Hub Group - Q4 2017
February 8, 2018
Transcript
Operator (participant)
Hello, and welcome to the Hub Group fourth quarter 2017 earnings conference call. Dave Yeager, Hub's CEO, Don Maltby, Hub's President and Chief Operating Officer, and Terri Pizzuto, Hub's 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 or contained in the release represent the company's best good faith judgment as to what may happen in the future. Statements that are forward-looking can be identified by the use of words such as believe, expect, anticipate, and project, and variations of these words. Please review the cautionary statements in the release.
In addition, you should refer to the disclosures in the company's Form 10-K and other SEC filings regarding factors that could cause actual results to 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.
David P. Yeager (CEO)
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. Hub Group had a strong finish to 2017, with revenue growth of nearly 20% in the Hub segment and 11% in the Mode segment. Intermodal volume was up 3% due to prioritizing price and network benefits while adhering to customer commitments. As we indicated in our third quarter earnings call, capacity was tightening and pricing was strengthening. These conditions gained momentum throughout peak, resulting in one of the tightest capacity markets that I've seen in decades. The strong peak was in large part due to the growing economy, the restocking of depleted inventories, the tight truck market, and rail service disruptions. Intermodal market tightness was largely due to an uptick in demand.
In addition, rail service deteriorated, thereby shrinking available capacity. Thus far, we're effectively working with our customers to minimize the impact of the rail service issues. Rail service is nonetheless slower year-over-year, and that has resulted in a longer turn time for equipment in a high-demand market. Despite capacity being extremely tight during peak, Hub did meet our equipment commitments to our customers. In fact, Hub won more Carrier of the Year awards in 2017 than in any other year in our history. That is a testament to our exceptional customer service. In addition, we also provided limited capacity to targeted customers that had been left without equipment by their other contracted carriers. Now that we've created a foothold in these accounts, we are convinced that we'll be able to gain share with reasonable prices and margins.
We believe there will be several trends that will carry through 2018 and into 2019, the first of which is a strong intermodal pricing environment. As we previously expressed, in 2016 and most of 2017, we experienced tremendous downward pressure on our rates. The direct result of this pressure was a decrease in margins to an unacceptable level. This year, we're focused on increasing intermodal yields through a combination of price increases and optimization of our network. Although we're confident we'll be able to realize a mid-single-digit price increase, much of the resulting revenue will go to higher driver and rail costs. But we are committed to increasing prices to outpace the driver wage and rail inflation in order to secure reasonable margins that will allow us to reinvest in our intermodal product. Another area of focus in 2018 is the recovery of accessorial costs.
We're in the process of renegotiating unsustainable accessorial agreements made in the past with a focus on enhancing overall margin. The dedicated acquisition that was closed on July first of last year continues to move forward according to plan. We're very pleased with our focus on safety, customer service, and profit, as the cultural alignment between our organizations is excellent. And lastly, our thesis of cross-selling dedicated services to Hub's customers has exceeded expectations. Hub remains committed in its desire to acquire businesses that will diversify our service offerings and create value to our existing business lines. In all instances, we remain focused on acquisitions that have a strong management team, is culturally aligned with Hub, is not a fixer-upper, and is immediately accretive.
And not to steal Don's thunder, but brokerage did have a stellar fourth quarter, while Unisyn continues to complete the migration of both existing customers and new customers to our Oracle technology platform. Lastly, Hub reached a major landmark with revenue exceeding $4 billion in 2017. With that, I'll turn the call over to Don to go into more depth about the specifics of our business segments.
Donald G. Maltby (President and COO)
Thank you, David. As Dave mentioned, this peak started earlier than anticipated and continued through the end of the year. To help us better prepare for peak, we started our planning process earlier than normal to establish peak plans with each of our key customers. This open dialogue and process allowed us to manage through this volatile period and provide our customers capacity and multimodal solutions. In addition to the established customer demand, we were constantly managing the flows of our network and having continual communication with our clients, establishing real-time demand needs. Throughout the quarter, we focused on servicing our customers and standing by our commitments. While doing so, we were also able to improve price across all of our service lines for volume that was not committed on contracted business and that spiked beyond anticipated demand.
As the demand continued, our teams pivoted quickly to offer our customers capacity and solutions, while at the same time, providing market pricing. This peak was by far the best performing in Hub's history from both a customer service and yield improvement perspective. Throughout 2017, we were recognized by our customers for service, despite deteriorating rail service in the fourth quarter. As we stated on our last call, we have been communicating these service challenges to our customers and increasing transit times accordingly. However, this not only harms our competitive position versus truck, but also adds unnecessary costs to our operation and reduces our fleet utilization. As we enter 2018, with the ELD mandate in place, new tax laws that should improve the economy and our results, along with a very tight truck market, we believe we are positioned well for success.
Now, let's talk about the businesses. As Dave mentioned, truck brokerage had a great fourth quarter, coming in with an impressive growth of 22% for the quarter and 23% for the year. This is its sixth straight consecutive quarter of volume growth. Our strategy has been and will remain to provide multimodal solutions and expand the breadth of our services to include contract, transactional, and value-add. We, like many, believe 2018 will be a challenging capacity market. We expect the ELD mandate and impending enforcement to reduce overall capacity, creating extreme volatility throughout the year and bringing about new opportunities where we are well-positioned with our customers and carrier base. In 2018, we'll continue to work with our strategic carrier base to further support our key markets and align with our customers to provide value-added services.
Logistics demonstrated strong top-line growth of 19% in the quarter and 18% for the year. This was driven by new accounts secured and onboarded throughout 2017, as well as strong growth from existing customers. During the quarter, we supported our customers with multimodal capacity while enhancing margin opportunities. In 2018, we will continue focusing on process and operational improvements, investing in our TMS technology, working to enhance our pipeline for future growth, and creating savings and operational efficiencies with our existing customers. Mode had strong top-line growth of 11%, and for the first time, reached $1 billion in annual revenue. Mode experienced revenue growth across all service lines, led by truckload, which was up 16%, and logistics, up 20%. For the year, Mode revenue rose 8%.
This growth is attributed to a strong IBO network and a technology platform, which allowed Mode to meet the challenges of the market and position the company for growth in 2018. Now I will turn it over to Terri to review the results.
