Hub Group - Q4 2016
February 2, 2017
Transcript
Operator (participant)
Hello, and welcome to the Hub Group Fourth Quarter 2016 Earnings Conference Call. Dave Yeager, Hub's CEO, Don Maltby, our President and Chief Operating Officer, and Terri Pizzuto, our CFO, are joining me on the call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. In order for everyone to have an opportunity to participate, please limit your inquiries to one primary and one follow-up question. Any forward-looking statements made during the course of the call represent our best good judgment as to what might happen in the future. Statements that are forward-looking can be identified by the use of the words, such as believe, expect, anticipate, and project. Actual results could differ materially from those projected in these forward-looking statements. As a reminder, this conference is being recorded.
It is now my pleasure to turn the call over to your host, Dave Yeager. You may now begin.
Dave Yeager (CEO)
Great. Thank you, Adrian. Good afternoon, and thank you for participating in Hub Group's fourth quarter earnings call. With me today are Don Maltby, our President and Chief Operating Officer, and Terri Pizzuto, our Chief Financial Officer. I'm pleased to say that Hub had a strong fourth quarter. Although we had not seen much of a peak at the time we reported our third quarter earnings, peak did begin in full force a few weeks later and lasted through the end of the year. We continue to successfully execute our strategy to increase market share by focusing on targeted customers across all business lines, providing excellent service to our clients as we continue to invest in our people, thereby providing a differentiated service. Today, I'll talk about the intermodal business, and then Don will discuss the other business lines, followed by Terri, who will cover the financial results.
Although volume in the domestic intermodal market was up only 1% in the fourth quarter, Hub consolidated volume was up 5%. For the year, Hub's volume was up over 2% after a lackluster start to 2016. Hub's on-time performance was 200 basis points higher than Q4 of last year. This is one of the reasons that we're able to grow at a pace greater than the market. Our customers are recognizing the value of Hub's service and taking that into account when making carrier selections. We believe that volume should grow between 3% and 7% in 2017. As previously discussed, our goal is to increase market share with strategic accounts in corridors that complement Hub's network. We're currently in the initial stages of bid season. We're taking a very disciplined approach to our pricing, with the goal to increase prices between 1% and 3%.
This would allow us to cover our projected rail cost increases, as well as potential additional costs on the origin and destination drayage. Our fleet size is now 32,000 containers. We placed an order for 4,000 containers, which we expect to be delivered in the spring. We'll be retiring 800 containers for a net add of 3,200 this year. Our fleet turns declined to 15.6 days, compared to 15.4 days last year, despite rail on-time performance improving by 5%. We continue to execute our strategy of a balanced approach to our drayage selection. We're focused on offering the best cost service package for our clients and remain neutral as to whether to use Hub-owned drayage versus outsource. As a result, the amount of drayage that Hub performed on our business was down to 54%, compared to 61% last year.
Lastly, we continue to search for acquisitions that would either complement existing service lines or diversify our service offerings. While we've not closed an acquisition to date, we're making progress and are investigating several opportunities. With that, I'll turn it over to Don.
Don Maltby (President and COO)
Thank you, Dave, and good evening, everyone. For all lines of business, the fourth quarter started slow and then came on strong as the quarter progressed. With 70% of our overall business in the retail and consumer verticals, we found momentum and volume across our customer base. The emergence of e-commerce has shortened the supply chain, thus impacting how peak is measured and managed. As I mentioned on previous calls, our strategy has been to target specific verticals and accounts, in addition to providing our overall customer base with multimodal solutions. That strategy is yielding results with the growth of our intermodal product and also with the growth of our truck brokerage and logistics business. Our efforts will continue to further develop our services to support our customers, while also strengthening our operations to service all of our lines of business. Our truck brokerage.
Our truck brokerage business grew volume 33% in the quarter in a very price-sensitive market. For the year, truck brokerage revenue increased 10% to $391 million. In Q4, we experienced a strong surge in demand from our retail and e-commerce customers, along with growth from our targeted multimodal accounts. To support our growth initiatives, we continue to enhance our relationships with our carrier partners to effectively service the dynamic volume swings and overall demand. Our strategy remains focused on our target accounts for multimodal growth opportunities and overall value-added services. We remain confident in our ability to grow market share, and we believe the truck brokerage marketplace will stay highly competitive in 2017. Logistics. Our logistics business demonstrated strong top-line growth of 17% in the quarter, while also improving margin.
This growth was driven by new customer onboardings, as well as a strong growth from existing customers. For the year, logistics sales were $558 million, or top-line growth of 5%, as we overcame the headwinds felt earlier in 2016. New accounts secured throughout the year produced the strongest new business onboardings in logistics history. These new onboardings will continue to ramp up in the first and second quarter of 2017. We were also successful securing several multiyear contract renewals. The pipeline remains strong, and we remain confident in our ability to continue to grow this business line. Mode. Mode managed through a strong competitive environment and challenging year-over-year comparisons to finish the quarter with 6% revenue growth.
Each line of business continues to grow by executing on the strategy to introduce and cross-sell all of our service offerings to our customers. We again made progress in growing our IBO and sales network by adding 3 new IBOs, along with 23 new salespeople. Our pipeline remains strong for new recruits going into 2017. With that, I will now turn it over to Terri.
