that philosophy presently. And so perhaps there is less need and less opportunity, based upon kind of how they've set their network up.

What we're encouraged by, they're also, we think, being very forward-thinking relative to automation within the terminals, which, as you look at the Class I railroads, one of the biggest items or one of the largest items they have to deal with is landlocked around those terminals. And so the ability to get more efficient within and do things that invest in activities and capability that drives efficiency within those terminals is, we think, just a great opportunity to improve the whole fluidity of the network. And so maybe that'll be their version of precision railroading. And again, I'm hesitant to speak for them, but that would be kind of our view looking from the outside in.

Allison Landry (Senior Transportation Research Analyst)

Okay. That's... Yeah, and totally understood, you know, in your last comment there, but that's, that's definitely good context. I'm sorry if I missed this earlier, if this came up, but wondering if you could give us any sense in terms of, you know, for 2019, what you're expecting for, for rate increases from the rails?

Mark Rourke (COO)

Well, our mechanisms that we have and our arrangements with our railroad partners is that from a rate standpoint, there's mechanisms that recognize where the market's at, and so that will adjust up or down based upon where the market's at. So I can't get into the details of that, but there are elements that allow for both parties to enjoy where the market is currently performing.

Allison Landry (Senior Transportation Research Analyst)

Okay. And is it sort of fair to think about, you know, when you guys are, you know, whether you have longer term contracts or if any, or annual with your own customers, is there anything linked in maybe the multi-year ones, to, you know, what the rail rate increase is or if that changes?

Mark Rourke (COO)

We have long-term arrangements in place with our two primary railroads. The mechanisms are consistent, and again, they adjust based upon where the market is at. So, so we don't anticipate any changes to the mechanisms. We just, we'll have to see where the market's at, and, and those things, take care of themselves.

Chris Lofgren (CEO)

Yeah, relative to the customer contracts, those we have to do the work relative to the market, as opposed to have anything in customer contracts that take that into account.

Steve Bruffett (CFO)

The only thing I would add-

Allison Landry (Senior Transportation Research Analyst)

Okay

Steve Bruffett (CFO)

... is that there's not like one date where everything resets. It's a more fluid process.

Allison Landry (Senior Transportation Research Analyst)

Right. Understood. Okay, great. Thank you very much.

Operator (participant)

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

Brad Delco (Managing Director)

Hey, guys. Good morning.

Chris Lofgren (CEO)

Good morning, Brad. You're gonna get to be the last one here.

Brad Delco (Managing Director)

Well, I appreciate that. Chris, congratulations, and Mark, congratulations to you as well. I had an easy one, I think, and I apologize, I jumped on late, so I hope you didn't address this. Can you comment on what bid season looks like? I mean, has it started? Have you heard any anecdotes from shippers about when they plan to come to bid? And are there any surprises to either of you?

Mark Rourke (COO)

Brad, at this juncture, as we, in our opening comments, we're largely through as we, I think, in our truck business in the mid-90s and our Intermodal segment, we're in the upper 90s of being through the kind of the rate reset process here for calendar year 2018. In many respects, I think the carrier community and the shipper community are getting what they need and wanted out of those arrangements, with solid routing guide performance and predictable coverage. The whole network is operating, as I mentioned in my opening comments, with a lot less chaos as associated with that. At this juncture, as we sit here in early fourth quarter, there is no surprises to that, either for the shipper or for the carrier, at least from our vantage point.

So I don't know if the question is pushing, is people moving up, moving back? I mean, it's, it's, all operating pretty much as we would expect at this point.

Brad Delco (Managing Director)

Okay. No, that, that's helpful. And, and then maybe just to follow up on that, as it relates to sort of Dedicated bid activity, would you say that slowed down just by the nature of, supply-demand dynamics being less out of balance, or is Dedicated bid activity still, pretty robust?

Mark Rourke (COO)

Yeah, I'd break that down in a couple of what type of dedicated are we referencing there. We've been very cautious of putting our resources against the capacity-generated type dedicated, meaning things that are troublesome in a network, one-way configuration being reformatted into a dedicated type coverage point. We don't generally subscribe that those are durable through cycles, and our resiliency focus and learnings over the years would suggest that that's generally not in our best interest to do that. And so we haven't been pursuing those at all through the 2018 capacity crunch timeframes. Our focus has been on those specialty type, or you're giving a higher level service configuration that is durable through cycles. And that pipeline is still very, very good.

It's not, you know, it's not driven by people just looking for capacity coverage type solutions. So we feel that's our focus, and that's what we'll be taking into our strategy and approach to 2019.

Brad Delco (Managing Director)

No, that, that's very helpful. Thanks for the color there. And, and again, congrats to you both.

Chris Lofgren (CEO)

Thanks. Thanks, everyone, for joining the call. We appreciate it. We'll get back to work, and see you in 13 weeks.

Operator (participant)

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.