Terri Pizzuto (CFO)
Thanks, Don, and hello, everyone. I'd like to highlight three points. First, operating income grew 33% in the fourth quarter. Second, intermodal pricing accelerated as the quarter progressed, and we're encouraged that this is a solid foundation for margin growth in 2018. Third, truck brokerage had a very strong quarter, with gross margin up 23% on a tough comp. Now, let's take a more in-depth look at our fourth quarter performance. The fourth quarter includes a $75.2 million, or $2.25 a share, decrease in income taxes, resulting from our estimate of the change to our deferred tax liability at December 31st, 2017, caused by the reduction of the federal tax rate, which is part of the recently enacted Tax Cuts and Jobs Act. Today, I'll focus on the results, excluding the impact of tax reform.
Hub Group's fourth quarter revenue increased 19% to $1.2 billion. Hub Group's adjusted diluted earnings per share was $0.74 compared to $0.55 last year. That's an impressive 35% increase over last year. Now I'll talk about details for the quarter, starting with the financial performance of the Hub segment. The Hub segment generated revenue of $904 million, which is a 20% increase compared to last year, due to organic growth of 12% in all three service lines and the addition of Hub Group Dedicated in the third quarter. Taking a closer look at our business lines, intermodal revenue was up 8% due to a 2% increase in loads and an increase in fuel revenue and freight rates. Mix was favorable.
Local East volume was up 8%, Transcon was up 6%, and Local West volume was down 4%. Truck brokerage revenue was up 22%, after being up 46% in the fourth quarter of last year. The growth comes from increases in transactional business. Truck brokerage handled 2% more loads on top of a 33% increase in loads in the fourth quarter of last year. Fuel price and mix combined were up 20%. Logistics revenue increased 19%, due primarily to new customers onboarded this year. Hub Group Dedicated revenue was $57.8 million. Hub's gross margin increased by $16.9 million, or 19%, due to Hub Group Dedicated and growth in truck brokerage and intermodal margin, partially offset by a decline in logistics margin.
Gross margin as a percentage of sales was 11.7%, or 10 basis points lower than last year. Intermodal gross margin increased because of price increases, lower Hub Group Trucking drayage costs, and higher volume. Drayage costs at Hub Group Trucking are down because of improvement in loaded miles and lower insurance and claims costs because of our continued focus on safety, including using in-cab cameras and the technology in our trucks. Partially offsetting these increases in margin were higher repositioning costs and slower box turns. These factors drove a 20 basis point decline in intermodal gross margin as a percentage of sales. Truck brokerage gross margin increased 23%, primarily because of more spot business. Spot business was about 30% of total loads this year, compared to 20% last year in the fourth quarter.
Truck brokerage gross margin as a percentage of sales increased 20 basis points because of changes in customer mix. Logistics gross margin decreased due to changes in customer mix and higher purchase transportation costs. These same factors contributed to a 240 basis point decline in logistics gross margin as a percentage of sales. Costs and expenses increased $6.8 million-$71.3 million in the fourth quarter. The primary reason for the increase is Hub Group Dedicated. In addition, medical claims were up about $1 million, salaries are up about $1 million, and IT and consulting costs increased about $700,000. Offsetting these increases is a $6.8 million decrease in bonus expense.
Finally, operating margin for the Hub segment was 3.8%, which was 60 basis points higher than last year and the highest that it's been all year. Now I'll discuss results for our Mode segment. In the fourth quarter, Mode's revenue was $286 million, which was up 11% from last year due to an increase in revenue in all three service lines. Revenue breaks down as $139 million in intermodal, which was up 6%, $92 million in truck brokerage, which was up 16%, and $54 million in logistics, which was up 20%. Mode's gross margin increased $800,000 year-over-year due to an increase in logistics and intermodal margin, partially offset by a decline in truck brokerage gross margin.
Gross margin as a percentage of sales was 11.3%, compared to 12.3% last year, due mostly to a 270 basis point decline in truck brokerage yields resulting from higher purchase transportation costs. Mode's costs and expenses went up $600,000 compared to last year because of higher agency commissions. Operating margin for Mode declined slightly to 2.3%, compared to 2.5% last year. Turning to headcount for Hub Group, we had 2,030 employees, excluding drivers, at the end of the year. That's down five people compared to the end of September. Turning now to the balance sheet and our cash.
We ended the quarter with $28.6 million in cash and $303 million in debt, including capitalized leases and $45 million of borrowings on the revolver. Our leverage ratio was 1.5 to 1. Cash generated from operating activities for the full year was $125 million, or 22% higher than 2016. We spent $34.6 million on capital expenditures this quarter, mostly related to containers, tractors, technology, and trailers. That brings 2017 total capital expenditures to $74.5 million. Now I'll discuss what we expect for 2018. We believe that our diluted earnings per share will range from $2.30 to $2.40.
A comparable adjusted earnings per share for 2017 would be $2.18, which factors in adding back $6.1 million of one-time costs and using a 25% effective tax rate. We estimate high single-digit to low double-digit revenue growth for the year. By service line at the Hub segment, we expect 7%-11% revenue growth in intermodal, 1%-5% growth in truck brokerage revenue, and a 2%-5% decline in logistics revenue. We project dedicated revenue for the year will be between $255 million and $265 million. We expect consolidated gross margin as a percentage of sales to range from 11.9% to 12.2% for the full year.
We believe that our quarterly costs and expenses will range from $104 million-$109 million, and will be highest in the fourth quarter and lowest in the first quarter. We estimate that operating income will increase between 17% and 22% compared to our reported operating income of $96.6 million in 2017. We project that our effective income tax rate will be about 25%. From a cash perspective, we don't expect to pay any federal income taxes due to the immediate expensing of eligible capital expenditures. We estimate we will pay several million dollars in state income taxes. Capital expenditures are expected to range from $150 million-$170 million in 2018.
We will execute on our strategy, investing approximately $120 million-$130 million for equipment and between $30 million and $40 million for technology. Included in this equipment spend is between $65 million and $75 million for Hub Group Dedicated, related to customer contract renewals and new customer wins. That wraps up the financials. Dave, over to you for closing remarks.