Terri Pizzuto (CFO)
Thanks, Don, and hello, everyone. I'd like to highlight three points. First, the truck brokerage growth that we saw at the beginning of the quarter continued, resulting in an impressive 40% increase in gross margin. Second, our Intermodal business exceeded expectations because of strength in retail sales and operational efficiency. Third, the Hub segment revenue growth of 13% resulted from our diversified services and customer-centric approach. Here are the key numbers for the fourth quarter. Hub Group's revenue increased 10% to $979 million. Hub Group's diluted earnings per share was $0.55 compared to $0.63 last year. Now I'll discuss details for the quarter, starting with the financial performance of the Hub segment. The Hub segment generated revenue of $754 million, which is a 13% increase compared to last year.
Taking a closer look at our business lines, Intermodal revenue was up 5% due to a 5% increase in loads. Declines in freight rates were offset by positive mix. The volume growth was driven by a 12% increase in loads with retail customers, including e-commerce customers, and a 27% increase in loads with automotive customers, partially offset by a 5% decrease in loads with durable goods customers. Truck brokerage revenue was up 46%. Truck brokerage handled 33% more loads, and fuel price and mix combined were up 13%. Logistics revenue increased 17%, due primarily to growth with new customers onboarded in 2016. Hub's gross margin increased by $4.5 million or 5%. Truck brokerage and logistics margin growth was partially offset by a decline in Intermodal margin.
Gross margin as a percentage of sales was 11.8% or 80 basis points lower than last year. Truck brokerage gross margin increased because of an increase in new business and seasonal business. Truck brokerage gross margin as a percentage of sales decreased 70 basis points due to pressure from spot rates declining and lower customer contract rates. Logistics gross margin was up due to growth with new and existing customers. Logistics gross margin as a percentage of sales increased 10 basis points due to improved customer mix and operational efficiency. Intermodal gross margin decreased because of lower prices than last year and rail cost increases. Volume growth, lower dray cost, and improved mix and lane balance partially offset the decline. These same factors drove a 140 basis point decline in Intermodal gross margin as a percentage of sales.
Sequentially, compared to the third quarter, the Hub segment gross margin as a percentage of sales increased 80 basis points. Intermodal gross margin increased 100 basis points, and truck brokerage increased 80 basis points, while Logistics decreased 60 basis points. Hub's costs and expenses increased $8.6 million to $64.5 million in the fourth quarter of 2016, compared to $55.9 million in the fourth quarter of 2015. The increase relates to a $6.4 million increase in salaries and benefits, and a $1.9 million increase in general and administrative expense. Salaries and benefits are up due to higher headcount, annual employee raises, and an increase in bonus expense.
General and administrative costs are higher because of an increase in IT costs, including costs for our Transportation Management System and human resource system, as well as an increase in professional fees. Finally, operating margin for the Hub segment was 3.2%, which was 100 basis points lower than last year. Now I'll discuss results for our Mode segment. Mode's revenue was $256 million, which was up 6% from last year. Revenue breaks down as $131 million in intermodal, which was flat, $80 million in truck brokerage, which was up 4%, and $45 million in logistics, which was up 33%. Mode's gross margin decreased $800,000 year-over-year, due primarily to a decrease in intermodal gross margin, resulting from a 2% decline in loads and cost increases.
Gross margin as a percentage of sales was 12.3% compared to 13.4% last year, due mostly to a 100 basis point decline in intermodal yields and a 340 basis point decline in logistics yields. Mode's costs and expenses went down $400,000 compared to last year, primarily because of a decline in agent commission. Operating margin for Mode was 2.5%, compared to 2.9% last year. Turning now to headcount for Hub Group. We had 1,784 employees, excluding drivers, at the end of December. That's up 38 people compared to the end of September. Now I'll discuss what we expect for 2017.
We believe that our 2017 diluted earnings per share will range from $2.35 to $2.50. We estimate high single digit to low double digit top line growth for all three business lines. We expect gross margin as a percentage of sales for the year to range from 12.2% to 12.8%. We believe that our quarterly costs and expenses will range from $86 million to $89 million. There are three key assumptions that'll impact our earnings in this year. Number one, intermodal price increases. As Dave said, our goal is to increase prices between 1% and 3% during the bid season.
Number two, higher operating costs and capital expenditures, due partially to the investments we are making in technology, including our transportation management system, where we will operate our logistics, intermodal, and truck brokerage business. We believe these investments will give us a strategic advantage and support our customer needs. Number three, higher interest expense, because we intend to fund a portion of our equipment purchases with debt. Turning now to the balance sheet and how we used our cash. We ended the quarter with $127 million in cash and $174 million in debt, including capitalized leases. We spent $47 million on capital expenditures this quarter for containers, land, tractors, and IT projects. That brings total year-to-date capital expenditures to $107 million.
Capital expenditures are expected to range from $155 million to $165 million in 2017. We ordered 4,000 containers. We expect to purchase between 100 and 150 tractors and about 1,300 chassis, and to expand our corporate headquarters. We're evaluating whether it's best to finance our equipment purchases with leases or debt. We will also be investing in technology projects. Dave, over to you for closing remarks.
