C. H. Robinson Worldwide - Earnings Call - Q2 2013

Transcript

Speaker 0

Good afternoon, ladies and gentlemen. Welcome to the C.

H. Robinson Second Quarter twenty thirteen Conference Call. At this time, all participants are in a listen only mode. Following today's presentation, Tim Gagnon will facilitate a review of previously submitted questions. As a reminder, this conference is being recorded today Tuesday, 08/06/2013.

Now I'd like

Speaker 1

to turn the conference over to Tim Gagnall, the Director of Investor Relations. Please go ahead sir. Thank you, Vince, And thank you and on our call today will be John Wehof, our Chief Executive Officer and Chad Lindblum, our Chief Financial Officer. John and Chad will provide some prepared comments on the highlights of our second quarter and we'll follow that up with a response to pre submitted questions that we've received after our earnings release this afternoon. If time allows I'm sorry, just I was going to comment about opening it up to live questions.

But with the number of questions that we receive, it's likely that it will be difficult for us to get to live questions. We also will be referencing prepared slides as part of the call today. The slides can be accessed in the Investor Relations section of our website, which is located at chrobinson.com. John and Chad will be referring to these slides in their prepared comments. I'd like to remind you that the comments made by John and Chad or others representing C.

H. Robinson may contain forward looking statements, which are subject to risks and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management's expectations. Before I turn it over to John, I'd like to reiterate a couple of changes in the earnings release and slide deck. First, we've separated our truckload and less than truckload services to provide more detail to the area we formerly called truck.

We have also provided a schedule with historical perspective for LTL and truckload revenues as well as for customs, was formally bundled in the other logistics services line. That historical reference can be found in Appendix C in the slide deck, the very last slide in the deck. Also with the impact of our purchase of Phoenix International and the divestiture of T Check in 2012 and similar to our quarter one earnings release. We have provided pro form a financial measures for net revenue and income from operations to provide meaningful insight and an alternative perspective of our results of operations. We believe that these pro form a financial measures reflect an additional way of analyzing aspects of our ongoing operations that when viewed with our actual results provides a more complete understanding of the factors and trends affecting our business.

A reconciliation of actual results to pro form a numbers is provided in Appendix A and B at the end of the slide deck. With that, I'll turn it over to John to begin his prepared comments on slide three with a review of our quarter two twenty thirteen results. Thank you, Tim, and thanks to everyone who's taking time to listen to

Speaker 2

the call today. As Tim suggested on page three, we've got our enterprise results for the 2013. For our total revenues, they increased for the quarter 11.3% to $3,200,000,000 Both the income from operations and the earnings per share decreased a little over 1%. If you look at total revenues for the year to date for the first two quarters, they increased 14.1% to $6,200,000,000 If you look at our gross revenue increase for the first half of the year, we increased roughly $775,000,000 and we're reasonably happy with our top line revenue performance and our market share gains. About half of that revenue growth came from acquired revenue and about half came from organic growth.

Similar to the quarter year to date both income from operations and earnings per share were down rounded 1% down and we're obviously less happy with our ability to increase our earnings off of those revenue and market share gains. Also on the first page, it highlights that we did have a auto liability settlement of $5,000,000 in the second quarter that impacted our EPS by $02 a share. Turning to page four. As Tim mentioned, we have prepared pro form a results given the materiality of the Pfenex acquisition and T Check divestiture from last year. And because of the fact that the Phoenix business is being aggressively into combined Global Forwarding business within C.

H. Robinson, the only meaningful way to really create a pro form a analysis is to adjust the prior year information to include the historical Phoenix information in it and to adjust out T Check from the history. So if you look on page four, what it is showing is our actual twenty thirteen information that includes operating income of $182,000,000 and it shows our actual 2012 information of $184,000,000 of operating income and then adjust that for TTEC and Phoenix as I described. If you look at the far right hand column for the percentage change based on the pro form a information, what we believe you should take away and we believe this schedule is showing is that adjusted in this pro form a fashion for the ongoing operations, our net revenue grew at 3.1%. And as you see in the two columns below that, the expenses grew faster both personnel and SG and A.

We'll talk separately about those. The SG and A line item of $79,000,000 for the current year includes the $5,000,000 charge related to the accident. If you adjust that out of the current year, the percentage increase gets to be between 6%. So the schedule from our analysis is showing that net revenue is up a little over 3% and both personnel and SG and A expenses are up in the 5% to 6% range. So we will make comments about our expense growing faster than our revenues and that's sort of our frame of reference for looking at it.

The top line of that is that from a personnel standpoint, we did increase our hiring. Our headcount growth outside of the pro form a transactions that we discussed were in the range of 8% and it's largely reflective of additional bodies into our North America network primarily for salespeople to grow our business and to go after gains. Our cost per employee did decline, which is why the personnel expenses are up 5.6% on a pro form a basis. And that really is reflective of our business model and the variable expense nature that when we don't grow our earnings, the compensation is automatically reduced. So you see the personnel expense increase being a little bit less than the headcount increase.

