J.B. Hunt Transport Services, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the J.B. Hunt's third quarter 2020 earnings call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, press star 0. I would now like to hand the conference over to your speaker today, Brad Delco, Vice President of Finance and Investor Relations. Thank you. Please go ahead.

Good morning and thanks for joining us. Before I introduce the speakers on today's call, I'd like to take some time to provide some disclosures regarding forward-looking statements. This call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, estimates, or similar expressions are intended to identify these forward-looking statements. These statements are based on J.B. Hunt's current plans and expectations and involve risk and uncertainties that could cause future activities and results to be materially different from those set forth in the forward-looking statements. For more information regarding risk factors, please refer to J.B. Hunt's annual report on Form 10-K and other reports and filings with the Securities Exchange Commission. Now, I would like to introduce the speakers on today's call. This afternoon, I'm joined by our CEO, John Roberts, our Interim CFO, Chief Accounting Officer, Controller, and SVP of Finance, John Kulow, Shelley Simpson, our Chief Commercial Officer and President of Highway Services, Nick Hobbs, President of Dedicated and Final Mile Services, and Darren Field, President of Intermodal. At this time, I'd like to turn the call to our CEO, Mr. John Roberts, for some opening comments. John? Thanks, Brad.

Well, we are all learning to live with the changes that have been presented by the virus. When we began in mid-March, the response to a very sudden change in how we do business was incredible. From day one, we had to pivot to a new normal on the go, and we are so proud of our teams across the country for the different ways we have found to make it work. As noted, we set out our priorities to deal with the situation clearly and from the start. take care of the health and safety of our people, and work hard to honor the commitments we have made to our customers. Initially, the adrenaline pushed us through, but over time, we start to see why we work together in person. The benefits of being together and collaborating, building on our culture, solving problems as a team, and sharing time with each other show their value to us more now than ever. This reality has prompted good work to find ways to begin coming back together, particularly in our corporate offices, very slowly and very carefully. We should also call out that due to the nature of the business, 75% of our people in the field have been effectively in position since day one of the crisis. Our drivers and so many of the people that support them. We are extremely grateful to all of our employees, both at corporate and in the field, and thank them for their commitment. The third quarter showed us some new opportunities in spiking customer demands across all businesses that I don't recall seeing in the past. At different points, we regrettably had to turn away business that was offered but not built into our original network plans and commitments. The supply side of the equation, our carriers and our rail providers all experienced pressure and congestion during the quarter. Also, due to what we believe is a labor shortage at our customers causing unloading delays, we have not been able to turn our trailing equipment as well as we have been able to in the past. Topping off the list is an abnormally high demand to hire company drivers for both replacement and growth. Currently, we are entering the typical annual bid cycles with more uncertainty about capacity and demand. We are actively discussing directional ideas for the next 12 to 18 months internally and with our customers, including support for fleet expansion in intermodal and highway services training equipment. ROIC has long been our guiding principle when it comes to determining where to allocate capital. We ask ourselves, what does the customer need and can we generate a proper return on the investments to serve those needs? How can we advance the agreements and relationships we have with customers to better align our deal cycles with our equipment cycles? Personally, I think annual jump ball bids are dated and not good for the customers. We can't jump ball our equipment every year. Encouragingly, we have seen some progress in modernizing the business models in intermodal and highway services. We hope that will continue. I will ask our business leaders to cover the segments. For the overall current state of our business, let me just say that I continue to be encouraged with the work being done in our digital transformation with 360 Marketplace, not only within our brokerage business, but also as a toolset for us to use with other asset and non-asset services. I'm also encouraged with the progress so far in developing our big and bulky final mile services. This includes the performance of our acquisitions, before COVID and also the organic growth we have experienced. Both of these key plays were called to help the company evolve several years ago, and as with any difficult business, we need time to reveal the progress. We will continue to lean into both of these channels going forward. Our more established lines, Intermole and Dedicated, give us a solid base to work from, and we believe that both of these businesses present sound growth and return profiles going forward. Let me close by saying that during the past eight months, I have witnessed a true test of what I have long believed to be a culture at J.B. Hunt that is centered on people, a commitment to each other, and our duty to serve our customers. We see that duty as a privilege and know that we need each other to get the job done. I have seen true leadership from our executives in every aspect of running the company, and I look forward to building out our 2021 and 2022 plans together with this great team. With that, I will turn the call over to John Kulow.