Dave Yeager (CEO)
Great. Thank you, Terri. We're pleased with the 2016 results, and we're looking forward to 2017. As I hope we effectively conveyed in our prepared remarks, we believe the pricing environment will improve as we progress through the year, and we remain committed to grow in all of our lines of businesses and believe that we're well positioned to do so. With that, we'll open up the line to any questions.
Operator (participant)
Thank you. We'll now begin the question and answer session. If you have a question, please press star, then one on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star, then one on your touchtone phone. And we have Ben Hartford from Baird online with a question. Please go ahead.
Ben Hartford (Senior Research Analyst)
Hey, good evening, everybody. I'll stay on the intermodal side, I guess, for my two or one and a half. Dave, as you think about growing the business again, maybe provide some perspective on the sources of the volume growth of 5% this quarter and the 3%-7%, presumably both above market. What are the sources of these? Is the volume winning back business that you had lost in prior years, or are they new highway conversions?
Dave Yeager (CEO)
No, some of it will definitely be highway conversion. We're very focused on that right now, Ben, and believe that the timing, as fuel prices are continuing to increase, spot market pricing appears to be adjusting upward a bit, that this is a good time for truckload conversion. It's also a part of our overall strategy of focusing on specific clients and working to gain their business in areas that will help our network, so that we can actually give them a good price service combination, you know, thereby allowing them to use us. And so this has worked out very effectively, broadening the services that we're offering, not just intermodal, but introducing the truck brokerage product, unassigned, where appropriate. All of that helps us to grow the core intermodal business.
So we think that, we've got a lot of momentum behind us at this point.
Ben Hartford (Senior Research Analyst)
Okay. And then more strategically, Dave, as you've kind of, you know, as you've been reevaluating, you know, I guess, the business over the past several months now, talking about the Eastern intermodal strategy specifically, could you provide any context to kind of how, how you view your situation with your current partner, and to what extent might there be opportunities to potentially alter that strategy, diversify, et cetera? I mean, any changes on that Eastern intermodal market, in particular, as you think about Hub Intermodal?
Dave Yeager (CEO)
Well, I think that the main thing is we do think that local East Coast, that again the truck prices are rising a bit. We do think that it's a good time to be able to expand and convert business from over the road. So I wouldn't say any major changes. I think that the environment in 2017, particularly as we progress through the year, is going to become more and more favorable for intermodal, and will make it a lot easier for us to in fact convert some of that business, which we did lose to truck-
Don Maltby (President and COO)
Absolutely.
Dave Yeager (CEO)
as the fuel prices had declined.
Ben Hartford (Senior Research Analyst)
Okay, great.
Don Maltby (President and COO)
Ben, that'll be the first market that'll tighten up when trucks do get tight in the third and fourth quarter, locally.
Ben Hartford (Senior Research Analyst)
Okay, thank you.
Operator (participant)
Our next question comes from Justin Long from Stephens. Please go ahead.
Justin Long (Managing Director of Equity Research)
Thanks. Good afternoon, and congrats on the quarter. So, obviously, we saw a substantial pickup in brokerage during the quarter, but I was wondering if you could give us a sense for how much of that growth in brokerage was e-commerce related. And looking ahead, could you just provide a little bit more color on your expectations for truck brokerage, from both a revenue and margin perspective in 2017?
Terri Pizzuto (CFO)
It was our growth in this quarter, the 33% volume growth, Justin, was primarily new customers, and seasonal business. Some of that seasonal business was e-commerce, to answer your question on that. And then in terms of their growth in truck brokerage growth in 2017, it's tough to say because of, we're not sure what's gonna happen with capacity in the market. But our best guess is that for the full year, top line might be up between 10% and 15%, and margin could be up anywhere between 5% and 10% in brokerage.
Don Maltby (President and COO)
Yeah. Yeah, Justin, this is Don. So at the end of the day, what we've tried to do over the last few years is to penetrate our customers across our business lines, and we're seeing the fruits of that with brokerage and logistics. So we've grown with our existing customers. We've added new customers that we haven't had last year in 2016.
Terri Pizzuto (CFO)
Mm-hmm.
Don Maltby (President and COO)
So what we're seeing is a mix of that, and of course, e-commerce is part of that also.
Terri Pizzuto (CFO)
We had 11 new customers in truck brokerage of the top 50 growing customers.
Justin Long (Managing Director of Equity Research)
Great, that's all helpful. And Terri, maybe one clarification on your comment on truck brokerage margins. Could you maybe talk about what your expectation is for that margin percentage within truck brokerage for this year?
Terri Pizzuto (CFO)
Yeah, it's, you know, for the... It's hard to say because we're not sure what's gonna happen with capacity. Capacity is pretty loose right now. If it tightens up with ELDs going into effect at the end of the year, it - we're not sure how that's gonna impact the market. But I can tell you that overall, our best guess for margin percentage is what we said in our guidance for the whole company, the 12.2%-12.8%.
Justin Long (Managing Director of Equity Research)
Okay, but kind of hard to tell within truck brokerage what that will be.
Terri Pizzuto (CFO)
So-
Justin Long (Managing Director of Equity Research)
You referenced a 5%-10% improvement. I thought that might be gross margin dollar improvement versus gross margin percentage.
Terri Pizzuto (CFO)
That was the dollar improvement, yeah. I mean, we, we think we could get squeezed. We did, you know, year-over-year, truck brokerage margins were down 70 basis points. That was because of lower customer contract rates.