David P. Yeager (CEO)
Great. Thank you, Terri. Hub's fourth quarter results are a very positive note with which to transition into 2018. Not only was demand exceptionally strong and capacity tight, but all of our operating units executed at a very high level. We believe that the tight capacity in the fourth quarter has created a positive pricing environment for the upcoming bid season, as shippers are reminded that focusing solely on cheap prices without solid capacity commitment does not get their product to market. And with that, we'll open up the line for any questions.
Operator (participant)
Thank you, sir. We will now begin the question-and-answer session. If you have a question, please press star one on your telephone keypad. If you'd like to be removed from the queue, please press the pound sign or the hash key. If you're on a speakerphone, please pick up your handset first before dialing the numbers. Once again, if you have a question, please press star one on your telephone keypad. And from Wolfe Research, we have Scott Group. Please go ahead.
Scott H. Group (Managing Director and Senior Analyst)
Hey, thanks. Afternoon, guys. So wanted to kind of ask on the guidance. So if we take a look at the fourth quarter and, you know, look at the tax rate and sort of just a look at normal seasonality, it sort of implies a run rate of earnings right now of $3+, and obviously, you guys are guiding a lot lower than that for 2018. So, you know, maybe just help us understand if there was something, you know, unsustainable in the fourth quarter or what you think is changing and getting worse to help us get to your guidance a little bit.
Terri Pizzuto (CFO)
Yeah, sure, Scott. Oh, well, a couple things, really. First of all, fourth quarter was very strong peak season for us, very robust holiday season, and we capitalized on our opportunities with pricing and peak season surcharges for those customers who went over their volume allotment. So, and similarly, on the truck brokerage side, we had a lot of spot business, which helped the margin. And we have no bonus in the fourth quarter, even though we did such a fantastic job. Our bonus expense was down $6.8 million year-over-year. So for next year, if you look at, you know, so that's a really strong quarter all in, and it doesn't have a lot of costs in there for bonus.
Donald G. Maltby (President and COO)
Right.
Terri Pizzuto (CFO)
If you look at next year and you say, "Well, what, what will happen?" We plan on having bonus next year. So if you were to say, "Well, why are your costs and expenses up from the fourth quarter of seventeen till the first quarter of eighteen?" The biggest reason would be an increase in salaries and benefits. That's for a couple different reasons. Number one, we have increases for people, that's a couple million dollars. We also have- we're planning on earning a bonus this year because we're planning on doing well. That's about $3.5 million . And then we have additional expense of about a one million dollars for restricted stock in the quarter.
And then our G&A cost does ramp up a little bit in Q2, Q3, and Q4 for additional IT costs because of our IT investments.
Donald G. Maltby (President and COO)
Yeah, and the other thing to add, Scott, is don't forget our, you know, the intermodal pricing with regards to bids, 30% of those bids are in the first quarter, 33% in the second quarter. So as price goes on throughout the year, we're gonna take it as we reprice our bid business.
Terri Pizzuto (CFO)
Right. And then in the first quarter, the other couple costs that we have is we did, we want to attract the best and brightest drivers, and we put a driver increase out there to attract and retain more drivers. We've also enhanced our recruiting efforts, and so we think that will be a benefit, but it's additional cost. And then we did have a part of a rail increase go in during the first quarter.
Donald G. Maltby (President and COO)
Mm-hmm.
Scott H. Group (Managing Director and Senior Analyst)
Okay, that's very good color. Can I just a couple, just quick follow-ups to that. Terri, is there any way you can maybe help frame how you think first quarter is going to look, either from an earnings perspective or percent of the year. And then, maybe for you, Don, can you say what you think your intermodal pricing is going to be up this year, percentage-wise, and what you think your rail costs are going to be up this year?
Donald G. Maltby (President and COO)
Yeah, we're looking at increases to our customers is mid-single digits on price increases, and we have visibility now into our rail cost increases for the remainder of the year. So we will, as Dave mentioned in the call, we are going to price our business with the spread of increased costs and price to our customer.
Terri Pizzuto (CFO)
In terms of the earnings growth cadence, Scott, that you asked about, you know, Q1 maybe versus Q1 of last year, you know, we think we will be at a higher EPS than last year. But as Don mentioned, about 30% of our business reprices sometime during the first quarter, meaning that could be in February, it could be the very last day of March. So we're not going to get a lot of benefit from the price increasing until the year goes on. And so we expect that in intermodal, in particular, gross margin as a percentage of sales increases as the year progresses, and that gross margin percentage is, in fact, higher than last year for the last three quarters of the year.
Donald G. Maltby (President and COO)
Right. Mm-hmm.
Scott H. Group (Managing Director and Senior Analyst)
That would be earnings growth with or without the tax rate, or is that just?
Terri Pizzuto (CFO)
That's with the tax rate, yeah. Mm-hmm.
Scott H. Group (Managing Director and Senior Analyst)
Okay. All right. Thank you, guys. Appreciate it.
Donald G. Maltby (President and COO)
Thanks, Scott.
Operator (participant)
From Stephens, we have Justin Long. Please go ahead.
Justin Long (Managing Director of Equity Research)
Thank you, and congrats on the quarter. So maybe to follow up a little bit on the guidance to start, could you talk about the assumptions that you're using for Hub segments, intermodal business within the 2018 guidance? I know you just mentioned the mid-single-digit pricing, but I'm just curious what you're assuming for volumes and the % change in margin for intermodal as well.
Terri Pizzuto (CFO)
Yeah, we're assuming between 3%-5% volume growth. We think we can grow volume and price for the year. And it might even be higher than that, we're not sure. And we're building in, as Don said, mid-single digit price increases, and that goes in, you know, 30% the first quarter, 33% the second quarter, 30% the third quarter, and only 7% in the fourth quarter.
Donald G. Maltby (President and COO)
Yeah. Yeah. We're confident in our ability to take price and volume this year.
Justin Long (Managing Director of Equity Research)
That, that's helpful. So I, I'm guessing that all means that intermodal margins are improving, but could you share on, just in terms of basis points, how much of an improvement you're anticipating in 2018?
Terri Pizzuto (CFO)
Yeah, for the whole year, it's up about, I don't know, mid- between 50 and 70 basis points.