John? Thanks, John, and good morning, everyone, joining us on the call today. I'll provide a couple of quick comments on the third quarter from a consolidated perspective and then let the business unit leaders cover their segments. The most prevalent cost impacts in the quarter were driven by the disruption in our networks due to congestion and capacity tightness from labor challenges. We saw other direct costs related to the pandemic begin to moderate during the quarter. We continue to offer paid time off for our employees, that have quarantined, as well as invest heavily in caring for our employees through protective equipment and workstation enhancements as we return to office. We incurred approximately $4 million in specific costs in the quarter that were not planned prior to the pandemic, for a total of $29 million year-to-date. We performed well in repositioning and redeploying our people and assets as effectively as possible to avoid furloughs and layoffs, which was the right call given the labor challenges noted. We continue to carefully review our spend, balancing the need to invest for the long term, but being mindful of our current environment and resource needs. Regarding the management of accounts receivable, we are pleased with how our teams worked with our customers to handle payment issues, and we saw customer loss reserves return to pre-pandemic levels during the third quarter. We continue to closely monitor our working capital metrics and the changing credit landscape. As we've communicated throughout the year, our long-term approach to capital management has not changed. However, like the second quarter, and given the uncertainty in the freight markets and the pandemic, we made intentional adjustments to our approach for the sake of protecting liquidity. While still confident in our balance sheet strength and investment-grade status, we maintained higher cash positions through the third quarter as we felt it prudent given uncertainty in market liquidity. Accordingly, we ended the quarter with approximately $320 million in cash, with the resulting net debt just under $1 billion. We still target our leverage ratio at one times EBITDA and anticipate staying within close range of that metric. As of today, we're forecasting our full year 2020 capital expenditures to be approximately $600 to $625, which includes revenue equipment as well as approximately $100 million of technology investment in our core transportation management system. Overall, we're pleased with our balance sheet strength and feel we are in a great position to invest in our long-term asset and technology plans. That's all I had prepared, and I'll now turn it over to Nick Hobbs to expand on dedicated and final miles.

Thank you, John, and good morning, everyone. I want to spend my time this morning discussing the performance of both dedicated and final mile segments. I'll also provide some updates on our pipeline and give some high level expectations for these businesses in the future. I'll start with dedicated or DCS. DCS had another solid quarter highlighted by strong executional performance that delivered a 5% improvement in operating income year over year on roughly a similar tractor fleet. In addition, strong utilization of our assets, the benefits of greater density in our operating region, performance was also driven by lower driver turnover, lower T&E expense versus the prior year, and less customer startup cost. As we stated last quarter, we expected new contract wins to be offset by some attrition at accounts. Given all the unique challenges, the current environment and the pandemic, that has presented us a broad and diverse portfolio of customers. And that would ultimately keep our truck fleet account stable for the remainder of the year. While that is still the case, we are feeling a lot better about the pipeline, which I will address next. As of September 30th, we have sold 890 trucks worth of new dedicated business year to date, which compares to 430 trucks sold as of our last quarter. As a reminder, we had previously expected to sell 600 to 800 trucks worth of new business this year, and I'm proud to have achieved this goal a quarter earlier. We have seen a meaningful uptick in conversations and conversion of opportunities to sign contracts over the last three months. Customer challenges, including lack of available drivers, higher insurance costs, the desire of companies to allocate capital to their core businesses, in addition to some of the flexibilities offered by a professionally outsourced dedicated fleet solution, are all driving greater demand for our services. Our service and ability to adapt to customer needs throughout the pandemic has served as a testament to the value we bring, which we believe is evidenced by this positive update on our pipeline. Looking out, we continue to target 11% to 13% operating margins over the long term, as customer startup costs, higher driver wages, recruiting costs, and travel and entertainment expenses normalize. Now, shifting gears to final mile or FMS. FMS was able to deliver all-time record revenue of $182 million in the quarter, or 22% growth versus the year-ago period and return to slight profitability as we predicted last quarter. We are seeing strength across our portfolio in the furniture, appliance, and pool distribution business with ample opportunities for growth in new market segments like home exercise equipment and home improvement. To put it bluntly, the pipeline of opportunities is as strong as I've ever seen it. As a result, we are continuing to invest in our product and service offering to ensure the highest standards of service, safety, and satisfaction are met in this critical component of the supply chain as we deliver products of our customers' customer. Looking out, we remain optimistic about our long-term opportunities in this rapidly growing channel. That concludes my remarks, so I'll turn it over to Shelly.

Thank you, Nick, and good morning, everyone. Today, my comments will focus on our performance in highway services, which includes both ICS and trucks, how we continue to respond to complex challenges on behalf of our customers, and an update on our investments in the marketplace for JBI 360, as well as 360 Box. First, I'm extremely proud of the progress the team in both ICS and JBT made in the quarter on many strategic and operational fronts, as we and the industry continue to face unique challenges. ICS was able to deliver a record $431 million in revenue in the quarter, a 28% increase year-over-year, and a 42% increase versus the second quarter. More encouraging is ICS's ability to capitalize on this growth despite only a 5.5% increase in operating costs in the segment, highlighting the benefits of scale and leveraging the build-out of our platform. JBT delivered 16% revenue growth versus the prior period despite a 7% decline in average truck count as JBT continues to evolve into more of an asset-light service offering with a continued rollout and investment in 360 box. As a result, third-party capacity providers have tremendous visibility to select power-only loads, hauling our trailers, utilizing our 360 box trailer pools. We continue to see promising data across both ICS and JVT related to our customer activity and engagement and our ability to scale the model to grow to meet the needs of our customers. Next, I'm also extremely encouraged by our team's ability to help customers solve for their capacity challenges by providing solutions tailored for what fits the customer's unique needs. The marketplace for JVM 360 provides a platform to serve whatever a customer wants whether that is a J.B. Hunt asset or a third-party carrier solution, committed or spot capacity, or guaranteed tender acceptance, and at the service levels that beat industry standards, whether the alternative is an asset or non-asset solution. In addition, we provide tremendous visibility with data and market analytics to help our customers make informed decisions that will save them money through greater efficiencies. All of J.B. Hunt's segments have visibility into the platform as well with the ability to leverage opportunities to drive efficiencies with our own assets. As you will hear from Darren, this helps us serve customers and meet our commitments when circumstances might not otherwise allow. It's a comprehensive approach to being able, to the best of our ability, to tell our customers yes when we or others might otherwise say no. We will continue to focus on partnering with customers that see the value of our comprehensive team approach with our goal to build raving fans. In closing, our investments remain focused on our people, technology, and scaling the platform, and we continue to be on track with our long-term plans. As we stated in our last call, scaling the platform is one of the greatest risks and opportunities to achieving our long-term targets, and our recent performance has us even more encouraged. In the third quarter, 360 saw truckload volume growth of 22% and all-time records in the number of carriers, users, and loads on the platform. In JBT, we are and will continue to make investments, albeit on a smaller scale, in building out our 360 box program. We see that business continuing to evolve into a more asset-light blend of trailers, third-party carriers, with some blend of company trucks and being complimentary value-added service offerings to our customers. I'd now like to turn it over to Darren to talk about intermodal.