So those are the comments on page four for the adjusted earnings. Page five does the same thing for the year to date adjustments around Phoenix and T Check. We don't have any prepared comments on page five because the year to date numbers and comments would be very similar. Turning to page six then moving into the analysis for the quarter around the transportation results. This is the chart that we've been showing for total transportation revenue of $2,800,000,000 and net revenue margin of 15.3% for the quarter.

And then down below you see the ten year history by quarter of the transportation net revenue margins. In the past, we've covered the six or seven items that influence the net revenue margins from the market conditions to fuel to many of the things. One of the things we've talked about is the mix factors. When we look at the results for the 2013, the 15.3% well really this whole year the mix issue is going to be more significant. Second quarter of the Global Forwarding net revenue constitutes 18% of the transportation net revenues versus only 8.5% last year.

So there is a pretty meaningful mix change. As we go through the results by service line, we have the directional comments for each of them around what's a contributing increase or decrease to the net revenue margin percentage. So the mix is a big deal, but it is as we talked in our last call, the increase for the quarter is reflective of some stabilization in the North American truck margins like we talked about. So then moving to page seven into the truckload results for 2013. Our truckload net revenue for the quarter increased 3.2%.

Again, pro form a numbers for the quarter were 3.1% of net revenue growth. So you can see that truckload being the largest category is the principal driver of that. As you see for the enterprise, the volume growth was 9%, 4% of that growth coming from or 4% growth coming from the acquisition of Appreo where there's a much higher volume increase of short haul freight. Our pricing increase was 1% for the quarter and both year to date. And on an enterprise basis, the net revenue margin declining, but as you see in the note below for the North American truckload portion of it, was flat for the second quarter of this year compared to last year.

So what you're seeing is in our European business, which represents about 4% of our net revenue and about 7% of our volume that volume increase contributes pretty meaningful because the North America volume was 5% increase and the Europe adding it up with 4% to a total of 9%. And the margins on that lower length of haul freight in Europe leading to the overall decline with North America being flat. One other comment about the 1% rate increase. Again, you see in the bullet point for the quarter in North America, we had about a 1% price increase to our customers as well as a 1% increase in the cost of hire. And we've talked about this before, but just as a reminder, we do not have any centralized tariffs that 1% rate increase is a combination or a byproduct of thousands of tariffs across the network.

I would say that almost every rate in our system has been rebid or relooked at within the last twelve months. Many of the rates have stayed constant with a common theme of customers trying to hold rates stable. Others have increased. The 1% just becomes the mix or the byproduct of all of the different pricing decisions across of our network. The other comment I would make with regards to trends and there were a lot of questions submitted around this as well.

When we analyze our truckload business for the quarter and net revenue margins being relatively flat, we do continue to see a meaningful trend in towards what we refer to as the balanced market where the supply and demand relationship is pretty static and freight is moving as planned by our customers. We can see that by metrics that we track things like a very high route guide compliance where we're involved and understand that the pre planning and bidding of the freight that the freight is moving very much accordance to that. We also can see a pretty meaningful dissipation of surge freight or transactional freight both within our larger dedicated customers where through business reviews and seasonal mapping of the freight flows we can see that there is less surge freight or peak freight this year than in previous years as well as less transactional business from smaller customers as well. So the trend that we've been talking about for the last couple of years about a balanced market, heavy focus on cost containment and cost control by shippers and elimination of unplanned or transactional freight is a trend that we did continue to see during the quarter.

Turning to slide eight then for the LTL results. Net revenues increased 7.6. See the directional trends of pricing increase and net margin decrease as well. For pricing within LTL, as we've commented in the past, we work off a number of different tariffs that are priced in a variety of ways. So it's difficult to quantify precisely, but there is generally a small trend upwards in pricing for the quarter as well as the year to date and a slight net revenue margin decrease for both the quarter and year to date.

Volumes grew at approximately 8%. And again, when we look across our customer base, what we see is a much more meaningful increase in the larger more contracted or planned freight customers and less growth in the transactional customers for the quarter. Moving to page nine in the deck around our intermodal net revenue results. The intermodal net revenue decreased 1% for the quarter with net margin improving for the second quarter in intermodal and pricing being relatively flat. Similar to the comments in the truck market, we did see classify as transactional customers or transactional freight that moved by rail.

In the intermodal area for our business that can be a combination of rail pricing and decisions that they've made around what types of market share or pricing they want to put out there along with as we've discussed many times our intermodal business tends to be more interchangeable with the truckload environment and with the availability of capacity more of that transactional freight tends to move by truck than rail. As we've talked, we've been converting our intermodal business more towards higher volume larger customers. And the results for the quarter really show the continuation of that with some lapping and some more stable net revenue margin, but less volume growth due to the elimination of transactional freight. Moving to page 10, the Phoenix integration. There are and were a lot of questions about this and it is a very significant event going in on within our company.