Justin Long (Managing Director of Equity Research)
Okay, that's, that's helpful. And then, you know, secondly, I wanted to ask about rail service. I know you made some comments about that in the prepared remarks, but is there any way to put numbers around how much of an earnings hit that was in 2017? And as we go into 2018, what are you assuming in terms of the year-over-year impact from rail service?
David P. Yeager (CEO)
Justin, that is... This is Dave. It is- that is a little bit difficult to put an exact number on, because it certainly, A, it does hurt our competitive stance against trucks. That's hard to measure. In addition, it does add a certain degree of operating costs to us, particularly, when in fact, the service may be inconsistent, because there's a lot of rescheduling of appointments, you have to pull loads and then store them. There's just a lot of additional costs which aren't necessary when the rails are really operating very efficiently. So, we, we talked about it and the numbers, but it's just, it's very difficult, it's very soft to be able to put an actual to quantify it.
Terri Pizzuto (CFO)
Yeah, I would, I would tell you, too, for the whole year, our utilization was about 15.6 days, whereas last year it was 14.9. And, so, you know, basically half a day different, a little bit more than that. And a day of utilization for us is anywhere between $6 million and $8 million.
David P. Yeager (CEO)
But that's just one component.
Terri Pizzuto (CFO)
That's just one component, not the accessorial piece.
David P. Yeager (CEO)
Right.
Terri Pizzuto (CFO)
Right. Mm-hmm.
Justin Long (Managing Director of Equity Research)
Got it. That's helpful. I'll leave it at that and get back in line. Thank you.
Donald G. Maltby (President and COO)
Thanks, Justin.
Operator (participant)
From UBS, we have Tom Wadewitz. Please go ahead.
Michael Triano (Equity Research Associate)
Hi, this is Mike Triano on for Tom. Could you comment on the timing of the rail cost increases this year? Were there any at the beginning of the year, and how that progresses throughout the rest of the year?
David P. Yeager (CEO)
Yeah. Yeah, we have an increase on January the first, and then also on May the thirty-first, we'll have both rails with increases, which we do. I would say we have relatively good visibility on.
Michael Triano (Equity Research Associate)
Mm-hmm. Okay. Maybe another one. On the CSX domestic intermodal service changes, have you been able to secure some additional business from the service changes, or is the freight just not attractive enough to deploy capacity to take on the business?
David P. Yeager (CEO)
It seems like an awful lot of the service changes that CSX made earlier were in markets that were not necessarily competitive with Norfolk Southern, where they may not have service. So we have not seen, I would say, a big surge of business as a result of that, although certainly our local lease business is up.
Donald G. Maltby (President and COO)
Mm-hmm.
David P. Yeager (CEO)
If you look, I would suggest that possibly the Norfolk Southern has seen some amount of transfer of business, just if you look at their numbers versus that are released weekly versus what CSX has seen in intermodal. It certainly appears to be the case.
Donald G. Maltby (President and COO)
Right. It's kind of hard to identify. We've seen some conversion more on the truck side than we have on the CSX side.
David P. Yeager (CEO)
Right.
Michael Triano (Equity Research Associate)
Okay. Thanks for the time.
Operator (participant)
From KeyBanc Capital Markets, we have Todd Fowler. Please go ahead.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Great. Thanks, and good evening. Dave, on the intermodal pricing, comments, is there a reason why intermodal pricing couldn't be up more than mid-single digits in 2018? And I guess what I'm thinking about is the pressure that the intermodal market has seen over the past couple of years, what's happened to your gross margins, and then really what we're seeing on the truck side, where it feels like that, you know, pricing is probably gonna be in the high single digit range, and I understand that intermodal is at a discount to that. But is this something that, you know, you could see something that materializes stronger than what you're expecting, or, or why is mid-single digits kind of the right placeholder to be using right now?
David P. Yeager (CEO)
No, we, you know, as always, Todd, we're a bit conservative. We certainly feel as though there's a lot of upside with intermodal pricing this year. As I'd said in my final comments, really it was the fourth quarter was kind of a perfect storm created a lot of capacity tightness, a lot of demand, and I think the customers realized that being just procurement focused that that's not gonna work for them over the longer term. So yes, we're certainly striving to get as much price as we can. There are certain clients, candidly, which are very low priced and we'll be looking at 15% increases.
Donald G. Maltby (President and COO)
Right.
David P. Yeager (CEO)
And there's others which have been more working with us that would be less than that. But yeah, I'd say that mid-single digits is a good conservative number, and but certainly we have targets and goals which can be a bit higher than that.
Donald G. Maltby (President and COO)
To Dave's point, we're also pricing it to the market, right? So we're looking at our network to make sure in these bids that we're pricing to the right markets and then we're not repositioning those boxes out. So it's a balance, right? But we are pushing that price envelope. It's early in the bid season, but we're testing the waters and pushing it every time we can.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Okay, that, that helps, and that makes sense. And then, I think you had some comments on your visibility into your rail cost increases. Can you just talk about what your experience right now is with the dray capacity? And it sounds like that there are some efforts to recruit drivers, both on what you might have to do with your own cost structure and then availability to get, you know, third party dray capacity, given some of the capacity constraints, especially with ELDs coming, or at least enforcement of ELDs, early in the second quarter.
David P. Yeager (CEO)
Right. And to that point, we've had ELDs in all of our tractors, owner-operators, as well as company drivers, for at least 15 years. So it's we're, we're very used to it. It's not gonna have any changes for our operating. But drivers are certainly scarce right now. It's a function of, you look at the unemployment levels, they're very, very low. Construction is booming, and as a result of that, a lot of drivers or potential drivers may select to be in the construction industry. So we are making a concerted effort.
We're combining the recruiting groups of both dedicated as well as our intermodal to dramatically expand our driver base this coming year, and that's why we did take a wage increase that became effective, I believe, just last week. So it's a very competitive market, as you know, for drivers. Retention's a key. We actually went below 40% on our turnover most recently. So yeah, it's, it's an ongoing focus, and it really is going to be... It's a constraining factor, I think, for obviously the trucks, that they have a lot of idle tractors right now, but as well as intermodal and the constraint on that.