Thank you, Shelly, and good morning, everyone. Today, I wanted to focus my comments on three key topics, network performance, the current demand and pricing environment, and some general thoughts around how we begin to move forward from here. First, I continue to be encouraged with our team's relentless effort to solve capacity challenges for our customers. Despite what I view as the most difficult environment from a network balance and fluidity perspective I've seen during my career, rail terminal congestion and a slower pace of unloading at customer destinations have contributed to a meaningful slowdown in the velocity of the supply chain and thus the productivity of our equipment. The primary theme across both of these challenges is centered around labor shortages. Our rail providers are working through labor shortages at some key rail terminal operations. While we are confident that they will get back to their productivity targets, this negatively impacted the quarter. Also, our customers have also been challenged with labor at the warehouses and the time it takes to unload our equipment has increased meaningfully year over year. impacting our overall equipment productivity and otherwise available capacity we can provide to the market. At JBI, we have also experienced cost challenges related to availability of labor, given the tight and extremely difficult driver market, which negatively impacted margins in the quarter. We are making progress on the driver front, but the driver shortage remains a challenge for the industry. We certainly expect some improvements in all of these areas moving forward. but we don't yet know if we can achieve even last year's velocity in the fourth quarter. During the quarter, volume demand was extremely strong. The challenges from weaker velocity began to impact us in late July and continued throughout the quarter. Volume growth in July was 6%, August was flat, and September grew 2%. Across the board, our customers have asked us to provide more capacity. Our ability to flow across empty equipment back to the West Coast to support the eastbound demand was limited during the quarter due to the velocity challenges previously mentioned, which we estimate prevented us from completing as many as 20,000 more loads in the quarter. Many of you may want to ask if we were able to yield manage our capacity during the quarter in an effort to chase higher prices. At J.B. Hunt, we communicated two priorities as the pandemic began. Number one, the health and well-being of our employees, and two, to honor commitments we made to our customers. We believe a business that takes care of its people and honors its commitments to customers, particularly in challenging times, is a recipe for long-term sustainable growth. With that in mind, all of our capacity has been consumed with meeting minimum commitments during this difficult capacity-constrained environment. On a positive note, we have worked closely with both ICS, JBT, and DCS to provide additional capacity solutions for our customers while we continue to focus on our work to improve velocity in our network. We believe that working collectively to provide solutions for our customers provides a strong foundation for long-term growth. As we move forward into Q4 and 2021, we don't see anything changing on the demand front. We continue to make small steps of progress on the velocity front. At this stage of the peak season shipping cycle, we expect the velocity challenges experienced in Q3 to continue in Q4 with small improvements in all the areas. The pricing bid cycle for 2021 is just beginning. Certainly, we would expect a lot of discussion with our customers regarding capacity planning and cost management. We are prepared to expand our container fleet for growth. but we will need to balance appropriate targeted returns on our investments to do so, and we will engage with all of our customers with that thought in mind. In closing my prepared comments, I want to say that we're not satisfied with these results in our volume trends, margin performance, or equipment utilization. We are not changing our long-term margin target of 11 to 13, and we continue to believe we have a pathway to improvements in this area. That concludes my remarks, so I'll turn it back to you, Brad.

Thanks, Darren. And just as a reminder to all those on the call, I ask for you to just provide one question and one very quick follow-up so we can get to as many questions as possible. So, Stephanie, I'll turn it over to you to open the line for questions.

Your first question comes from the line of John Chappell with Evercore.

Thank you very much. Darren, just wanted to ask you, the volume trends were good to hear. As we think about the repositioning, the imbalances, even the shortages of labor, did that get any better July to September entering October, especially considering that the volumes were maybe the greatest in July, or was it kind of equally bad throughout the quarter and no kind of meaningful improvement yet as you're through the first month of this quarter?

Well, I would say, frankly, in July, we had a slightly better fluidity in the system. As we got into the back half, really August, throughout the quarter, we have continued to really struggle with the velocity of the equipment. So July had 6% growth, as we highlighted, over the previous July of 2019, and As we went throughout the quarter, though, velocity of the equipment and our ability to relocate empties has remained very challenging. And so far in October, that challenge continues.

