XPO - Q2 2016

Transcript

Operator (participant)

Welcome to the XPO Logistics second quarter 2016 earnings conference call and webcast. My name is Christine, and I will be your operator for today's call. At this time, all participants are on a listen-only mode. Later, we will conduct a question-and-answer session. If you have a question, please dial star one on your telephone keypad. Please note that this conference is being recorded. Before the call begins, let me read a brief statement on behalf of the company regarding forward-looking statements and the use of Non-GAAP financial measures. During this call, the company will be making certain forward-looking statements within the meaning of applicable securities laws, by which their nature involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those projected in the forward-looking statements.

A discussion of factors that could cause actual results to differ materially is contained in the company's SEC filings. The forward-looking statements in the company's earnings release or made on this call are made only as of today, and the company has no obligation to update any of these forward-looking statements, including its outlook, except to the extent required by law. During this call, the company also may refer to certain Non-GAAP financial measures as defined under applicable SEC rules. Reconciliations of such Non-GAAP financial measures to the most comparable GAAP measures are contained in the company's earnings release and the related financial tables, or in the Investors section of the company's website at www.xpo.com. You can find a copy of the company's earnings release, which contains additional important information regarding forward-looking statements and Non-GAAP financial measures, in the Investors section on the company's website.

I will now turn the call over to Brad Jacobs. Mr. Jacobs, you may begin.

Brad Jacobs (CEO)

Thank you, operator, and welcome to the call, everybody. With me today are John Hardig, our CFO; our Chief Strategy Officer, Scott Malat, and our Head of Investor Relations, Tavio Headley. Last night, we reported second quarter results that confirmed that we're at a positive inflection point in the evolution of our business. We achieved record net income, record EBITDA, record cash flow from operations, and record free cash flow. Our Adjusted EBITDA was $355 million, and we generated strong cash flow from operations of $261 million, and free cash flow of $170 million. Our highest top-line growth came from our last mile and truck brokerage operations in North America and our European contract logistics operations. E-commerce continues to be a major tailwind.

It drove margin expansion in last mile and gave our logistics operations some major wins on both sides of the Atlantic. From a profitability standpoint, our North American LTL business was the star of the quarter. We grew operating income in LTL by a whopping 66% over second quarter last year, which was pre-acquisition. Operating income for the quarter in LTL was $115.5 million, a record accomplishment for our LTL operations, and the operating ratio was 86.7%, the best ratio in a decade. These are monumental improvements, and we achieved them in just seven months after buying the business. Looking at the full year, we now expect to generate at least $1.265 billion of Adjusted EBITDA, which is up from $1.25 billion.

We've raised our free cash flow target to at least $150 million from a range of $100 million-$150 million. We expect our free cash flow to accelerate significantly in 2017 and 2018. For 2018, we have a well-defined path to our target of $1.7 billion of EBITDA. More than $300 million of our profit improvement opportunities are company-specific and independent of macro conditions. This is only a little more than 2% of our $14 billion of addressable spend. The largest categories of savings will come from procurement, real estate, technology, shared services, and transferring best practices globally. Our company-wide focus continues to be on driving results, on accelerating EBITDA and free cash flow while making the investments to grow our business long term.

With that, I'll turn it over to John to review the quarter. John?

John Hardig (CFO)

Thanks, Brad. We had an exceptionally strong quarter despite a sluggish market. Our EBITDA and free cash flow were well above our expectations. Adjusted EBITDA for the quarter was $355 million, and net income was $50 million. We delivered these results despite a low growth market environment. On a pro forma basis, excluding fuel and FX, as if we had owned all of our acquired companies on April first last year, adjusted revenue increased 1.8% year-over-year in the quarter. As Brad said, our strongest growth was in our last mile, truck brokerage, and European supply chain operations. This was offset by market softness, which impacted our domestic intermodal and expedite operations. Organic growth in the quarter also reflected our yield management and restructuring initiatives to improve the profitability of former Con-way operations.

Excluding Con-way, our pro forma revenue growth for the quarter was 4.3%.... Revenue in our transportation segment was $2.4 billion during the quarter, up 181% over last year, and Adjusted EBITDA was up 365% to $276 million. Operating income in transportation was $153 million. Within our transportation segment, in freight brokerage, we increased revenue by 12% year-over-year. Net revenue margin declined to 17% from 20.1% last year due to decreases in expedite and intermodal margins, while truck brokerage margins were flat. In truck brokerage, we increased share and grew volumes organically by over 20% year-over-year, while revenue per load decreased due to lower rates and lower fuel revenue.