Don Maltby (President and COO)
Exactly right.
Terri Pizzuto (CFO)
It was up sequentially from Q3 to Q4, 80 basis points. That was predominantly because of more value-added services.
Justin Long (Managing Director of Equity Research)
Okay. And lastly, maybe to just follow up on the trend that we've seen in e-commerce and the pickup in your business, can you help give us a sense for how margins in that e-commerce business within truck brokerage compare to consolidated truck brokerage margins? Is it a favorable mix?
Don Maltby (President and COO)
Yeah, I would say it's slightly higher than our everyday business in brokerage, because we're providing more services. It's 24/7. It's additional capacity, so it would be higher, but I wouldn't say it's significantly higher.
Justin Long (Managing Director of Equity Research)
Okay, great, Don. That's helpful. I'll leave it at that and pass it on. I appreciate the time.
Don Maltby (President and COO)
Thanks.
Thanks, Justin.
Operator (participant)
Our next question comes from Todd Fowler from KeyBanc Capital Markets. Please go ahead.
Todd Fowler (Managing Director)
Great. Thanks. Good evening, everyone. Dave, just on the pricing expectations, the 1%-3% percent in 2017, is that where the market's at? Is that where the market's at now? Or is that something that you think is more achievable because of your targeted focus and kind of the fact that you're targeting certain customers in certain lanes? I'm just trying to get a sense of, you know, kind of your view on achieving kind of that low single-digit pricing range here this year.
Dave Yeager (CEO)
Yeah, I think that's a really interesting question, Todd. Because if part of it is due to our targeting specific lanes where we believe we may have a competitive advantage and specific clients. But I would say, we're obviously very early in the bid season.
Todd Fowler (Managing Director)
Mm-hmm.
Dave Yeager (CEO)
But what I've seen thus far is not particularly how I had originally forecast everything. We have a competitor that is showing very aggressive behavior in and out of California. Now, this could be an aberration, but that will certainly, if that continues, it'll make it much more difficult for us to get to the high end of the range.
Todd Fowler (Managing Director)
Okay, so what you're saying is that when you set 1%-3%, and now with what you're seeing with, you know, certain participants within the market, maybe it 1%-3%, it's a little bit more competitive now than maybe what you thought when you think about the 1% to 3?%
Dave Yeager (CEO)
Yeah, Todd, you know, it's obviously very early in the bid season, and so we don't want to just judge the first 24 bids we've seen and the reaction to that on what the entire season. We started out last year with a very aggressive pricing environment that did kind of lapse as time went on through the year. But I am just saying, and it's just one competitor that is being particularly aggressive into and out of Southern California, that in a market, in all candor, at this point in time, we're so far under truck that it doesn't seem to be very compelling or to make any sense whatsoever. But that's the environment we're in.
We do think that, pricing will rise as we go through the year, and, so we're still comfortable with that range. As I said, though, it'll just be more difficult to get to the higher end of the range, if in fact, the existing pricing of that one competitor continues.
Todd Fowler (Managing Director)
Okay, good. No, and I would agree with that about building momentum throughout the year. Just for my follow-up, Terry, on the gross margin guidance, the 12.2%-12.8%, you know, I think in the past you've talked about first half, you know, versus second half. Can you just help us think about, because I know that, you know, some of this is going to depend on when the new contract rates are put in and the comparisons are different on a year-over-year basis. But do you have a sense of maybe where gross margins would be in the first half of the year versus the second half of the year?
Terri Pizzuto (CFO)
Sure. We expect that Gross Margin dollar growth will accelerate as the year progresses, and we'll continue to see the headwinds from the decrease in the freight rates resulting from mid-season last year and the first half of this year.
Todd Fowler (Managing Director)
Mm-hmm.
Terri Pizzuto (CFO)
We expect gross margin as a percentage of sales in the first half of this year to be similar to or slightly higher than the fourth quarter of 2016. There are a lot of moving parts for the back half of the year, and that's why we have a range. It'll depend on the pricing environment that Dave talked about, rail cost increases, and capacity in the truckload market.
Todd Fowler (Managing Director)
Okay, that, that helps. One last one, if I could just sneak it in. Do you, do you also have the dollar amount for the higher, incentive compensation for the fourth quarter for this quarter?
Terri Pizzuto (CFO)
Compared to the third quarter sequential?
Todd Fowler (Managing Director)
Yeah, I just felt... I thought in the prepared remarks, there were some comments about additional bonus or expense here in the fourth quarter, and I just wasn't sure if that was, if you had a number for that.
Terri Pizzuto (CFO)
I do. Year-over-year, that was up about $1.6 million. Sequentially, from Q3 to Q4, it was up about $5 million.
Todd Fowler (Managing Director)
$5 million. Okay. Okay, thanks a lot for the time, and nice quarter.
Dave Yeager (CEO)
Thanks, Todd.
Don Maltby (President and COO)
Thanks, Todd.
Operator (participant)
Our next question comes from Scott Group, from Wolfe Research. Please go ahead.
Scott Group (Managing Director and Senior Analyst)
Hey, thanks. Afternoon, everyone.
Dave Yeager (CEO)
Hello.