Okay. Thanks. And then, Shelly, super quick follow-up for you. Just on the ICS, the growth on the top line has been tremendous, but the margin pressure remains. Any change to the thought of becoming breakeven in that business by the middle of next year? Does that get pushed to the right at all, given some of the investments that you're making?

Well, so as I mentioned in my prepared remarks, we are encouraged with the growth we're experiencing and also the appetite that our customers have to really be interested in doing business differently. John talked about that in his opening comments, that the jump ball scenario we believe could be something different and we are pushing Insight 360 to deliver that on behalf of our customers. Having said that, we have more confidence as we progress through the quarter and into the fourth quarter of that our comments around the second half of next year remain intact and that we should return to profitability by sometime next year, second half.

Great. Thank you, Shelly. Thanks, Darren.

Your next question comes from the line of Chris Weatherby with Citi.

Hey, thanks. Good morning. Um, so maybe thinking specifically about some of the costs, the elevated costs on the intermodal side in the third quarter, it doesn't sound like they all come out of 4Q, but can you give us maybe a little bit of a cadence of how we should think about sort of regaining fluidity and what that means from a cost perspective, you know, understanding that you still think that the longer term margin guidance is intact, how quickly can you kind of recover towards those levels?

Yeah. Um, you know, as, as, as we get into, um, The bid cycle, we're talking about that very challenge with our customers. I think you've heard that theme from our comments so far is we've got to find a way to deal with that a little bit differently than what we've done in the past. So the reality is we need time to implement new prices. Certainly we need the rail system congestion to be relieved somewhat. I don't really expect that to happen in Q4, and as we move into 2021, clearly I would expect some congestion challenges to relieve a little bit in the first quarter. That would be normal, but nothing about 2020 has been normal so far, so we'll have to wait and see. But certainly new pricing, which would also help to cover some of our cost challenges is not likely to be visible until Q2 or even Q3 of next year. And that's when we would get the bulk of the business repriced as we go through the bid cycle.

Okay. That's helpful. And then the quick follow-up is just on the loads. When we think about the fourth quarter, what it sounds like you're saying is fleet's not necessarily getting bigger on a year-over-year perspective. Fluidity's not necessarily getting better. So you're not going to get utilization enhancements. from where you were in 3Q, so roughly kind of that lower single-digit run rate is a reasonable expectation?

Well, I don't know that we're ready to provide any kind of guidance on volume, but like I said, I don't really anticipate velocity changes to be beneficial during Q4, and so it's difficult to think that we would have any kind of material benefit coming in Q4.

Understood. Thank you very much.

Your next question comes from the line of Amit Mothra with Deutsche Bank.

Hey, thanks a lot, Darren. I very much appreciate the comment on pricing just now. I was hoping if you could just remind us of the cadence of how much of the – I assume in the third quarter, none of the book of business and intermodal reflected pricing that is reflective of what's happening in truckload. If you could talk to us, you said 2Q, 3Q, the bulk of the business, but – Is it kind of equally through the fourth quarter you get, you know, 20% of the book repriced? And if you could just help us with that cadence. And then, you know, I appreciate – I'm sure the shippers appreciated kind of J.B. Hunt standing by them with respect to honoring contract amendments. But, you know, that kind of implies that those shippers are by J.B. Hunt workload, which kind of fell through the floor. And if you could just talk about that dynamic, because it seems like there are certain carriers out there that are revisiting – kind of what minimum contract volumes were when the equation was the other way and the pricing leverage was in the hands of shippers. If you can just talk about kind of the exercise you guys did there to make sure that there wasn't necessarily money that was being left on the table from a pricing perspective in the third quarter.

Okay. Well, from an implementation standpoint, I think what you're hearing is we do want to engage with customers in terms You know, trying to rethink how we typically do this, it's, it's the jump ball is difficult and in fast changing times around us, it really gets amplified in terms of how harsh it can be on us. And probably, you know, maybe some customers feel the same way if, uh, if it's moving the other direction. But historically, uh, we would implement new prices on the smallest percentage of our business during Q4. So, you know, call it 10 to 15% of the business gets a new price on it implemented and running through the system during the quarter. Q1 would be more like 25 to 30 and the same for Q2 and Q3. So if you just kind of break it into maybe call it 30% in the first each quarter of the first three of the year and more like 10% in Q4 is just a good rule of thumb. I'm not going to give you the exact percentages, but that's a good kind of benchmark for us. As it relates to volume commitments and our willingness to honor those commitments relative to this demand environment compared to a customer's willingness to honor a commitment maybe when times are changing. I think, um, I think we're, um, we felt confident that we needed to do a minimum expectation because, you know, at the end of the day, while our commitment to the customer, we would, we would like for the customer to have an equal commitment to us, but, but they're the customer. I mean, we're going to have to, we have to earn their business every day. We have to continue to provide capacity. and serve those customers in the way that we set up our plan to do. And we felt like right now, in this very, very difficult time, for us to take capacity away and do something different with it would have been a challenge that was just extremely difficult to overcome. So I know Shelly may want to have a comment or two about customers relevant to that, and I'll let her comment at this point.