So I have like last quarter some more meaningful prepared comments on the Phoenix integration. Slide 10 is doing for our Global Forwarding business of Air Ocean and Customs similar to the pro form a analysis earlier. It is taking the prior year Phoenix net revenue of $46,000,000 for the quarter and adding it into our 2012 results and showing that on a pro form a basis as calculated this way that our net revenue for the quarter in Global Freight Forwarding was up 2%. As far as an update from our Global Forwarding from an integration standpoint, while that represents a fairly modest net revenue increase, we do feel very positive about the integration project and would classify it as being on track to deliver the returns that we're hoping for and feel pretty good about things eight months into it. As kind of a brief recap of the integration plan and where we're at in the first couple of quarters, the shorter term focuses on synergies and putting the businesses together were around defining and deciding the combined management structure and which offices and leadership roles would be combined and those have all been completed.

We do have a common structure for the business and feel good about our leadership team that's in place. We were successful in combining our service contracts or combining our buy volume and routing our freight in a joint way through the spring as the service contracts were negotiated. There are a number of accounts where we have combined account management structures that were put in place. And overall, we feel very good about retaining our customers, retaining our employees and having no meaningful service disruptions in the first eight months of working together as a combined organization. In an acquisition like this, it can cause a lot of internal focus and competitors tend to go after the business more aggressively and we feel very good about retaining the business, growing a little bit of market share and not a great environment and making the early decisions that we need to make to figure out what the combined organization is going to look like.

The meaningful parts of the integration that are still going on and are going to continue to happen for quite some time largely center around the technology conversion and the combination of both operating systems. As I've talked before, our approach to that is kind of a best of both from each of the businesses where we're taking some of the technology capabilities and uniquenesses and the customer relationships and processes that exist in both businesses and combining them into our Navisphere platform from a one common platform standpoint. Most of that gap closure has been identified and created. As the slide says, we've begun the technology transition that will happen office by office and start with the simpler freight and finish next year with more complicated conversions around any customization or anything else that we need to do. And I think one of the real important points that we've talked about a lot internally, we are putting a lot of resources and a lot of effort towards this integration and it is a really important part of redefining Robinson to a global platform.

I personally believe that what most companies would define as integration of an acquisition is largely complete within Robinson and that our definition of integrating our Global Forwarding platform not only includes some of the typical integration challenges around leadership combinations combinations. But in our world, it's almost the equivalent of an ERP implementation as well, because we're really looking at how every transaction flows through the system and remapping them and making sure that we convert all of the processes of both business to the most effective format. And getting on that common platform and really looking at that transaction flow while it's taking a lot of resources and we're spending a lot of effort to do it that's what really sets up the second phase of synergies and approach around efficiencies and productivity and having all the information together to look better at consolidations and cross selling and integrating our services across the network. We think we'll be in a position to start driving that more effectively next year. And again, our long term goal being mid single digit net revenue increases and market share gains and then utilizing cross selling synergies and efficiency gains over the coming years to drive digit growth that I described last time.

So the market environment is difficult. I know several others and there's been a lot of industry data points about difficulties in the environment of global freight forwarding. We do see that it's a fairly weak market out there. But again eight months into it, we feel pretty good about what we've been able to accomplish and consider ourselves on track for the realizing the return. A lot of people have asked and we've talked internally about integration costs and trying to understand and quantify them better.

I think in addition to it being important that you understand we've taken this best of both approach, we've also really handled the integration expenses largely internally. And the best example that I can give you is in addition to several million of hard dollars around travel and different expenses that we've incurred throughout the year. We do spend about $75,000,000 annually on our IT department and this has clearly been and will be the number one priority of our IT department. There are a number of people in that group that are solely dedicated to this. Almost everybody in the department is probably touching one aspect of it or another.

But in our integrated platform, there's a lot of overlap between what our planned enhancements, what our integration efforts, dealing with things like security and different components of our system that there's an ongoing requirement, but there's also something new from the integration. It really becomes difficult to impossible to identify what component of our spending is integration related. We And really just don't want to take the time or effort to have all of our people try to track that or break it down because it's so judgmental. I'm not sure it would be as helpful. But I do know that this is the biggest transformation initiative that we've ever undergone in my twenty years here and it's a really important component to how we're reestablishing ourselves in a global platform.

And we're absorbing

Speaker 0

all of

Speaker 2

the costs associated with it and taking the beating for the spending that is occurring. But I feel very positive about the long term investment that we're making and how this is going to position us for the future both within Global Forwarding as well as the platform that it's creating to integrate our services and really take the business and the portfolio of services to the next level. From a timing standpoint, this project will go into next year. Like I said, the office conversions happen one by one with a lot of training and implementation to make sure that there are no disruptions. During 2014, the cost will start to phase out, but it is a long term project that's going to take the better part of two years to complete from start to finish.