So we're very focused on that issue, and we feel as though we've got a good handle on it, and we need to execute, but there will be a cost associated,
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Mm-hmm
David P. Yeager (CEO)
... with that. But as well, we've said in the past, it's our focus that we will in fact be able to manage the driver costs and the rail inflation costs, and get priced at a premium to those two numbers.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Okay, good. That helps. Very nice quarter here. Thanks for the time.
David P. Yeager (CEO)
Thanks, Todd.
Operator (participant)
From J.P. Morgan, we have Brian Ossenbeck. Please go ahead.
Brian P. Ossenbeck (Managing Director and Senior Analyst)
Hey, good evening. Thanks for taking my question. So just wanted to come back to the pricing just for a clarification, really. Does the mid-single digit in intermodal, does that include what you're talking about earlier about going after the recovery of accessorials, or would that be a separate item, and you're just talking about core pricing?
Terri Pizzuto (CFO)
That would actually be on top of that. So our mid-single digits is our planned price increase. We also plan to increase our recovery of accessorial costs, and we've got pretty good traction doing that. If we don't get there with a particular customer, then we'll increase the price, and it could be up more than the mid-single digits.
David P. Yeager (CEO)
Mm-hmm. What we're finding is that most of our customers that, that may have accessorial agreements, which really aren't very fair, that in fact, the accessorials are really under their control.
Terri Pizzuto (CFO)
Mm-hmm.
David P. Yeager (CEO)
Instead of taking an increase plus an accessorial increase from us, we're finding that they are willing to take control of the accessorials and have a reasonable agreement because, again, it is within their control.
Donald G. Maltby (President and COO)
Mm-hmm.
Brian P. Ossenbeck (Managing Director and Senior Analyst)
Okay. Got it. So it sounds like you have some recovery of accessorials baked into your expectations, but customers are able to mitigate some of that, which I assuming would help you on the optimization or on the utilization rather, of your fleet-
David P. Yeager (CEO)
Certainly help from the equipment.
Donald G. Maltby (President and COO)
Absolutely.
Terri Pizzuto (CFO)
Yeah. It might be, you know, not as much price, like Dave says, as reduction of those costs because the customers and us work together to try and bring them down.
David P. Yeager (CEO)
We've had a lot of meetings with customers about how to take the cost out, and it's either in the price of what we're going to bake in or the accessorial agreement.
Brian P. Ossenbeck (Managing Director and Senior Analyst)
Okay. Thank you. Terri, you gave us information on CapEx already. I don't think I heard anything on containers or or chassis or anything like that. If you could give us a sense of how big the fleet was at the end of the year and what you might be planning to add to it this year?
Terri Pizzuto (CFO)
Sure. We are adding about 3,500 containers growth, and our net add will be about 1,600. So our container fleet will be up to about 36,000, and that's a 4% increase.
Brian P. Ossenbeck (Managing Director and Senior Analyst)
Okay. And are those weighted throughout the year, kind of on a ratable basis?
Terri Pizzuto (CFO)
Yeah, during the year, but before peak.
David P. Yeager (CEO)
Right. We try to get a lot of them in, right around peak, because, of course, they do, disembark from the vessels, in Los Angeles or Seattle.
Brian P. Ossenbeck (Managing Director and Senior Analyst)
Got it. Okay. Thanks for your time.
David P. Yeager (CEO)
Thank you.
Operator (participant)
From Susquehanna Financial, we have Bascome Majors. Please go ahead.
Bascome Majors (Senior Equity Research Analyst)
Yeah, you broke out a lot of different components of your CapEx budget. If we were to label it just growth and kind of a maintenance, maintaining number, how would you break out that $160 million?
Terri Pizzuto (CFO)
Yeah. Well, I can tell you that, you know, $37 million is for containers, $17 million of that's for growth and $20 million is for replacement. Our tractors at HGT are about $25 million. That's mostly for growth. And the $70 million for dedicated tractors and trailers, that's about 45% for growth.
Bascome Majors (Senior Equity Research Analyst)
Thank you.
Terri Pizzuto (CFO)
And then the technology investments will be ongoing. We're going to continue to have technology investments. Those are about $30 million.
Bascome Majors (Senior Equity Research Analyst)
Well, I appreciate that. And kind of taking a step back to some of the earlier questioning, I mean, clearly, you're guiding the earnings growth versus where you ended up last year. But, you know, if you compare this outlook to what you initially guided 2017 last February, it's actually a few cents less. I mean, since then, you made an acquisition, you got a tax tailwind from the U.S. corporate rate reduction, and we've seen, you know, what could be the best surface transportation pricing environment in over a decade. You know, just really high level, you know, why aren't we seeing more leverage in the business? And is it a timing issue or something more structural that investors may be just missing?
David P. Yeager (CEO)
Well, I believe it is a timing issue.
Terri Pizzuto (CFO)
Right.
David P. Yeager (CEO)
If you look at it again, if you look at the bids, the way that they fall in there, 30% is in the first quarter, 33% Q2, and 30% Q3. And so it'll gradually improve. We do believe, as you said, this is a very positive rate environment, where we were able, during the fourth quarter to realize surcharges based on peak capacity. But that's not the case in the first quarter, and nor the second quarter. And so it'll be. And, again, to Don's earlier point in his prepared remarks, we live by our commitments to our clients, both from a capacity perspective and what we commit to a price.
So, it will be gradual, but we do think that this window may be a very wide window and very well could reach into 2019.
Bascome Majors (Senior Equity Research Analyst)
I appreciate that color. So, you know, kind of taking what you said in there about the timing of the pricing increases and what you said earlier about incentive comp being a fairly large headwind on a year-over-year basis, is it, I mean, is it fair to assume that the leverage in the business could actually be better in 2019 than 2018, as long as pricing doesn't roll over?
David P. Yeager (CEO)
Yes. Yes, I think that's a good assumption.
Bascome Majors (Senior Equity Research Analyst)
Thank you.
David P. Yeager (CEO)
Yep.
Operator (participant)
From Barclays, we have Brandon Oglenski. Please go ahead.