Thank you, Darren. So, and that we took a similar approach that we have in our past. If you looked at our 2017 and 2018 cycle, which was very similar, albeit this time has a lot more disruption about it. We did stick with our customers throughout that cycle and then started having conversations so that they could plan for it, do appropriate budgeting. And I think that was prudent on our part and our customer's part. In the end, we were able to grow with our customers at appropriate margins. We've recognized that we have more cyclicality happening right now over the last four years or so. Usually the market swings about every five or six years. In this case, it's swung twice now in this five-year period. We believe sticking to our commitments and walking our customers through it, we are so focused right now on making sure we help our customers grow through this very difficult time. That's why we're unleashing every lever we have internally in every piece of capacity that we have and making sure that we don't just fulfill our commitments, but also help them through this very difficult time.

I was going to jump in and say, we have the same customers and dedicated a lot of them that they have in the other business units. And I clearly feel the impact of them being true to their customers. It pays big dividends on our side. We have a very high retention rate, as you see in our business, and that plays across our entire portfolio. So you take care of them in one segment that across all segments are there with you through thick and thin. We've seen that historically.

That's very helpful. And just one quick follow-up, if I could, just going back to what Darren said in terms of the pricing on the book of business, the puts and takes as you enter the fourth, some of the pricing embedded in the book of business, obviously the fluidity is still an issue. COVID is still an issue, but I assume it gets better. Do margins come down? Sorry, did the OR come down as you move from 3Q to 4Q? Just talk to us about the puts and takes as you move from 3Q to 4Q.

Yeah, I think, you know, that's sort of the question that we all have. We're continuously looking for improvements in our on our cost front, without implementing a significant amount of new pricing or some really significant change in our velocity, it's hard for me to see a pathway towards any real material change. Certainly, we think that over the course of the next year, we should be able to see a trend where we're moving back towards our long-term guidance.

Great. Okay, thank you for the time. Appreciate it. Have a good weekend.

Your next question is from Scott Group with Wolf Research.

Morning, guys. So, Darren, I don't know if you have any thoughts on fourth quarter volumes, but if you do, that'd be great. And then just as I think about third quarter, I look at IANA volumes that were up 10%. I see BN's intermodal train speeds were up. Norfolk's were flat. Is this a A rail issue, or is there a reason why you're lagging the broader industry in intermodal right now?

Well, I understand that BN's train speed is up. There hasn't been a lot of challenges in the line of road. When the trains get out of the terminals, they're moving, but terminal congestion is is not a part of that velocity measure that you see. And that has been a significant impact on our ability to drive volume growth. Now, do I think that the IANA data shows significant growth? Yeah. And some of that is in the LTL and parcel. So that business today moves. In the past, you would see that more in trailers. Today, a lot of that business has converted to 53-foot containers. So the IANA data doesn't really break out LTL and parcel and container moves compared to domestic intermodal. So I feel like the industry was able to grow faster than J.B. Hunt. I'm not going to argue that. Certainly, we would have expected to maintain our same growth rate, but the congestion in our system frankly didn't allow it during the quarter, and that's what we've highlighted. And I would expect to get back to where we're growing at a similar pace to the industry and domestic intermodal. As it relates to all the parcel and LTL growth that the railroads are experiencing, I'm going to leave it to you guys to figure out better ways to see that. Scott, we're turning down. I mentioned in my prepared comments that we think we could have handled 20,000 more loads in the quarter. And that's a, I think that's a soft conservative estimate. We are turning down thousands of loads per week. In some cases, we're turning down Eastern Network growth opportunities because we have to struggle to find the capacity to serve and honor these commitments we've made. And we feel strongly that over the long term, that will absolutely benefit us. It certainly hurt us in the quarter.

Okay, and then if I can just ask one for Shelly. So I think in 2017, you were the, I think the first one that prepared the market for double digit rate increases in 18. How are you thinking about the magnitude of pricing? Should it be similar in intermodal and truckload next year? Or is there a reason why one would be up more than the other?

Yeah, good morning, Scott. So we did host a conference call with our customers It's actually a video call, had about 70 to 80% of our revenue actually on that call. And it was just an open discussion with our business segment presidents along with John Roberts. And really just wanted to give our customers an update and a view of what's happening in the market from a dislocation perspective and a labor challenge issue. We've got a lot of questions around that from our customers, really just looking to lean into how they should think about next year. And we just aren't prepared or ready to have that discussion. We really want to wait through more of peak season and past the election for us to really come to a better consensus on what we believe pricing will do. But having said that, Scott, our cost challenges are real. I think our customers are having cost challenges too. Also, we do want to have a metered approach in making sure we understand our growth with customers along with cost recovery, and I believe that we'll be talking with our customers towards the end of this year. I really couldn't say what range I feel like that is because if I gave one, I think it would be quite off. I do think it will be up. It could be up significantly or could be more modest. We'll just wait to see what happens. And I would expect to talk to them towards the end of the year. Okay. Thank you.

Your next question comes from the line of Justin Long with Stevens.

Thanks and good morning. I wanted to start with a question on dedicated. It was good to hear about the activity in the pipeline. picking up. Nick, when you think about the trucks that have been sold year to date, I think you said 890 units. Can you help us think through the cadence of those new business winds coming on board going forward? And then from a startup cost perspective, what we should be expecting? I'm just curious if margins sequentially should be coming under some pressure because of startup costs or if there's enough operating leverage from growth to offset that.