So those are my comments on the integration project or process and where we're at. If you turn to page 11, these represent the actual results for Global Forwarding for the year. As we've reported the ocean air and customs, you see the double digit increases for all of those as the new business rolling in with volume increases across the board. Price decreases in both air and ocean being reflective of the weak environment that I discussed earlier and primarily on the ocean side seeing the net revenue margin improvement for us on the combined business really being a byproduct of the early synergies that I discussed before around our combined Global Forwarding business. Moving to page 12, our other logistics services represent a 14.8% net revenue increase for the quarter to $17,000,000 and $34,200,000 for the year.

It includes primarily our transportation management services as the largest source of revenue. Similar to what we've commented on in other quarters, we continue to feel very good about our backlog of services and opportunities here. We do think that this will continue to provide probably the highest growth opportunity for Robinson. It really represents the way we think about our strategic plan and growth goals that offering transportation services, truckload less than truckload intermodal and international. And then this really represents the logistics management supply chain services beyond that around technology and consulting generally fee based services.

We think this bodes well and is reflective of the long term opportunity for 3PLs like us to continue to do more for customers, while the shipper attitudes of driving efficiencies and the balance of growth and efficiency being heavily skewed towards the efficiency side of things, while that puts margin pressure on the transportation offerings, it's also what creates the opportunity here from a logistics services standpoint. And also as I've mentioned in past sessions, while these services are relevant to our revenues and material, they also are tied to a significant portion of our transportation revenues through the joint accounts that we manage and that integrated service offering that we talk so much about it is an important part of the foundation. Page 13, the last of our service line, the sourcing results. You see a net revenue decrease for the quarter of 3.6%. We don't talk about it a lot in the transportation area, but this is where our produce sourcing and distribution of fruits and vegetables this is the revenue or the net revenue that's recognized on the product portion of that.

For those of you who are familiar with the food patterns in the country, there was a very wet spring and there was a lot of disruption to different crops, particularly things like melons and tomatoes and seasonal vegetables. That impacts the total available crops commodities that we can move and has us serve a lot of the dedicated business with the more limited product and eliminates some of the transactional opportunities. So our volume was up slightly, but weather related margin compression resulted in a net revenue decrease of 3.6% for the quarter. I'll turn it over to Chad at this point for some prepared comments on slide 14 and the other financial information that's in the deck.

Speaker 3

Okay. Thanks, John. Moving to slide 14, I will cover some information on our cash flow, balance sheet and capital structure. The second quarter of twenty thirteen was a strong cash flow quarter. As you can see year to date, the cash flow looks pretty low.

But it's important to remember we talked about in the first quarter that we had an over $100,000,000 income tax payment, which was a result of the divestiture of T Check last year. Our capital expenditures are within the plan that we outlined earlier this year. We expect our total to be about $55,000,000 including the construction of another office building on our Eden Prairie campus, which we will move our IT department into. They are currently at a leased facility that we will be terminating at the end of this year or early twenty fourteen. You can also see that we have continued our share repurchase activity during the quarter.

We repurchased 872,225 shares at an average price of $57.26 When you look at our share repurchases and our dividends combined year to date, we have returned about $259,000,000 to shareholders. We expect to continue returning this capital to our shareholders with a target of 90% to 100% as we discussed last on last quarter's call. Thanks to our business model and the strong operating cash flows, we are able to return these levels of capital to our shareholders while maintaining the liquidity required to grow our business over time. We finished the quarter with $150,000,000 in cash and $365,000,000 outstanding on our revolving credit facility. With that, I will turn it back to John for some closing comments.

Speaker 2

Okay. I've got one more page of prepared comments and then we'll address some of the questions that were submitted. So on page 15, a look ahead. I'll try to do the best I can to share what we're seeing and what we know from a look forward around the prominent themes. The first one is the divestiture of T Check and the acquisition of Phoenix.

I know the last two quarters, there's been a lot of discussion about that and adjustments for Given the materiality of those we know that we're in for two more quarters of significant changes driven by the repositioning of the business through those transactions. So there will continue to be acquired revenues, purchase accounting, meaningful integration costs and dilution from the T Check earnings being sold throughout the remainder of 2013. We had the unusual costs and the transactions associated with that in the fourth quarter. So the one thing we know is that as we've planned for the fourth third and fourth quarter, we'll continue to see effects in our results from that. As far as the North American truckload conditions go through July and currently we are not seeing any meaningful change or significant adjustments to the market conditions.

The North American truckload market for us continues to be similar. Really if you look at our first and second quarter results, they're fairly similar and we haven't seen any meaningful drivers to significant movements in the market at this point. Really if you look at the factors that have been driving it, I talked about the customer approach and the significant cost reductions. While there's some discussion of maybe that's starting to run its course, it's not going to go away instantly and there's plenty of momentum to continue that through the remainder of the year. On the supply side with a slower growth environment, limited new capacity, cost pressures on carriers from new regulations and new equipment and driver pressures.