Van Kegel (Research Associate)
Hi, this is Van Kegel in for Brandon. Thanks for taking my question. I just wanted to go back to rail service. I guess, given the focus on productivity and growing volume faster than headcount by many in the industry, could you talk a little about how some of the conversations have gone with rail partners, and what kind of service expectation they have set with regard to your volume forecast of 3%-5%?
David P. Yeager (CEO)
Well, we do have weekly operational calls with both of our rail partners, updating us and looking for how, in fact, they feel as though they can overcome some of the existing service deficiencies, and improve back to what are more historic levels. In addition, we do meet with the top of the house as well regarding that. And I think at this point, the way that, and in all candor, I don't view that we're going to see an immediate shift back to normal rail service levels. It seems as though the combination of having too few assets in certain places, coupled with winter weather, coupled with just volume surges that we're going...
The overall service levels, we do believe, will improve throughout the year, but we're not going to be at 2016 levels, I don't believe, in 2018.
Terri Pizzuto (CFO)
... We haven't planned that we would be in our budgeting.
Donald G. Maltby (President and COO)
Right. Yes. Yeah, we didn't assume for any improvement.
Terri Pizzuto (CFO)
Right.
Van Kegel (Research Associate)
Understood. Thank you. And then on, on brokerage, I guess with some of the transactional market strength during the fourth quarter, can you just talk about what kind of expectations are, are baked into the guidance in terms of additional tailwinds from that throughout the rest of the year?
Donald G. Maltby (President and COO)
Well, for the year, you know, we, we're, we've always traditionally been more contract than transactional. And in the fourth quarter of 2016 and the fourth quarter of 2017, our transactional business has really risen. We expect our transactional business to be a higher percentage in 2018, simply because there's more need for that service.
Terri Pizzuto (CFO)
In fact, it was in January, and so our guys were really good at that, and capacity is tight, and so it's a good market for us.
David P. Yeager (CEO)
It's a very good market for that.
Van Kegel (Research Associate)
Appreciate it.
Operator (participant)
From Buckingham Research, we have Matt Brooklier. Please go ahead. Matt, your line is open.
Matthew Brooklier (Senior Equity Research Analyst)
Yeah, sorry, mute. So I just had a good evening. Follow-up question on the truck brokerage side of things. I guess when I look at your revenue guidance, and granted, we're coming off a difficult growth comp, but you know, you just talked about having more transactional volume in 2018 versus 2017, and it feels like given market tightness, there's a lot of volume moving in that particular side of trucking. I'm just curious, you know, why such a low revenue growth guidance for the year if, you know, you may have mix at your back and most likely price?
Donald G. Maltby (President and COO)
Yeah, two things. One is obviously being a heavy bid season on the truck brokerage side also. We're going to be selective in who we grow with and be selective on where we can manage that business in a tight market. As you might have known, around three years ago, we went to a market where we would service certain markets very well, and we've stayed with that strategy. So you know, we're conservative in nature, but I think we're comfortable with the guidance of what we've done, what we've given you on brokerage.
Terri Pizzuto (CFO)
Yeah, I mean, part of the reason we beat in the fourth quarter was truck brokerage, that we just didn't anticipate all the business that we got, and it's a guess on what this year is. So we took our best shot, and we'll update it as we need to throughout the year.
Donald G. Maltby (President and COO)
Throughout the year. You're also seeing, too, on the intermodal and truck side, you know, although this peak season started earlier than anticipated and was intense, the end of it was very strong, especially on the truck brokerage side. I mean, up through Christmas.
Matthew Brooklier (Senior Equity Research Analyst)
Okay, and then you mentioned putting through some driver wage increases in first quarter. Is that just on the drayage side, or is that also for Hub Dedicated?
David P. Yeager (CEO)
That's on both.
Matthew Brooklier (Senior Equity Research Analyst)
It's on both sides. Can you give a little color in terms of the magnitude?
Terri Pizzuto (CFO)
It's single digits, but it varies by market.
Matthew Brooklier (Senior Equity Research Analyst)
Okay. And then just given Hub Dedicated new to the model, maybe you could talk about, you know, how that business reprices. When I think about dedicated trucking, you know, longer term contracts, potentially not all that business repricing in a given year. Maybe just walk us through, kind of the dynamics of Hub Dedicated, you know, contract business. And I guess, what percentage of the total book of business do you think you can reprice and, you know, what is going to be most likely a really strong price year?
Terri Pizzuto (CFO)
Mm-hmm. Yeah, we're able to reprice, especially when we have you know, to the driver market on all of our dedicated contracts. So while the contracts are three years, they do have escalators built in them for the driver wage increases.
David P. Yeager (CEO)
We do, yep.
Terri Pizzuto (CFO)
Yeah. So we're able to recover our driver wage increases from our customers.
Donald G. Maltby (President and COO)
Mm-hmm. In the new business that we've been pricing with the pipeline, we've priced it with, obviously, with price increases going in place for our drivers.
Matthew Brooklier (Senior Equity Research Analyst)
Okay. So I guess, I guess it gets to kind of the where I'm headed with the question, driver wages moving up on the dedicated side of things, but, you know, your, your ability to take up, you know, reset pricing in contracts, then it sounds like some of this newer business you're, you're pricing at market currently. You know, everything combined, should we assume that, that margins do expand in this business? Do you think they're more flat? Like, what are, what are your thoughts there?
Terri Pizzuto (CFO)
In terms of the Gross Margin as a percent, the margin dollars themselves should go up significantly. We've been very successful with some of our cross-selling efforts. Our best guess is Gross Margin as a percentage of sales stays fairly similar to what it was for the past six months of the year.
Matthew Brooklier (Senior Equity Research Analyst)
Mm-hmm. Okay. That's helpful. I appreciate the time.
Donald G. Maltby (President and COO)
Thank you.
Terri Pizzuto (CFO)
Mm-hmm.
Operator (participant)
From Loop Capital Markets, we have Rick Paterson. Please go ahead.
Rick Paterson (Equity Research Analyst)
Thank you. Nice quarter, and another question for Dave on railroad service. Now, the degradation in service we've seen over the last six months, it seems to be excessive relative to the challenges the railroads have faced with regard to volumes and weather. So from your vantage point, have you noticed any fundamental changes in how the railroads are running their businesses over time that might explain this?