Yeah, thanks Justin. The timing of those, you'll see some of those start up in Q4. Some of them are already starting up right now and some of them will come towards the end of the year and then there's a pretty good group of them that starts early in Q1. So towards the end of the year, beginning of next year's when those that have been sold right now. So it's typically, when we sign them, it's typically 90 to 120 days till you start seeing those trucks on the ground. So anyway, we feel good about that. Startup cost, we've got a larger base to cover a lot of that cost. And so you'll see some cost. It's hard to predict just because drivers are very tight. And so driver wages and recruiting costs are going to be up as we try to find those drivers. So it's pretty hard to predict, but I think you'll see a slight pressure on us from some of those costs.

Okay. So just to be clear, it sounds like margins and dedicated in the fourth quarter could be down a little bit sequentially versus the third quarter. Is that your expectation?

We haven't provided guidance on margins, but I think like Nick suggested, maybe a little bit of startup costs, but there's still pretty good momentum in dedicated and these guys are executing. We'll see. Winter weather can always play a role in cost, but no specific guidance for dedicated margins other than what we've stated long-term being 11 to 13.

Okay, fair enough. And then maybe shifting to ICS, Shelley, I was wondering how you're thinking about the level of tech spend and operating expenses in general going forward. Is the idea that operating expenses can kind of hold with current levels and you can scale the business to get to profitability in the back half of next year, or how should we be thinking about that operating expense trend in the next 12 to 18 months.

So from an investment perspective, we really talked about investing in three areas, in our people, in our technology, and in scaling the business. And so you saw some benefit actually inside the third quarter that's buried in there from some of the efficiencies that we're seeing from our operations groups. From 360, we've reinvested some of that into our shipper work and That has been part of our plan. As we continue to scale through the rest of next year, we believe that our cost basis will stay relatively the same, maybe up just slightly. But if you were to look through this year, we've done a great job really managing our count of people in a very constrained environment, I might add, but our platform has really produced great results for us. I spoke of that earlier in my prepared comments that the platform has reached records and continuing to reach records inside our segment that's allowing us to scale more quickly in that part and invest in the rest of it. So for next year, I would expect our margin improvement for the second half of next year to come as a result of cost as a percent of revenue in both labor and technology to improve as we progress throughout the year.

Okay, great. That's helpful. I appreciate the time.

Your next question is from Ravi Shankar with Morgan Stanley.

Thanks. Morning, everyone. Shelly, on the July call, you were the first to kind of flag that gross margins were running at, I think, what do you call it, an unacceptable rate. Seems like gross margins were pretty tough for the entire quarter, but can you just talk about how that trended through 3Q and how that's running in October so far?

Yeah, great question. So the third quarter was the exact inverse of what we saw in the second quarter as the brokerage market was really trying to find that balance between supply and demand. So as we looked into July, that was our worst gross margin performance, and we continued to improve as the quarter progressed. And as we've moved here into October, I think our customers have responded well. There is a lot of business that is moving that is unplanned. that really published pricing would not be appropriate. You saw some of that in our percent of business that's actually in the spot market. But I would say margins in September and October are better than they were in both July and August.

Great. Thanks for the color. And maybe as a follow-up on the intramodal side, John, it seems like some of these issues are not going to be resolved overnight. Clearly, investors are focused on the extremely tight truck market and the potential for spillover from truck into intramodal. Do you feel like the upside opportunity could be restricted somewhat because of these operating issues at the end of 2020 and into 21?

I'm going to have Darren answer that.

Yeah. Well, certainly, we're We're working with our customers across the board to where we're talking about what we're capable of doing with our intermodal capacity. And like we've said, honoring those commitments. And then when we run out of capacity, but we've honored the commitments, they still have more demand. And we're talking as an organization about how we can drive value into the organization and to the customer with the capacity we can find. As it relates to the railroads, I just think all of the railroads want to have ongoing dialogue about improving productivity at their terminals. And I think we're engaged in those conversations. Now, it's very difficult to implement significant changes in that area during the course of this really unusual rapid climb in demand that occurred over the course of the summer. As we go into next year, we will be talking about What are the ways that we can expand capacity in the rail system without necessarily investing or just buying new terminals? The long-term value for railroads can't just be that they're going to expand and buy more parking in order to accommodate intermodal growth. We all have to work with our customers, railroads, and us together in order to drive more productivity through those terminals. And I'm 100% convinced the railroads want to do that. And that's not going to be something that we have to push for. They want to do that. It has been painful in 2020. And, yeah, in the remaining part of this year, certainly I don't expect I would be surprised if that really changed in any material way. Great. Thanks, everyone.

Your next question comes from the line of Jason Seidel with Cowden.

Thank you, operator, and good morning, everybody. You mentioned a little bit about changing sort of how you view jump ball bids. I'd love to get some more color on that and how that would change across your different units. Is this something where you're going to look to set up contracts more like Dedicated has?