None of those things are going to move real quickly and we do see continuity in the market. We don't know if there will be a fall peak season or things will be different. But as far as what we can see now, the North American truckload conditions remain fairly balanced and competitive. The last two bullet points, I would say the most common question is, there were changes in the market over the last three years and basically us asking ourselves and other people outside. So what are you going to do about it?

How are you adapting the business that the idea of taking market share has always been a core part of our value creation and some of the questions will get back to this as well too. But I guess we feel good about our formula for how we think about taking market share and pursuing profitable market share or a balanced approach. Our business model and our disciplines are that there's really three variables that drive the third party transportation. It's you got to go get volume, you got to maintain your margins and you got to be productive about the labor resources and the cost that it takes to go do that. And we've got a very time tested and refined system around how we manage our incentives and all of us are motivated to make sure that we're making a good balance of investment around that.

So we will continue to aggressively go after market share. We've got very disciplines around making sure that the freight that we bring in is profitable and sustainable and continuing to look at as the market flattens or gets more competitive that we're making certain that we're accepting the productivity challenges and the cost reductions that it takes in order to continue to take meaningful market share and grow and expand our business. So as I said earlier in the call, I feel good about our continued growth and market share gains in a slower flatter environment. But we do have to continue to drive better cost control and make sure that we manufacture that we get to the return on investment and positive conclusions of a lot of the investments that we're making. The last bullet point around continuing to invest in the long term success of the business.

If you think about a lot of questions that we ask ourselves or ask what can you do in the short term to look at earnings changes and what can you do in the long term. The things that make a difference and the things that we spend our money on are those competitive advantages that we talk about in our slides and our road show and our annual report. There's really two groups of them around people process and technology. So we are investing in people. We're putting salespeople into the network and training them and making sure that we're being as aggressive as ever in the marketplace to go out and sell.

We're training our people as much as we've ever had. And we could cut back on that and we are managing headcounts aggressively, but it's a variable business model. There's pressure on all of us to make sure that there's a return on the people that we add in, but we do need to stay aggressive in terms of looking at the market share gains and adding the people that it takes to go out and get them. From a process and productivity standpoint, we have short term and long term initiatives to look at all of our productivity gains and how we consolidate freight, the automation of the interfaces. We're doing more EDI than ever every day.

We have more mobile apps and more connectivity to try to take parts of the process out. We're standardizing our processes and doing things that we hope will have both a short term and long term impact from a process and productivity standpoint. We're automating a lot of those things. We're spending significant amounts of money on technology not just to integrate Phoenix, but also to drive the capabilities of our management services and invest in the productivity automation of a lot of our services as well. So we look at all three of those things.

We are managing costs and thinking about them, but we're also very sensitive to the longer term impacts of what those investments can do for us. The other key area of competitive advantages that we manage and invest in is our network of offices, our portfolio of services and our relationships. So the network services and account management relationships, we did open a couple of offices in Eastern Europe and we continue to think about the strength and scope of our network and building out that global platform. As I mentioned in the integration process, we're investing in the combination and optimization of a lot of our offices, strengthening, expanding our portfolio of services, investing in Phoenix and strengthening global forwarding as well as the management services. We think that's a long term competitive advantage that will give us some more short term lift in terms of the types of opportunities that we have to cross sell and look for new market share.

And last on the relationship side, the account management relationships and really trying to take market share from existing relationships as well as making sure that we're pushing our value added capabilities and expanding and cross selling with current customers as well too. So those that's what we're focused on. It's a combination of productivity and cost takeout and cost management along with the longer term investments that we think will make a difference. When you put those all together, as I said earlier, we understand that the return on investment proof of these investments is greater EPS growth and we're committed to delivering that in the future. While we're confident about executing our strategic initiatives and continuing to take market share, when you add up the things that I just talked about, we do think it's going to be very difficult to grow our earnings in the 2013.

As we look into 2014 and beyond, there are some obvious changes around the comparisons cycling off from the transactions, some of the integration costs starting to wind down, hopefully more aggressive realization of some of the synergies and the realization or capturing of some of the integrated services initiatives that we'll get after. And we're prepared to continue to operate in a slower growth more balanced market like this and have the initiatives in place to try to drive longer term EPS growth in this environment, but also making sure that we protect and preserve the platform so that when the market changes and that growth starts to win out a little bit more in the marketplace that we're also positioned to take advantage of that as well and have some higher growth periods like we have in the past as well. So that's a lot of prepared comments, but it will have been some of the questions that were answered. And at

Speaker 1

this point, I'll turn it over to Tim to facilitate some more of the pre submitted questions that we can give a little bit more clarity to. Thanks, John. And just before I get into the results related questions, actually we got a couple of questions also throughout the quarter on why the change in format. So I thought I would address that real quickly here and then get into the results related questions. As John had just mentioned, over the last few quarters, has taken us a bit more time to explain results and go through the slides based on some of the activity, especially in the fourth quarter.