In intermodal, the market remained weak from continued excess truckload capacity and low fuel prices. Expedite volumes declined in the quarter versus a year ago due to the ongoing slow industrial economy. In less than truckload, we continued to improve service and profitability during the quarter. Compared to the prior year pre-acquisition, revenue per hundredweight, excluding fuel surcharge, increased 5.5% year-over-year, and daily LTL tonnage decreased 7.4%. Consistent with our strategy and the trend over the last few quarters, reductions in national account revenue were partially offset by increases in revenue from local accounts. Our LTL operating ratio was 86.7%. Adjusted operating ratio, excluding amortization of intangibles and integration costs, improved to 85.5% compared to 92.4% last year. Tonnage trends did improve through the quarter, with June being the strongest month.

In the third quarter, we do expect tonnage declines to moderate. We expect yield improvements to continue, but at a more measured pace as we begin to lap last year's yield initiatives. Our Last Mile operation continues to experience strong growth. We grew revenue by 18% year-over-year. We continue to see a high volume of new business opportunities, especially in e-commerce. Last Mile net revenue margin increased 80 basis points in the quarter from an increase in e-commerce business, as well as improved carrier utilization and productivity as we leverage our growing network density. In North American Truckload, revenue in the quarter, excluding the impact of fuel, was 1.8% lower than the same period last year, which was pre-acquisition. Volumes were flat, and rates, excluding fuel, declined 2.7% year-over-year.

In the face of a challenging market, we improved our truckload operating ratio over the prior year by reducing SG&A expense and improving empty mile percentage to 9.2% from 9.9% a year ago. In our European transportation operation, we drove revenue growth through higher volumes, while pricing was flat compared to the full quarter a year ago. Transportation management in France and our LTL operations had especially good revenue growth year-over-year. Strength in these areas was offset by lower fuel revenue and pricing pressure from more competitive market pricing in Spain and the Eastern European countries. We improved margin in our European transportation operations through actions to reduce infrastructure costs. Our logistics segment continued strong performance in the quarter.

Revenue increased to $1.3 billion, and Adjusted EBITDA increased to $107 million due to our 2015 acquisitions, along with organic revenue growth and margin expansion. Operating income in logistics was $51 million in the quarter. Performance in our European logistics operation was particularly strong compared to the prior full-year quarter. Year-over-year revenue growth was driven largely by new contract starts, notably with e-commerce and food and beverage customers. Supply chain margins in Europe increased year-over-year during the quarter, mainly by improving warehouse utilization and turning around unprofitable sites. In our North American logistics operation, we significantly improved margins by exiting low-margin business, optimizing the cost structure of our combined platform, and driving higher productivity. New contract wins were more than offset by exiting low or no-margin business.

Areas of strength included the high tech and chemical verticals, while retail and transportation management were weaker. Corporate SG&A expense decreased to $34 million in the quarter from $57 million a year ago. Included in corporate expense was approximately $4 million of integration costs. The reduction in corporate expense was primarily from higher transaction and integration in 2015. We expect corporate SG&A expense, excluding non-recurring integration costs, to be in a range of approximately $25 million-$28 million per quarter. Net capital expenditures for the quarter was $91 million. More of our CapEx will come in the second half of the year, which coincides with the timing of our revamped procurement processes. Our expectation for net CapEx in 2016 remains $475 million-$500 million.

Depreciation and amortization for the first quarter was $162 million. D&A was lower than expected, reflecting a reduction in the estimate of Con-way asset values in purchase accounting. Purchase accounting for the Con-way acquisition is not finalized. However, based on current analysis, we expect depreciation and amortization to be in a range of $168 million-$173 million per quarter for the rest of the year. Free cash flow exceeded our expectations for the quarter due to higher EBITDA, the timing of CapEx, and working capital initiatives. As a result, we raised our guidance for free cash flow to at least $150 million for the full year....

We ended the quarter with $378 million of cash and approximately $940 million of liquidity when taking into account the $100 million we had drawn on our $1 billion credit facility at quarter end. Now I'm going to turn the call over to Scott. Scott?