David P. Yeager (CEO)
You know, I don't think that we've really seen any fundamental changes. Of course, we have-
... one of the Eastern carriers, of course, has had some operational issues, which has, in fact, been widely publicized. And very frequently, the US railroads, they are, in fact, individual networks, but there's an awful lot of interline business that takes place. And usually, we've seen in the past, if one rail gets a cold, so does everybody else. So, I think that's partially it, and it has exacerbated as some of the changes were made at CSX. But I would agree, I don't, you know, winter does have a tendency. We have it every year in Chicago. It shouldn't be a surprise. I do think that in the Southeast, it's about may have, in the Northeast, may have been hit a little more severely than normal.
But nonetheless, we are hopeful that they'll be able to recover from this relatively quickly, and although not get back to the 2016 levels of service, at least get close and make progress towards that.
Rick Paterson (Equity Research Analyst)
Do you think they're trying to run leaner in terms of power and crews now versus, say, five years ago, for example?
David P. Yeager (CEO)
That's a good question, and I really can't comment to that. I don't know one way or another. That's a better question for the senior management of the rails.
Rick Paterson (Equity Research Analyst)
Yeah. Very helpful. Thank you.
David P. Yeager (CEO)
Thanks.
Operator (participant)
We have a follow-up from Scott Group. Please go ahead.
Scott H. Group (Managing Director and Senior Analyst)
Hey, thanks, guys. So, just a couple follow-ups here. So I think you had good logistics growth in the quarter. I think you're guiding to down logistics revenue for the year. Can you just explain that?
Terri Pizzuto (CFO)
Sure, yeah. We are really gonna concentrate on migrating our existing customers over to our new technology this year. We want to do it right, and we want to do it carefully in connection with our technology transformation. And the other component of logistics revenue being down is we did get rid of some lower margin business. And so that won't be in our revenue base, but our margin, we think, will go up year-over-year-
Donald G. Maltby (President and COO)
Right.
Terri Pizzuto (CFO)
even though our revenue is down.
Donald G. Maltby (President and COO)
So Scott, we had such a big onboarding year, right? So we've decided to focus on the customers to improve margin, and we still have a very strong pipeline for the logistics piece, but we really are focusing on enhancing the margin.
Scott H. Group (Managing Director and Senior Analyst)
Okay. Makes sense. So, I mean, I guess if I look at the guidance for overall gross margin, you've got logistics gross margin improving. I guess there's a mixed benefit with a full year of dedicated. Maybe can you comment, do you think intermodal gross margin percent is better, worse, flat, 2018 versus 2017?
Terri Pizzuto (CFO)
Yeah, I think we commented earlier that it would be better, and our guess is maybe 50-60 basis points better.
Donald G. Maltby (President and COO)
And Scott, back to what we said before, throughout the year, right? So as these bids come up throughout the first, second quarter, we'll build momentum as the year goes on.
Scott H. Group (Managing Director and Senior Analyst)
Okay, I mean, I guess I'll go back to then my first question, like, you know, we've got volume, we've got price, we've got margin, and if we take the guidance and, you know, it's excluding the tax and the dedicated deal, you know, there's not much underlying EPS growth here. I guess it's just a little... Is the message that we're being really conservative, or maybe we're missing something on just the operating expense side?
Terri Pizzuto (CFO)
No, I think, well, the operating expense side, you know, we talked about the bonus a little earlier, and that is gonna be up, like, as I mentioned, about $3.5 million a quarter over what 2017 was. And then we have our investment in IT that we think is gonna make this, give us a competitive advantage. It's gonna give us a- allow us to do a better job from an efficiency standpoint, a visibility standpoint, right, making the right multimodal selection. So that, too, is in our cost guidance, and we didn't have as much of that then.
Donald G. Maltby (President and COO)
Right. So as we, as we move towards implementing OTM across our network, you're gonna see the IT expense for this year and next, and then probably the year after that, be higher than you've ever seen it up.
Scott H. Group (Managing Director and Senior Analyst)
Okay. And then just last one real quick. I think you talked, Dave, that drayage was a net positive in fourth quarter. Other guys are complaining about drayage. Maybe just talk about what you're seeing differently in drayage and how you see that playing out in 2018.
David P. Yeager (CEO)
Well, I think that we've been able to attract a few more drivers. I don't know... I do think that drayage is gonna continue to be a differentiator. I think that we're going to be, you know, we're continuing to focus on building it. But it's actually, we do see that it's better in January, more so than the fourth quarter. And our current pipeline, I looked at it for this week, we've got probably the highest number of drivers that are being trained at this point in time, are going through our processes this week than I think any time in the last probably six months. So we're seeing some positive impact, and they partially that may be due to the driver wage increase that we took.
I think that, partially it could just be the beginning of the year, and people have a tendency, if they're gonna switch jobs, to do it then.
Scott H. Group (Managing Director and Senior Analyst)
Right.
Donald G. Maltby (President and COO)
One other point, too, with Dave is the third-party draymen that we use in certain markets, we actually act like a shipper, and-
... commit to those third-party carriers throughout the year. So as we flex up, we ask for them for help.
Scott H. Group (Managing Director and Senior Analyst)
But it sounds like you're seeing a mix towards your own internal dray. Is that basically what's going on here?
David P. Yeager (CEO)
No, actually, last year was relatively flat.
Donald G. Maltby (President and COO)
Yeah.
David P. Yeager (CEO)
So we're still, but what we are seeing is we're seeing fewer owner-operators, and we've seen growth in the company drivers. So we're watching that model change very closely to see if that's going to continue. But no, it's actually the internal drayage was within a couple hundred basis points the same as in 2016.
Terri Pizzuto (CFO)
Mm-hmm. Yep.
Scott H. Group (Managing Director and Senior Analyst)
Okay. All right. Thank you guys for the time.
David P. Yeager (CEO)
Thank you.
Scott H. Group (Managing Director and Senior Analyst)
Appreciate it.
Operator (participant)
Once again, if you do have a question, please press star one. We have a follow-up from Justin Long. Please go ahead.
Justin Long (Managing Director of Equity Research)
Thanks for taking the follow-up. Just had a couple quick questions on the model. So Terry, I think you mentioned consolidated gross margins are expected to be 11.9%-12.2% for the full year. Is there any color you can provide on the quarterly cadence throughout the year that we should be expecting? And then secondly, I wanted to get your expectation for interest expense as well.