And that's made it difficult to get to many of your questions. We've the results after the calls has been a lot of people waiting in the queue and really not having the ability to get to all of the questions that people have wanted to ask. And as we reflected on that, we talked about the best way to try to get more content and more subjects onto the call. So this is an attempt to do that and we'll evaluate the results here. As John had mentioned, he did his best to weave into some of his prepared comments and Chad's prepared comments some of the questions that we've received and now we'll build on those here.

But it really is an attempt to try to cover as much ground and be as productive as we can on this call and informative as we can be on this call. So I hope that clears up a little bit of the intent of doing this. And again, we will continue to evaluate how we get the most productive forum out of this sixty minutes that we spend together here. I'd like to thank all of you that have submitted questions. We did get a lot of questions in and we rallied to try to gather them into some themes here and we've got several that we'd like respond to at this time.

So what I'm going do here is I'll serve the facilitation role and John Chad and I will respond to some of the questions that come have come in. So the first question and actually several questions around productivity. And in some instances, I'll thematically roll these up. But in this particular one, one of the questions sized it up pretty well. So I'll refer to it specifically here.

And the reference was to in the first quarter call, we had talked about productivity challenges and that we had initiatives underway to address the issues and when we would start to see the results of our initiatives around productivity. And John is going to respond to that question now. And I think

Speaker 2

I set that one up a little bit around talking about the three variables that we look in our growth model, which is the volume or market share gains, the margin management or preservation and then the labor part of it or the productivity side of it. I've described in previous calls how in a balanced competitive market like this a very common tactic is rate pressure from the shippers and we continue to see that have for a number of years. And when we make that balanced approach decision towards taking market share that's profitable and how do we want to look at things, Oftentimes our network and our team is forced with making a choice around do you take flat pricing from a customer when you know that your cost of hire might be up 1% or two And the management decision that we've been making and we've been coaching our account managers to do is that for the long term and in this type of market conditions that most often we need to accept that productivity challenge and make sure that we're improving our processes and streamlining things and eliminating our costs just like all of our customers are being pressured to do in order to try to preserve the long term profitability ratios of our operating income and our growth for So while at some point we walk away from freight every day and we have to be smart about the balance between pricing and margins and the labor resources and the cost that we have to commit to doing it that we are very much like our customers in the mode of accepting the productivity challenge and working into that equation that we're going to automate things and we're going to look at process improvement.

The challenge with it as everybody knows is those things come in small chunks and they come continuous. It's really part of a continuous improvement theme where every quarter we do implement new releases in the system that automate some of our processes and we have longer term plans and road maps to look at consolidation and process efficiencies. So the results show up in a longer term more gradual way, but it's in a very important part of how we're running the company.

Speaker 1

Okay. Thanks, John. And I'm going to kind of move quickly through these topics here to try to be productive with the time here. So the second theme if you will and there were several questions around this really related to competition and pricing. And largely these topics are covered in some of the prepared comments.

But I'm going to take just a minute to give you a sense of how we think about competition and pricing. I don't believe this will be all that different than the way we've talked about it in the past, but just try to build on it a little bit in the premise of the balanced marketplace and some of what has impacted our results. And speaking specifically to competition, clearly, it's a very competitive environment. We've talked a lot about that. I think all of us in industry are feeling this and exaggerated by the balanced marketplace and the fact that we're all competing for a pretty stagnant pool of demand.

And it's really hard to quantify the impact of competition. We've always felt a very competitive landscape with over 10,000 licensed freight brokerage companies and tens of thousands of asset based carriers. It's really difficult to get your arms around the influence of competition. It's always been present. The way we measure it and there are a couple of things we measure and speak specifically to the truckload marketplace that's where most of the questions were centered is in a couple of ways.

The first is our volume growth. And it's one of the reasons we highlight volume growth in our prepared comments too and there's a number of different resources that quantify volume growth on a month in and month out basis. So we pay close attention to our ability to grow our volume and our goal is to grow our volume and take share in excess of what we see happening in the industry. So that's one way that we evaluated and we've been pleased with our ability over time to grow our volumes ahead of the industry. The second measure that we look closely at is the third party industry as a whole.

And there's a lot of different ways to look at this. But again, it's something that we watch closely. And by all measures that we track, we've also been able to grow our share in the third party space. I think third party space in total has been able to grow its share of total and we've been able to do that as well. I won't provide specific numbers around this, but kind of slow and steady growth is what we've seen and those are a couple of ways we look at an aggregated level how we're doing in the marketplace.

With all this being said, it's certainly not an attempt to dismiss the impact of competition, the viability of competition. There are larger competitors today than there have been in the past. They're focused on growing their scale and their share. And we pay close attention to the outcomes of our wins and losses and the opportunities as we compete every day. John spoke of our investments in delivering value in the marketplace, but we don't always win and we know that there are times when our competition is growing their business as well.