Scott Malat (Chief Strategy Officer)

Thanks, John. First, on the macro, both North America and Europe are in slow growth mode, but still growing. In North America, truckload capacity continues to be relatively loose, although we did see some seasonal tightening in June and into July. Customers are showing more interest in locking in longer-term capacity, which is usually a bullish sign. In Europe, Spain's economy has shown solid growth. It's been driven by consumer spending and industrial investment. The rest of the Eurozone has generally been more sluggish. E-commerce continues to be a strong tailwind, both in Europe and in North America. We benefit in our last mile and contract logistics operations when heavy goods are purchased online. Our e-fulfillment platform gets involved at two stages of the transaction, outbound goods and inbound returns. Within XPO, we have many company-specific opportunities to improve our profitability. It's independent of the macro.

We've identified over $300 million in profit improvement initiatives so far. They include roughly $120 million from our original profit improvement plan for LTL in North America, and at least another $180 million of opportunities across our global platform. We're attacking our $14 billion of addressable spend. One big area of savings is procurement. We have global sourcing initiatives underway to lower the costs of temporary labor, tractors, fleet maintenance, fuel, and warehouse equipment. Another area is real estate. We're consolidating our footprint, renegotiating leases, and reducing real estate maintenance charges. The cross-fertilization of best practices is a huge potential catalyst for profitable growth. We're sharing technology and engineered standards in areas such as route optimization, the optimal use of warehouse space, and insourcing and outsourcing decisions, to give you a few examples.

Our North American and European supply chain teams are working together to build out our global e-fulfillment platform by applying the best practices from each operation. Our less than truckload teams are taking a similar approach in the areas of customer service, pricing, cross-dock operations, maintenance, safety, training, and HR. With technology, we see the ongoing enhancement of our IT as being critical to our ability to continually improve customer service and leverage our scale. We've built an integrated cloud-based technology platform that gives us the agility and facilitates enhancements. We've completed over 160 IT projects so far this year, and we're rolling out updates monthly to get the best new functionality in the hands of our employees and customers.

Some of the big enhancements we're working on currently include automated load offers to our brokered carriers, LTL pricing and route monitoring tools, last mile innovations to tighten up home delivery windows, and labor productivity tools for our warehouses in Europe. The final thing I want to mention is sales. We're making big investments in our sales force. We have a large opportunity with our existing customers today to play a bigger role in supporting their supply chains. We've already hired 50 new local account executives. We're going to continue to grow that sales group, and we plan to double the number of our strategic account managers. We've established growth-based initiatives, and we've gained a more holistic understanding of customer needs through our new CRM system. We're also ramping up our cross-selling.

77 of our top 100 customers already use multiple XPO service lines, and approximately 21% of the sales generated from these customers come from secondary service lines. That's up from 19% in the first quarter. Customers want to do business with XPO. Our global pipeline for new business and contract logistics alone is over $1 billion. Those are active bids. Our win rate has been improving, and it's been approaching 25%. If you go to our new website at xpo.com, which we launched last week, you'll see our strategy summed up in 2 words, Results Matter. They matter to customers, and they matter to investors. We'll continue to push the pace on every initiative that can contribute to customer service excellence and profitability and cash. This quarter, we turned in very strong results that give you an insight into the future of XPO.

It's the best indication yet of the dramatic opportunity on our doorstep. With that, we'll turn it over for questions. Operator?

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press Star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of Chris Wetherbee with Citi. Please proceed with your question.

Chris Wetherbee (Senior Research Analyst)

Hey, thanks. Good morning, guys.

John Hardig (CFO)

Morning.

Chris Wetherbee (Senior Research Analyst)

Wanted to ask about free cash flow, and obviously a strong second quarter performance on the free cash side. You know, when you guys have talked about free cash, seasonality and the cadence we would expect over the course of this year and going forward, I think there's always been an expectation that the fourth quarter was the strongest free cash quarter for you. Now, I know CapEx probably is a little bit more back half weighted than we've seen in the first half of the year. But how do we think about that? It would suggest if there is, or if it still is the biggest quarter for you guys, that there could be, you know, a decent bit of upside to what you're talking about.

Can you walk us through some of the moving parts of how that plays out over the third and fourth quarter?

John Hardig (CFO)

Hey, Chris, it's John Hardig. Thanks, thanks for the question. Yeah, so we, you know, we, we are, you know, we did increase our guidance in terms of free cash flow for the year. So we said we'll do at least $150 million of free cash flow, whereas before we had a range of $100 million-$150 million. And we had we did have a very strong free cash flow quarter, and there were a couple of reasons for that. You know, one was the EBITDA performance. We, you know, we definitely exceeded our expectations from an EBITDA perspective.