Scott Group (Managing Director and Senior Analyst)
So just wanted to follow up on, on that last question. So Terry, if, if we had gross margin percents in that, call it, like, 12.5% range, give or take, in, in the first half of the year, do you think that gross margin dollars can be higher? Or is, is all of the gross margin improvement and I guess, earnings improvement more in the back half of the year?
Terri Pizzuto (CFO)
Yeah, good question. It's more back-end loaded, to answer your question. It'll be challenging with the decline in the freight rates that we have carrying over from last year's bid season to see gross margin dollar growth in the first half of this year. And we're hopeful we'll see that accelerate as the year progresses.
Scott Group (Managing Director and Senior Analyst)
Okay.
Terri Pizzuto (CFO)
And so our earnings would do the same thing.
Scott Group (Managing Director and Senior Analyst)
Mm-hmm. Okay, and then can you just kind of share with us kind of, early take on what you're expecting for rail cost increases this year and, and what that should mean for intermodal gross margin percents?
Dave Yeager (CEO)
Yes, Scott, this is Dave. We of course know where we are with our eastern carrier, and we're still in discussions with our western partner. So, we think we have a range of where we think it's gonna be, and it'll fall within our budgeting. So, but at this point, we don't have an exact amount for 2017 with the Union Pacific.
Scott Group (Managing Director and Senior Analyst)
Okay. But your guidance suggests you'll, you think you'll get intermodal gross margin expansion this year, percent?
Terri Pizzuto (CFO)
At the high end of the guidance. Uh-huh.
Scott Group (Managing Director and Senior Analyst)
Okay.
Terri Pizzuto (CFO)
Right. At the high end of the guidance is where we cover our rail cost increases with our price increases. That's our best guess, and we're projecting anywhere between 3% and 8% growth in intermodal margins at the Hub segment.
Scott Group (Managing Director and Senior Analyst)
Okay. And just lastly, real quick, can you just remind us how your model in intermodal works with respect to fuel, higher this year? Is it a pass-through? Does it help earnings, hurt earnings?
Dave Yeager (CEO)
You know, it's pretty much neutral. We obviously pay the rails what their fuel surcharge is, and then our clients, and I, it's been so long since I've looked at it, but I think it's 70% or 80% of our clients have their own fuel surcharges that, and you know, some of them are punitive, and we build that into our rates upfront. Some are realistic, and we obviously then give them lower rates. So it's really all over the ballpark, and it's really very customer specific.
Don Maltby (President and COO)
It's basically a flush. I mean, it's-
Dave Yeager (CEO)
Yeah, it's a wash.
Don Maltby (President and COO)
Yeah. Okay, thanks so much, guys.
Dave Yeager (CEO)
Thanks, Scott.
Operator (participant)
Our next question comes from Thomas Wadewitz from UBS. Please go ahead.
Alex Johnson (Financial Advisor)
Good afternoon, it's Alex Johnson on for Tom.
Dave Yeager (CEO)
Hi, Alex.
Alex Johnson (Financial Advisor)
Hi. Wanted to go back to the question and the comments about, you know, a particular competitor being aggressive out west. And I guess, try to tie that also to maybe some demand commentary, what you're seeing in demand in January, and I guess even into the first couple days here of February. You provided great commentary in terms of the progression of demand in fourth quarter, but any thoughts in terms of demand in January, and then if that's having an impact, out west? I think there's been some weather out west.
Dave Yeager (CEO)
And of course, the weather impacts everybody, whether it's truck, rail, et cetera. But it certainly did have an impact on some of our service levels. As far as overall demand right now, I'd say it's up a little bit versus what we had seen last year. If you look at January for us, January was up a bit. It was actually up close to 5%, but it had an extra business day, although January extra business days don't really count for much in all candor. But nonetheless, it did. So it's up a bit. This is the second of February. I don't really have any commentary on February.
Don Maltby (President and COO)
So yeah, volume in January, I would say, was okay.
Dave Yeager (CEO)
Yeah.
Don Maltby (President and COO)
- but it wasn't at what we've seen in obviously the third and fourth quarter.
Dave Yeager (CEO)
But we are encouraged because it does appear certainly that the inventory levels are much leaner than they were last year. Last year, there's no question we had an inventory surplus and glut, and a lot of that has been sold off. And so as a result of that, we do believe that we're going to volumes and demand will pick up as the year goes on.
Alex Johnson (Financial Advisor)
Mm-hmm. Okay, great. And yeah, sorry, I didn't mean to expect that you would have commentary on February at this point, but-
Dave Yeager (CEO)
No, not a problem, Alex.
Alex Johnson (Financial Advisor)
And then just another question. In terms of the logistics onboardings, how would you expect that to ramp through the first half of the year? Is it pretty steady through the first half of the year, more geared towards first quarter or second quarter? Just any thoughts you can provide there, I'd appreciate it.
Don Maltby (President and COO)
We've got, we've got just onboardings going on right now through the first and second quarter. So, what we saw in 2016 was not only the onboardings that we had throughout 2016 that were robust. We also see 2017 starting out the same way. So, our onboardings are strong for the first and second quarter.
Alex Johnson (Financial Advisor)
Great. Thanks for the time.
Dave Yeager (CEO)
Yeah, you're welcome.
Operator (participant)
Our next question comes from Brandon Oglenski from Barclays. Please go ahead.