So we take it seriously. We watch it closely And it's really hard to track quantifiably. But what we are focused on are those macro measures that we can track and really trying to make sure that the investments that we're making in our business, the initiatives in our business are focused on delivering value. And by the measures that we can monitor and do monitor, we are still succeeding. And we have challenges in some of the earnings growth that we've talked a lot about on the call today.

And our expectation is to get to a higher rate of growth going forward and we need some cooperation in the marketplace to do that. And there's a number of factors influencing that including our competition. And a quick correlation there too is weaved into the question around competition was also pricing. And we've talked a lot about this that there's really several factors that play in play the focus of our customers on optimizing their supply chains and their transportation spend and the competition in the marketplace and those are obviously very key in the balanced environment. Pricing has been very competitive.

You see that in the results of our revenue margin decline and it likely will continue. John made some comments around the second half of the year and it's been the case for several quarters now and we expect there to be a pretty consistent near term competitive marketplace and really price focused environment going forward. So I hope that those general comments respond to that question. I'm going to move now on to one of the third questions or themes that we had and it really relates to capital structure and capital allocation. I'm going to turn it over to Chad to comment on that

Speaker 3

topic. Okay. Obviously, this has been a topic of discussion and I covered a little bit in my prepared remarks as well. But I think all of you who have been following us for a while know we have a very long track record of returning capital to shareholders. So when you look at our capital allocation of the cash flow the business generates, first and foremost, we invest in the working capital it takes to grow the business.

We're constantly looking for the right acquisitions. We have a long standing 45% dividend payout ratio target and we view share repurchases to distribute excess cash beyond that. We view our dividend policy as more of a fixed policy and the share repurchases as a more variable way to return some capital to shareholders. As we discussed in last quarter's call and earlier today, our current intention is to return 90% to 100% of our net income to shareholders through a combination of share repurchase and dividends on an ongoing basis. We believe this payout total payout target is possible in most operating environments, but may be adjusted for things like acquisitions or other capital requirements including working capital growth, which we sometimes experience when we have significant gross revenue growth.

When you look historically about the amount of capital we've returned to our shareholders, For the years 2008 to 2012, we've averaged 102% of net income being returned to shareholders. As we look at the strategy, we believe it has served us well. It has allowed us to continue to grow the business both organically and through acquisition and allowed us to be flexible in the marketplace. We have adapted our capital structure to include debt while continuing to return these high levels of capital to our shareholders. We're constantly looking at our M and A pipeline, monitoring our stock in the debt markets and assessing our capital structure in relation to those.

We will take future actions as we see appropriate.

Speaker 1

Okay. Thanks Chad. And I'm going to move now into a topic around kind of a capacity question and specifically a question around shippers' appetite for capacity risk and how shippers their attitude towards the spot market and some comparisons to the way things were in previous quarters versus what we're seeing today in the contract versus spot market. John is going to respond to this question. Yeah.

Speaker 2

I would say probably one of the most prevalent themes in our customer interactions over the last couple of years is the combination of wanting to drive out any sort of expedited surge seasonal premiums or costs as part of their cost reduction strategies and really trying to make sure that they secure and lock down capacity for a variety of reasons probably some fear of limited capacity or this balanced market. But a lot of contributing things that as I commented earlier have really led to a reduction in spot market or transactional activity over the last couple of years. That is clearly a byproduct of the shipper attitudes and less appetite for their approach towards that. It's a good question as to whether or not that will sustain itself in the marketplace or not. That spot market or surge activity as I commented earlier is often driven by growth and lack of prediction around unanticipated needs.

And right now there doesn't seem to be anywhere near that level of it as we would see normally prior to the recession three or four years ago. So I do think that's one of the most meaningful secular shifts just driven by how customers are managing their supply chain and what their procurement attitude is towards transportation.

Speaker 1

Okay. Thanks, John. Our next topic is expenses and several questions around operating expenses and specifically why personnel expenses and SG and A expenses outside of the unusual item in this quarter why they grew faster than net revenue? And Chad is going to respond to that question.

Speaker 3

Okay. John covered the personnel I think pretty well in his opening remarks. We've continued to invest into the future of the business. The branches have continued to add people to help them with future growth, although part of that increase in the heads was offset by some reductions in some of the incentive programs. When you look at other SG and A expenses, there's for the quarter over last year's quarter, there's two real drivers of it.

One we've talked about already, which is the lawsuit. And if you look at our provision for doubtful accounts was the other significant variance compared to last year. In the 2012, we recovered some receivables that had previously been written off and actually had a negative expense or credit in our provision for accounts of about $1,000,000 This year we had what is more normal maybe slightly on the high end of our provision for doubtful accounts of $3,000,000 So when you look at just the swing in the provision for doubtful accounts that's about $4,000,000 and you take the $5,000,000 and the $4,000,000 and it's pretty much the whole increase of year over year growth in the quarterly operating expenses. There are some other increases and decreases mixed in there. The other probably area of biggest increase, but to a less magnitude is travel.