Terri Pizzuto (CFO)
Sure. I'll take the second one first, and total interest expense will probably be around $10 million for this year. In terms of the cadence of the gross margin as a percent of sales growth, we, as we've mentioned, you know, as our business reprices, that will go up. We think it will increase as the year progresses with the strongest gross margin as a percentage of sales really in the fourth quarter, after 93% of our business reprice.
Justin Long (Managing Director of Equity Research)
When you get to that point, do you think you'll be above that high end of the range, the 12.2%?
Terri Pizzuto (CFO)
Yes.
Justin Long (Managing Director of Equity Research)
Okay, great.
Terri Pizzuto (CFO)
Definitely.
Justin Long (Managing Director of Equity Research)
Perfect. Well, I'll leave it at that. Thank you so much.
Terri Pizzuto (CFO)
Mm-hmm.
Operator (participant)
We have a follow-up from Todd Fowler. Please go ahead.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Great, thanks.
Donald G. Maltby (President and COO)
Hey, Todd, before you ask the question, what happened to -- they traded the whole team today?
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
You know, Don, unfortunately, with all these earnings today, I've only caught bits and pieces of it. But I think that LeBron had the GM's ear, and I think that that's the results that you get. But it's been a tough couple of weeks here in Cleveland from a basketball perspective, so.
Donald G. Maltby (President and COO)
Yep, I hear you.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Once I get through these models, I'll get caught up on that, I guess, so. Hey, I just wanted to ask one last high-level question. You know, Dave, you've got the $6 billion revenue target in the release here. Can you give us some conceptual ideas about how you think about getting there? Is there how you're thinking about what component of that should be organic? And I'm kind of coming up with a high single digit, you know, CAGR to get to that from a $4 billion run rate. And then what you'd be thinking about from an acquisition standpoint to feather into that.
David P. Yeager (CEO)
Right. No, you are accurate there that a lot of it is, in fact, going to come from acquisitions. We do believe we can continue to grow our existing lines of business at a decent pace. But in order to get to the $6 billion, there's no question it has to be outside acquisitions. And where would we focus on outside acquisitions? I think that some of it is obviously businesses that might feed additionally our existing business lines. It could be another IMC. It certainly could be transportation management companies or a truck broker that would bring technology to us. But it could be other non-asset-based types of logistics operations. Could be cross-docking and things such as that.
But we're active in the market. Geoff DeMartino is doing a great job, and there's a very full pipeline right now of companies we can look at. And again, we feel as though the Estenson dedicated acquisition that we've been able to manage that very well. Our thesis that, in fact, we would see excellent cross-selling, has come to bear, and we've had a lot of opportunities, and we expect a lot of success there. So if I looked at it on a percentage basis, how to get from the up to the $6 billion, probably 60% or 70% is going to come from new acquisitions, the remainder from organic growth.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Okay. And then, I don't know if you want to comment on this, but is there anything in the acquisition pipeline that you feel that you're relatively close to? Is it, I mean, do you have any... I know it can be lumpy, but just from our planning purposes, is there something that we can expect sooner versus later, or just kind of any comments around timing would be helpful.
David P. Yeager (CEO)
Yes. There's nothing right now that's imminent. I mean, we're looking at multiple businesses, but there's nothing I would say that's imminent at this point in time. But you know, we'll obviously continue to update that with our earnings calls.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
Okay. Don, Don, we'll just have to see if LeBron follows Isaiah Thomas to, to L.A. at this point.
Donald G. Maltby (President and COO)
Yeah, wait till you see the trades, you'll be, you'll be amazed.
Todd C. Fowler (Managing Director, Transportation & Logistics Equity Research)
All right, guys. Thanks a lot.
Donald G. Maltby (President and COO)
Thank you.
David P. Yeager (CEO)
Thanks, Todd.
Operator (participant)
We do have one more question on the line. Please stand by for just a moment. And we have Diane Huang from MS on the line. Please go ahead.
Diane Huang (Equity Research Associate)
Good evening, Ian. I have two questions, one on the intermodal environment and a second is a modeling question. My first question is, can you comment on the intermodal competitive environment?
... I know your competitors have different business models, but, one TL carrier posted a very strong OR quarter in the fourth quarter. So wondering if you're seeing any standout behavior in the market?
David P. Yeager (CEO)
You know, I think that after 18 months of downward pressure on pricing, we've seen a very what I would call a normalized competitive environment, where a lot of people are all looking to get better returns so that they can reinvest in the intermodal product. So it's been very rational pricing. It appears to us that certainly the market is looking for price increases. Our customers are expecting them, and we in Canada we need to do it to offset our inflation in driver wages and rail costs, as well as get our own margins up to a reasonable level. So I think it's from a market environment, it's very much looking to increase price.
Diane Huang (Equity Research Associate)
Got it. That's good to hear. And my second question is to Terry. Do you still expect Estenson's revenue to grow at a 19% CAGR over the long term off the 2018 guidance that you gave? And, how much EPS accretion are you expecting in 2018 from Estenson? Thank you.
Terri Pizzuto (CFO)
Yeah, we had talked about, I think, about $0.20 of accretion, and that's close to what we expect for this year. And in terms of their CAGR for the out years, we were very successful in cross-selling, getting opportunities in the fourth quarter. Some of those are, you know, done deals at this point, so we're excited about that. We think there's a lot of room for growth there. But, you know, we think it'll be maybe mid-teens. We really haven't quantified how far out. We'll see how this year goes and then update the CAGR. But certainly for this year, we've already been very successful in bringing on new business in the first quarter.
Diane Huang (Equity Research Associate)
Okay, thank you.
Terri Pizzuto (CFO)
Sure.
Operator (participant)
Thank you. We will now turn it back to Dave Yeager for closing remarks.
David P. Yeager (CEO)
Great. Well, thank you again, everyone, for joining us, today. As always, Terry, Don, and I would be available if you have additional questions. But thanks again for joining us.
Operator (participant)
Thank you, ladies and gentlemen. This concludes tonight's conference. Thank you for joining. You may now disconnect.