And then from a CapEx perspective, as I said in my comments, you know, we are, you know, being very flexible around our procurement processes and pushing some of our CapEx to the latter part of the year to take advantage of some of those initiatives and really trying to optimize our pricing on investment. We also did a lot around our working capital processes, just trying to manage DSO, DPO, making sure we get our billing out quickly, making sure that we collect cash aggressively, and making sure that we pay our vendors only when they're required to be paid and not before. So we've done a lot in the quarter that was not really related specifically just to the performance of the business.

We are going to do at least $70 million of free cash flow in the second half, and that will be weighted, more towards the fourth quarter, than the third. But we're really, you know, just, just giving guidance for the, for the rest of the full year.

Chris Wetherbee (Senior Research Analyst)

Some of the working capital adjustments that happened in the second quarter, maybe kind of that's done now, and you don't necessarily get the incremental benefit going forward, and that maybe is part of the reason that in CapEx, kind of why fourth quarter may not be the strongest quarter for free cash this year.

Scott Malat (Chief Strategy Officer)

Well, working capital is a long-term opportunity, Chris. That's something we have invested heavily in. We have a best-in-class back office, and we are absolutely investing in making sure that we bill quicker, that we collect as well as fast as we can, and that we pay on time, but it doesn't need to be early.

Chris Wetherbee (Senior Research Analyst)

Okay. Okay, no, that's, that makes sense. And then I wanted to follow up on a Con-way question or an LTL question, if I could. When you think about sort of where you are in the cost savings run rate, I might have missed that in the prepared remarks, but, you know, I think last time we got it, it was in, you know, sort of the $90+ million range. I think maybe now we're in the low 100+ or so. You know, is the roughly $200 million of cost savings target still the right number to be thinking about Con-way, given all the progress you've made so far? And if it is, you know, is this sort of a potentially low 80s OR business for you guys?

I'm just trying to make sure I get a sense of where we are in that process and maybe what the opportunity is going forward.

Scott Malat (Chief Strategy Officer)

We have progressed on our plans for profit takeout. We are now up to $110 million of run rate profit improvement. That's up from $90 million last quarter. The difference is some procurement initiatives and then some back office consolidation. The $170 million-$210 million, we still have a bulk of the procurement opportunity ahead of us. There's additional technology savings, and some other rationalization of duplicative costs as we integrate the systems. When you look at the $300 million that we laid out, that takes into account the fact that while we're on a $110 million run rate, we'll report in 2016, about $80 million of those savings. On...

So when you, when you actually lay out the, the run rate, which came later in the year, you'll report about $80 million of savings. So if you assume we get to our $200 million, that's another $120 million from LTL between 2016 and 2018, plus another $180 million of additional opportunity. Within that $180 million is upside from LTL as well.

Chris Wetherbee (Senior Research Analyst)

Okay. Okay, that's helpful. And then one just follow-up question. In terms of the full year guidance, you've raised it a little bit, I know, on the back of a strong performance in the second quarter. Organic revenue growth, I think, John, you gave us some, you know, pro forma numbers there. How should we be thinking about sort of what's included in the full year target? Is it in that low single digits, or I know maybe a little bit higher ex the LTL acquisition. How do we think about that going forward?

John Hardig (CFO)

No, no, Chris, I, I think we'll see a, a consistent, rate of growth for the rest of the year. So we'll, we'll be in that, that, mid-single-digit range.

Chris Wetherbee (Senior Research Analyst)

Okay. That's helpful. Thanks very much for the time this morning, guys. Appreciate it.

John Hardig (CFO)

Thank you.

Operator (participant)

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

Ravi Shanker (Analyst)

Thanks. Morning, everyone. So Brad, a couple of longer-term questions. I've heard you guys use the phrase inflection point quite a bit in the last few weeks, which implies that you're kind of settled in and have digested Con-way and Norbert Dentressangle and kind of looking ahead to the future. So what does the next phase of XPO look like from here? Is it something that's mostly organic, or do you think that you've settled down enough that you can kind of go back to the M&A well?

Scott Malat (Chief Strategy Officer)

When I use the word or the phrase inflection point, Ravi, I'm referring to a record amount of EBITDA, $355 million, much higher than consensus expectations, and after generating $249 million last quarter. An inflection point in cash flow from operations, also a record $261 million cash flow from ops.