Some of that travel has to do with the Phoenix integration and some of it has to do with the Global Manager Meeting that was held in April to introduce the Phoenix managers to everybody else and to cover some key initiatives with our leadership team.

Speaker 1

Okay. Thanks Chad. We're kind of winding down here with a few minutes left. We're going to try to get a couple more in here. I'm going to quickly respond to questions around hours of service.

This is obviously more of a Q3 topic with the fact that the regulation went into effect on July 1. And we really don't really have all that much different to say than a lot that's been said in the industry. We are we did a lot of work in planning around this topic with our customers, especially as it related to long haul freight that was most affected by the new rules. And a bit too early to tell in terms of the impact, but and we have talked about in the past in some in the various forums that we've been in. We don't expect it to help at all in terms of the results.

It's another challenge for carriers in terms of their productivity and availability in already a difficult climate for them. So we expect that after the third quarter we'll be better able to quantify this as more time plays out in our truckload business and looking at some of the measures that we look at pretty typically. But in general, difficult for us to comment specifically at this time. We don't believe it will be a helpful factor in the challenges that we face today. But that being said, really too hard to tell right now or quantify specifically the impact.

So I'm going to move on to kind of a couple of questions that I'm going to combine into one and ask John to close our responses here with this topic. And I'll do my best to paraphrase it here. And they really talk about our growth and whether our growth our earnings growth trails or meets our expectation. And then also to comment about with the slower growth in The U. S.

Economy maybe more in the lower single digit area and I'll read here verbatim a little bit can our business model achieve double digit growth in earnings sustainably. So I'll turn it over John to talk a little bit about our earnings results here and our view of growth going forward with the current economic environment. So when we look at our

Speaker 2

earnings growth and our performance and try to address this topic as best I can. In the for the first question, we are disappointed this year in the earnings growth. Some of the things we anticipated the headwinds of tCheck and some of the integration spending, I would say that integration spending has been as meaningful as we expected maybe a little bit more. Margins are difficult to predict, but we really haven't seen any relief there. And we've had some unusual expenses in the first two quarters that we've highlighted and talked through that Chad just discussed and others.

So did we expect at the beginning of the year that 2013 would be a great year or the high end of our performance? No. Has it been a little disappointing to what we thought at the beginning of the year largely around expenses? Yes, it has been. When you step back and look at it longer term around our growth rates and our long term expectations, the way the primary way that we think about it, you look at that sort of ground level of GDP growth or inflation or some sort of economic growth in the 3% to 4% range historically maybe being less than that the last couple of years or going forward that would be the foundation of growth in pricing and margins that we would go after.

Longer term, we still believe that our volume and our net revenue is what will drive similar to our earnings growth that those over time while they're going to fluctuate should stay together. If you look at a foundation of GDP growth, we as Tim highlighted earlier, we feel pretty good about our ability to take market share and our ability to continue to do that in the future. In a slower growth environment with more competition as we've talked in previous calls, it's more difficult to take market share, but we feel like we can continue to do that. So in a slower growth environment of a couple of percent continuing to take market share at a single digit rate gets us up into the mid to high single digits. Over the last two or three decades, we've had periods of time where we've been able to have sustained margin expansion.

We've just gone through a period of time where we've had sustained margin contraction. We believe over time that will fluctuate but level itself off. Additional growth areas for us in the past have been productivity gains and leveraging our cost structure. We're going to continue to strive for those as I talked earlier to try to increase our earnings. We've also been able to acquire businesses or acquire shares to increase our earnings growth as well too.

So when we put that all together, there is a lot of opportunity left. There's a lot of momentum to the third party industry and how third parties are looked at and what growth there is in the supply chain. Our margins are going to fluctuate, our costs are going to fluctuate, our investments are going

Speaker 1

to fluctuate. But when we look at the industry landscape and our opportunity and how we can execute over a longer period of time, we do think that a double digit target is still reasonable for us even in a slower growth environment. Okay. Thanks, John. And think that will close out the hour here and we did our best to cover as many of the questions that were submitted as possible.

I know there were a lot that we were unable to get to. And if you would like to schedule some time with us as is always the case feel free to reach out My e mail is on the website and we'll try to coordinate some time to follow-up on some of your questions. I'd also like to remind you that there's a replay of the call available on our website and that replay will be available shortly. It can it's available by dialing (800) 406-7325 and entering the passcode four million six hundred thirty thousand four hundred forty.

And that will be available I guess about seven Eastern. So just in a well actually I should probably change that within the next sixty minutes or so it should be available to you through the website. If you have additional questions as mentioned feel free to reach out to me via e mail or by phone at (952) 683-5007. Thank you.