Yeah, this is John. So we've all been in this business for quite some time, and I have – witnessed a great deal of evolution in many areas of not only what we do, but what the industry does. But one area that really hasn't seemed to change is, frankly, for nearly three decades or longer, how we price and arrange for the services presented in our highway and intermodal business. And we have learned different ways to position that service contractually with some niche kind of approaches that really work. And if you think about the nature of the equipment that we need to procure to service customers, the lifecycle of those equipments and those contracts that we need to arrange with railroad providers and other carriers, it's out of sync with the way we do business with our customers. We've studied, in fact, Aaron and I just had a really good conversation about this last week, that historically there is no real value to the customer in that constant annual event that really takes a lot of time, doesn't really present a lot of value. And if we worked more collaboratively with agreements that were more logically aligned with The services and the equipment we were providing, I think everybody would win. We'd have better understanding for our networks. We'd have appreciation for how to buy the equipment. I think it'd probably do good for our labor and our drivers, our utilization. All the things that go into really what we learn at Dedicated, which is an engineered answer. Now, I don't suggest that we could apply all of the logic that we've learned from our DCS business, but There is a much better way to arrange these contracts to where particularly our larger shippers who need us year in and year out, frankly, could be set up to advantage both us, our providers, and our customers. And I've seen it already happen. And in some cases, we're in the middle of that, and we are all benefiting from it. My encouragement to the organization and to our customers is consider changing the way we do business in this one-way world to a more thoughtful and, frankly, logical approach. And I'm going to be pushing for it.

And that's something I'm assuming will take years to sort of move over customer contracts like that.

Most likely, but you've got to start somewhere.

Yeah, no, I hear you. Go ahead, please, Shelly.

Just wanted to add to that, you know, our customers are really asking us to grow across all of our segments. That's something we're seeing great success in, and we believe that that will be for longer term from a growth perspective. And so when we think about how we plan, we don't just plan with ourselves. We also plan with the railroad providers. And the more information we can give them and the more understanding we can give them about the customer's that are really secured and locked in in a lane level, the better that we can do together to make sure that we have great capacity across the board. So I feel like doing a one-year bid, it's very difficult for us to walk our railroad providers. Certainly what we need from a driver perspective, it's like we're short-term planning in a tactical environment versus really focusing on a better long-term strategic answer.

Now, that makes all the sense in the world. And let me throw really one quick one in. You mentioned growing the trailers and highway services. Is this because you need them with catch-up business, or is there something changing in how the supply chain is working that requires you to own more trailers going forward?

Well, one of the things that we've heard from our customers as we have introduced 360 Marketplace is, For the most part, that has been for our brokerage segment, and that's how the business started. But if you look at the truckload industry, about half of the business actually requires more capital from a trailing perspective. And so if you think about the capacity that is available in the market, 83% of the capacity available is in the small carrier community with 10 or less trucks. So moving into marketplace now, we've actually blended the both the drop trailer environment with a live load environment, creating one network instead of two. And our customers are loving that product. So we've leaned in with our customers early in bid season. It's one of the reasons our growth really started out strong this year. We continue to have customers ask us how many boxes we will move. But as I said in my prepared remarks, we're moving to a more asset light answer. And so we do have a great blend of company trucks, and independent contractors, and even brokering some of that business all sitting inside the platform. So I think the market is large, and the ability to create a better, more efficient network exists significantly, and putting 360 box or our drop trailers in that network just makes sense from a capacity perspective for our customers.

Well, thank you for the call, or I appreciate the time as always.

Your next question comes from Todd Fowler with KeyBank Capital Markets.

Great. Thanks and good morning. I understand, you know, the reluctance maybe to give some near-term guidance on dedicated margins. But, Nick, it sounds like that, you know, in your comments, you said that margins should kind of get back to the 11 to 13% range longer term. But, you know, it's been close to seven quarters where you've been above that range. You know, is there a reason why structurally the margin profile of that business can't be higher, especially in an environment maybe where, you know, travel and entertainment isn't what it was historically? You know, is there just a thought on, you know, why you can't continue to run at this range, even if you do see some of the expenses normalized, you know, longer term?

Yeah, I think the way we look at our deals, we price each one of our deals based on a set targeted return on invested capital. And so if we get some deals that are a little lighter on assets, say a customer has their own trailers, each deal is priced differently. And so I'm just trying to look at the long range. We don't know which mix of heavy assets, light assets are going to come in. So we think long term, that's still the guidance that we're very comfortable with based on deals that we see in the pipeline and so forth, just based on pure ROIC.

Yeah, Todd. Hey, this is Brad. And maybe just to say it a little bit differently is I think regardless of what happens over time, the way that Dedicated will approach pricing deals is always focusing on return on invested capital. And to the extent, as Nick alluded to, Some of the deals are more capital intensive. Yeah, that could push margins higher in order to achieve the same targeted return on invested capital. And so that, you know, to the extent there is changes in margin, you know, that could be a big driver of that change. But I think more importantly, what will not change is how we initially approach those deals, which is a focus on those returns.

Okay. Yeah, that makes sense. And so I think what's maybe difficult for us to see is a little bit of a mix of the deals that are coming through the asset intensity versus the asset light. And that's just something that, you know, it's difficult to kind of tease out of the numbers the way they're reported, it sounds like. Just for my follow-up, Nick, I guess maybe sticking with you, you know, with the growth that you're seeing right now in final mile and kind of the trends that you talked about, you know, can you talk about the platform that you have in place to support, you know, the growth that you're seeing both near term and kind of what you expect longer term? You know, do you think about that business continuing to grow? Is that something that is all organic at this point and requires just more infrastructure? Or is that something that you'd look to do more acquisitions? And how do we think about, you know, the costs that would be associated with facilitating what looks like, you know, some pretty decent growth in that segment?