Dan Kegel (Analyst)
Hi, this is Dan Kegel on for Brandon. Congrats on a great quarter, guys. Just wanted to quickly ask about your capital plan going forward. CapEx is coming up pretty significantly, and just curious to hear what that means for debt issuance and maybe buyback expectations going forward.
Terri Pizzuto (CFO)
Yeah, our CapEx, you're right, is we projected about $155 million-$165 million in CapEx. And in terms of debt issuance or leases, for that CapEx, we haven't decided yet which we're doing. We're evaluating our options now, but our guess is we'll do a combination, some debt, some leases. And in terms of share buyback, we are probably going to save our cash for acquisitions. That's our preferred use of cash, and we did our $100 million share buyback last year. So, but we likely will not be doing one this year.
Dan Kegel (Analyst)
Appreciate it. And then on the intermodal side, just given that rail service metrics are kind of starting to deteriorate as volumes pick up a little bit, could you talk a little bit about how that might impact your, repositioning and drayage costs for the intermodal business? Is that going to be an impact on the cost structure?
Dave Yeager (CEO)
If you look at the first quarter, it actually service in fact was slightly better, about 5% better than it had been year-over-year. You know, January it really is a crap shoot. Obviously, when you have massive snowstorms such as we've had out west, that creates avalanches, there's going to be some deterioration in service. But thus far, we haven't seen anything that has really negatively impacted us from a financial perspective, in as much as additional costs with drayage or storage or anything else.
Don Maltby (President and COO)
Yeah.
Dave Yeager (CEO)
So, I mean, we've seen worse. Certainly, 2014 was much worse. But those types of unforeseen events. I would say that I believe that the rails, our western partner, has recovered well from some of these avalanches, which have been, you know, pretty horrific, and just with the size and volume of snow that's going on out west. So, it really has not had an impact on us to date.
Don Maltby (President and COO)
I would call it a blip. It, it's not really impactful.
Dan Kegel (Analyst)
Okay. Thank you.
Operator (participant)
The next question comes from Bascome Majors from Susquehanna. Please go ahead.
Bascome Majors (Senior Equity Research Analyst for Industrials)
Yeah, thanks for getting me on this evening. It's been about a year since you hired Jeff to lead the M&A strategy. You made some comments earlier, but I was just curious if you give us an update, you know, have you been close at this point on multiple opportunities? And maybe what the sticking point has been in those which you chose not to go forward with?
Dave Yeager (CEO)
Yeah, we've looked at multiple potential acquisition targets. We have ongoing discussions with a few. You know, probably some of it, as you get digging deeper, there can be cultural fits that are an issue. It can be issues with the business itself, because we have some very basic criteria, some of which is that it can't be a fixer-upper. It's got to have good management. We have to have a good cultural fits. But we have some discussions going on now that I think we feel good about. I think that when Jeff first came on board, we discussed how would we define success in 2016.
I think from the number of properties and the way that we've refined our focus on acquisition targets, I think it was a very successful 2016. I'm looking forward to actually getting something under our belt in 2017.
Bascome Majors (Senior Equity Research Analyst for Industrials)
Well, thank you for that. So, you know, to your last comment, you know, it sounds like the pipeline here is as good or better. Can you just give us a sense of how it looks today versus three or six months ago?
Dave Yeager (CEO)
I would say that the opportunities that we're looking at are much more the fit is good, and I think the discussions are very fruitful right now. So I think that I think we're going down the right path on this. And again, as we anticipated, Jeff brought a lot of expertise in this area and has done a great job in finding these candidates and moving forward on them.
Don Maltby (President and COO)
Right. To add to that, I think, you know, we've added a process now that we've got into place where we can look at a company better, we can move quicker and do the evaluation faster. So, it was a process, and I think Jeff's done a good job of bringing us through that.
Bascome Majors (Senior Equity Research Analyst for Industrials)
Thank you for all the detail there.
Dave Yeager (CEO)
Okay, thanks.
Operator (participant)
Our next question comes from Matt Brooklier from Long—I apologize, Ben Hartford from Baird. The line, please go ahead.
Ben Hartford (Senior Research Analyst)
Oh, thanks for getting me back in. Terry, just a few quick points. When we think about kind of the run rate CapEx, you gave the number for 2017, but going forward, is this—I imagine the $160 is a little high for a run rate, perhaps not. But how are you thinking about 2018 and beyond?
Terri Pizzuto (CFO)
We're thinking a normal year of CapEx would probably be between $100 million and $125 million. That's comprised of a couple different areas. Our technology costs will be elevated for the next few years for our transportation management system, because we believe that's a differentiator and a critical investment. So we estimate our CapEx for technology could range between $15 million and $20 million prospectively. We'll also continue to invest in equipment, which includes tractors, containers, and chassis. And our best guess there is we buy between 2,500 and 3,000 containers each year, which translates to between $25 million and $30 million. And then we'll replace our tractors when they're five years old and purchase tractors to support our growth in key markets where it makes sense.
Our best guess there is we buy between 250 and 350 tractors a year, which equates to between $35 million and $50 million. And then, assuming we continue to invest in chassis, that could be around $15 million a year.
Ben Hartford (Senior Research Analyst)
Okay, that's helpful. And so, on the back of that DNA, 20% inflation this year. So, is that a good annual, DNA inflation number to think about as CapEx is rising here?