Yeah, I would just say the existing business that we're running today not a lot of infrastructure cost of facilities or anything like that. A lot of the new deals that we're doing is running out of customers' locations, doing home deliveries. So we don't see any big capital expense going in on infrastructure or anything like that. And so we feel good about continued growth. Acquisitions, we always look, but as those come in, the right deals approach us, we'll look at them. But There's a big runway just on organic growth right now from what we're seeing with five or six of our largest customers. We're just a small percentage of their business, and they're rolling out their networks, and we're kind of riding along on their coattails.

Okay, got it. Thanks for the time this morning.

Your next question comes from BASCA Majors with Susquehanna.

Yeah, thanks for taking my question. I just wanted to follow up on the jump ball comment and a couple of prior questions on that. The evolution, if you guys were able to move to what you think would be optimal for the industry and in a way that your customers would agree to, is it more of a cost plus type longer term commitment that you have in mind that accounts for the capital intensity of that customer? Is it, you know, setting some revenue or volume floors that would also protect you in down markets? I just want to understand more tactically what a new world could look like in intermodal pricing that you think would have a win-win sort of setup for both you and your customers. Thank you.

Yeah, thanks, Bascom. I'll start and then ask Shelley or Barron or anybody else to come in. I think you hit on a lot of ideas that we have explored and have had success with in the past with different customers. One of the things we implemented some time ago and dedicated was kind of an index-based pricing strategy where we have a way to recognize labor costs and other inflationary pressures that are visible and easy to process and recognize and applied to our pricing in a way that doesn't require all the activity we present in a bid, work out, and we spend that time working on the business. We have a program we call Customer Value Delivery where we identify metrics, key performance indicators that keep us on track with service and performance. All those things can be tied together so that the energy is on the service, not the one way, as we call it, jump ball pricing. I think, you know, volume and, you know, different levels of either lane or total commitment can be helpful to, as Shelly said, provide the really needed guidance that we would want to present, i.e., to our rail providers to say, hey, this is what we've got on the book. And if you look at Nick's business, Nick, what's our retention now? Still 90? It's 97. High 90. So we know what's happening in that business year in and year out and can really plan for that. And I think the reason that we have such high retention is because we do a really good job for the customer. Why else would they stay with us? And so that's the idea here is can we apply some of that logic? We have had some experimentation with this. We've seen it work. We do think it's better for the customer. I mean, it's not just better for us. It's actually really better for the customer. And we've, frankly, made a living by prioritizing that need. Let me see if Shelly or Darian want to add anything to that.

Bascom, I would say our customers really want a prediction for their budgeting. And I think our ability to give them that prediction, particularly from an asset perspective, largely comes down to how long we can do business together. Because in our cost basis to that, if you think about bid season, we're able to actually fill in gaps and fill in lanes that are embedded in our price the longer that we have the business together. I do not think that our customers are interested in, nor do I think it's good for us to do cost plus on all of our business. That does not leave a predictable budget to a customer, and I don't think that's a good business model. However, I believe in the bid process that the business that should be in there would be business that is static and regular, and that business can be published and predicted for a customer. That business also could go into a longer-term agreement. But there is a lot of business that moves in a more dynamic nature. And that business is stale and old, trying to go up against a published price that really is not commensurate to the market at every time. And that's what causes so many issues in the market. And as we're talking to our customers about that, whether that's an intermodal or any of our highway services area, as our customers have lanes and loads that are unpredictable and and that we can't get into a repeating pattern, that business really needs to match up directly with capacity in the moment. And we have found that over a longer period, that actually is better for customers. That is a factual number that we've assigned to that internally to say we actually could save our customers more money if we were able to do that for them and improve their service and capacity.

Thank you for the thoughtful answer.

And Stephanie, we'll do one more quick question before we hang it up.

Your final question comes from the line of David Ross with Stiefel.

Yes, thank you, everyone. Nick, I just want to talk a little bit about the FMS segment. And, you know, we've seen nice growth there, slight turn in profitability, but obviously not where you want it. What's the biggest obstacle of getting the margins either in line with dedicated or where you want them? Because I know they're not going to be in line with dedicated because it's more asset-light, but how do you get from here to there?

Yeah, it's a very, very fragmented industry, and so I try to look at it and take the same approach in dedicated. You give a customer fantastic service and great people that's executing that service, then you'll be able to go in and get the appropriate returns that you need on rates as the contracts come up. And so it's just a very methodical approach of executing, being best in class on service, taking care of our customers' customers. And then over time, you will be able to improve the margins to an acceptable rate of return. And we're methodically going down that path right now. trying to execute that. But it is a very fragmented industry, and so you have to be very careful because there's a lot of small barriers to entry right now. It's pretty low, but we think with a lot of our background checks, safety and security and things that we do, we're going to set the bar higher to come into the industry, and then we'll be able to get a higher price on our product and a better return.

And are you seeing much consolidation yet in the industry, or is it still as fragmented as ever.

No, there's some consolidation coming in. There's four or five folks that's starting to do some acquisitions. So, it is seeing some consolidation, but it's still a slow process.

Excellent. Thank you.

All right. Thanks, everybody, for the time. We will... Be in touch with you during the quarter at a couple conferences, or if not, we'll talk to you next quarter. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.