Terri Pizzuto (CFO)
Yeah. Mm-hmm.
Ben Hartford (Senior Research Analyst)
Yeah. Lastly, tax rate. I don't know if you gave that for the first quarter or for the full year, either, or both of those for 2017.
Terri Pizzuto (CFO)
For 2017, we think it'll be between 38% and 39%.
Ben Hartford (Senior Research Analyst)
Okay.
Terri Pizzuto (CFO)
Assuming all else being equal, and we don't have any changes in the tax laws.
Dave Yeager (CEO)
Although we're rooting for 15%, but that-
Terri Pizzuto (CFO)
We are.
Ben Hartford (Senior Research Analyst)
Thanks for the time, guys.
Dave Yeager (CEO)
Okay, Ben.
Operator (participant)
And as a reminder, if you have a question, please press star, then one on your touchtone phone. And our next question comes from Matt Brooklier from Longbow. Please go ahead.
Matt Brooklier (Senior Equity Research Analyst for Industrial Transportation and Manufacturing)
Hey, thanks. Good afternoon. I wanted to circle back to potential M&A and just ask the question, what does an ideal target for you guys look like, you know, from a transportation mode perspective, from a structure perspective? You know, would you prefer a company-owned model versus an agent model? I'm just trying to get a sense for, you know, what you're shopping for in the marketplace right now.
Dave Yeager (CEO)
Sure. I think that, you know, part of our focus is to continue to diversify our service offerings to our clients. So a diversification play is something that would be critically very relevant to us, such as dedicated trucking. We certainly are willing and have focused on adding on businesses onto some of our core businesses. That certainly isn't out of it. But I think that if we looked at it, we would prefer to be company-owned versus agent-based. We feel as though we have a very strong agent model with Mode. We really do think it's the best agent model out there today.
To throw levels of complexity of it at the management and take them away from focusing on bettering the agents and driving the agents forward to be able to grow and make more money, I think would probably be doing them a disservice. So, it would be company-owned. As I said, we've got some pretty basic criteria with cultural fit and management teams, and not a fixer-upper. Immediately accretive to earnings is critically important to us. So, it, it's not an insig- there aren't insignificant hurdles that we've self-imposed upon ourselves.
Don Maltby (President and COO)
Mm-hmm. Mm-hmm.
Matt Brooklier (Senior Equity Research Analyst for Industrial Transportation and Manufacturing)
Okay, that's helpful. And I guess, with the dedicated trucking comment, you're comfortable with potentially getting more heavy from an asset ownership perspective?
Dave Yeager (CEO)
We are. We do think that it's a critical component to what Hub will look like in five and 10 years. We think that the dedicated space is one that has tremendous opportunities. We'll continue to see it grow at a very rapid pace. Again, we would, particularly with something where you have more asset intensity, where you have more truck drivers, et cetera, we, you know, we're very focused on safety culture, and being able to make sure that it really is very much culturally aligned with us.
Matt Brooklier (Senior Equity Research Analyst for Industrial Transportation and Manufacturing)
Okay. That's all I got. Thank you.
Dave Yeager (CEO)
Okay, thanks, Matt.
Operator (participant)
Our next question comes from Matt Frankel from Cowen. Please go ahead.
Matt Frankel (Investment Analyst)
Hi, guys.
Dave Yeager (CEO)
Hello.
Matt Frankel (Investment Analyst)
Two things for you. One, on the TMS. You know, it's gonna touch seemingly everybody at the company, clients internally, each of the three business lines. So I wonder if you can talk about the timing of this rollout, how it's going, you know, if you can give some examples on the way it's going to enhance the business, make it more seamless, just anything on that front, because it seems to be pretty important, and we haven't touched on it yet, so.
Don Maltby (President and COO)
Sure. This is Don. So, you know, we went down the path of implementing TMS with our logistics business, and we're roughly 60% into that, meaning we're converting all of our existing clients onto the new platform, and taking them off the old platform. And any new business that comes on, onboardings in 2016 and 2017 will be onboarded with our new TMS. So the end game of this is to provide our operating systems, where we have visibility across the network, across our intermodal products, our truck brokerage and logistics, to be able to see capacity in the marketplace and to be able to give our customers visibility to that, and also our operators to do that. So, down the road, we'll see a one platform across visibility across all our businesses.
Dave Yeager (CEO)
If I may, Matt, just to add to that, is that this is based on Oracle's TMS. We are not building this.
Don Maltby (President and COO)
Right.
Dave Yeager (CEO)
We have ceased building software.
Don Maltby (President and COO)
Yeah.
Dave Yeager (CEO)
We did a lot of research over the last several years on the best platform, and Gartner and everything that we saw with it said that Oracle was the best product to build on. And so we're going down that path. And as I'm sure you're aware, the upfront software expense is really not that great. It's the implementation costs and the amount of money you have to spend on consultants and advisors to make sure you get it right, because there's so much power within the system, you need to make sure that you're using it effectively.
Don Maltby (President and COO)
Right.
Dave Yeager (CEO)
I think that we're going down that path properly.
Matt Frankel (Investment Analyst)
Thank you. Do you have a timeline in terms of when you want to have this system, you know, touching every part of the business and having that clear visibility across all business lines? Is there by 2018, 2019, 2020, something like that?
Don Maltby (President and COO)
Yeah, we'll have our intermodal business onboarded the latter part of 2017, beginning of 2018, and shortly thereafter, we will start onboarding our truck brokerage.
Matt Frankel (Investment Analyst)
Okay.
Don Maltby (President and COO)
By the end of 2018, beginning of 2019, we should have all the businesses online.
Matt Frankel (Investment Analyst)
Got it. Thank you. And the last thing I wanted to ask you about was cross-border Mexico. Can you just remind us what percentage of your revenue, or if you can give us a number, is cross-border?
Don Maltby (President and COO)
I'm going to let Terry give you the exact percentage, but I'll talk about that.
Terri Pizzuto (CFO)
It's about 3%-
Don Maltby (President and COO)
Yeah
Terri Pizzuto (CFO)
... of our total volume.
Don Maltby (President and COO)
So we have an emphasis on we talked about growing our business across our business units. We have a strong push right now to grow our cross-border business, not only in Mexico, but also Canada, to have a push-and-pull system, where we're pushing business into Mexico and then pulling it back into the States. Same is true with Canada. So we have a strong emphasis on that. It's too small a percentage of our business, and we need to grow it.
Matt Frankel (Investment Analyst)
Okay. All right, fair enough. Thank you.
Operator (participant)
Our next question comes from Matt Young from Morningstar. Please go ahead.
Matt Young (Equity Analyst)
Thanks. Good afternoon. Just quickly here, I'm, I'm guessing this is hard to gauge, but wondering if you have come across any hints from international intermodal customers that they're beginning to shift or have been shifting more cargo from the West Coast to the East Coast through the Panama Canal? And I'm guessing any impact over time would, would be felt in the transcon business.
Don Maltby (President and COO)
We've seen very little of that. The only thing we've seen a shift of is, north of LA, where Seattle has become more prevalent in 2016. But we have not seen a shift to the East Coast ports yet.
Matt Young (Equity Analyst)
Are you hearing more chatter about that, or is it still, mostly the way it's been?
Don Maltby (President and COO)
I have not. Our customers have not.
Dave Yeager (CEO)
I think the East Coast ports did have very strong years.
Don Maltby (President and COO)
Yep.
Dave Yeager (CEO)
The West might have been a little more flattish for the overall 2016, but... There's undoubtedly some conversion, but it doesn't seem to be anything that's really monumental at this point in time.
Matt Frankel (Investment Analyst)
Great. That's all I had. Thanks.
Operator (participant)
Your next question comes from Thomas Wadewitz from UBS. Please go ahead.
Alex Johnson (Financial Advisor)
It's still Alex here, and just a quick follow-up for Terri. I think, interest expense was one of the three key assumptions in the guidance that you outlined earlier. What, interest expense should we model for 2017?
Terri Pizzuto (CFO)
Yeah, Alex, we're thinking that if we financed everything with debt, it could be up to $1.5 million more dollars in interest expense.
Alex Johnson (Financial Advisor)
Okay, great. Thank you very much.
Operator (participant)
The next question comes from Justin Long from Stephens. Please go ahead.
Justin Long (Managing Director of Equity Research)
Thanks for taking the follow-up. I just wanted to ask or clarify something on intermodal pricing. You talked about a 1%-3% increase this year, and I'm guessing that your realized intermodal pricing in the first half might be worse than that range, just given the competitive environment we saw during the bid season last year. So does this guidance actually imply that pricing during the 2017 bid season is above that 1%-3% range?
Terri Pizzuto (CFO)
the guidance in the second half, that's guidance for the second half of the year. So during-
Justin Long (Managing Director of Equity Research)
So that's for the bids, it's for the 2017 bid season?
Terri Pizzuto (CFO)
Correct.
Dave Yeager (CEO)
Correct.
Terri Pizzuto (CFO)
Right.
Justin Long (Managing Director of Equity Research)
Okay, that's helpful to clarify. And then, lastly, Terry, you gave guidance on consolidated gross margin expectations, but I was wondering if you could talk about your gross margin expectations for the Hub segment, and should the quarterly trend be pretty similar to what you talked about on a consolidated level?
Terri Pizzuto (CFO)
Sure, Justin. We expect that gross margin dollars for the Hub segment will increase between 5% and 10%, and we expect more margin growth in the last half of the year than the first half of the year because of the decline in freight rates, you know, resulting from last year's bid season. Q4 gross margin as a percentage of sales should be sustainable for the first half of the year, and same as for the consolidated guidance. The full year, you know, the second half will have a lot more moving parts, and that's why we have the range, because that'll depend on the pricing environment, the rail cost increases, what happens to capacity in the truckload market. At the high end of the guidance range, we assumed we covered the rail cost increase with the price increase.
Justin Long (Managing Director of Equity Research)
Great. That's very helpful. Thanks again.
Terri Pizzuto (CFO)
Sure.
Operator (participant)
I will now turn the call back over to Dave Yeager for closing comments.
Dave Yeager (CEO)
Great. Well, again, thank you for joining us on our fourth quarter earnings call. As always, Terri, Don, and I are available for if you have any further questions or follow-ups. Thank you again for joining us.
Operator (participant)
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.