Brad Jacobs (CEO)

... an inflection point in terms of turning free cash flow positive at a very healthy $170 million free cash flow positive. And an inflection point in terms of we expect to continue to generate increasingly more cash flow going forward. So that it's an inflection point in the sense that we've done the heavy lifting over the last several years in terms of acquiring, financing, the tough part of the integrations, putting in place the infrastructure, and now we're benefiting from operating leverage, and we're turning into a cash machine while still investing in growth. So you ask, are we? What, what does it look like? Visually, it looks like we're wearing green visors with our head down and running the business very, very well.

And focusing on a very well-defined plan to take the $1.265 billion of EBITDA this year, to our target of $1.7 billion of EBITDA in 2018, with the vast majority of that profit improvement coming from actions that are company-specific and are independent of the macro environment, especially global procurement. And as Scott said, attacking all $14 billion of our global spend. So we're not looking at acquisitions now. We're not. We're looking at dozens and dozens of specific work streams to optimize the business that we have and to delight customers more.

Ravi Shanker (Analyst)

Got it. Very helpful. And just you personally, I mean, you've obviously kind of been here for a while and have kind of steered the ship to get to where it is right here. Kind of, where do you see, you know, how do you see your involvement kind of continuing over time? I mean, do you feel like you have a lot more to do here, or can you just help us understand that?

Brad Jacobs (CEO)

Seven days from when I wake up to when I go to sleep, I'm fully involved and plan to stay fully involved.

Ravi Shanker (Analyst)

Beautiful. I love it. Thank you so much.

Brad Jacobs (CEO)

Thank you, Rob.

Operator (participant)

Our next question comes from the line of Rob Salmon with Deutsche Bank. Please proceed with your question.

Rob Salmon (Analyst)

Hey, good morning, guys, and real nice quarter. You know, it's been a long time since we've seen Con-way Freight operate in kind of the mid-eighties, and you did it in a tough backdrop. Can you give us a sense if your longer-term expectations have changed at all in terms of where that margin can go to, given the execution that you achieved in the second quarter? And if you could also give us an update in terms of the pricing and tonnage July month-to-date trends that you've experienced quarter to date.

Scott Malat (Chief Strategy Officer)

On operating ratio, we're working our way into the high 80s. Now, just keep in mind, there is seasonality with the business. You have your best operating ratio quarters in the second and third quarters. We do have upside opportunity as we execute on the $200 million or so of improvement, and then the upside that's included addition. But it's too early to say that we can get past the mid-80s and get into the low 80s. We're really working our way into the mid-80s.

Brad Jacobs (CEO)

On, on the July numbers, it's the same trends as we've been seeing. Yield up about 4%, volume down about 6%, and that's how the model's been trending. Now, as we work through the tonnage that was unprofitable or very low margin, we'll, over time, see that volume trend improve a little bit, but we're going to hold firm on, on pricing. We think we have a very rare product in the market that wins awards for number one in on-time pickup, number one in on-time delivery, very low damages, excellent service, and we want to charge a fair price for that. So we want to hold firm on price, and over time, we'll improve the volumes.

Ravi Shanker (Analyst)

Makes a lot of sense. With you guys highlighted about $180 million of kind of run rate profit improvement across a broad spectrum. Can you give us a sense of some of the new cost opportunities that Ramon has identified since joining the company, that are included in that kind of longer range target that you guys laid out?

Brad Jacobs (CEO)

Yes. So procurement is a very, very big component of that because we're buying billions and billions of dollars of things now as a $15 billion company that were previously purchased as a $3 billion or a $5 billion, or $9 billion company, and now we deserve the $15 billion price, and vendors understand that. As we consolidate our vendor base and we become a more meaningful purchaser of trucks, of trailers, of tractors, of fuel, of tires, of temporary labor, of office supplies, of forklift equipment, of all the things that we're spending $10s of millions or $100s of millions of dollars a year on, we deserve a better price. We're very much focusing on global procurement. We're also focusing on real estate.

We've been doing. Ramon's been doing some wonderful work on real estate and finding ways that we can get better rebates from the brokers that we use and other ways that we can optimize our real estate spend, because we have $600 million of company-wide real estate spend. We're also looking at how to improve labor productivity, dollars of labor costs, both salary and temporary labor, direct and SG&A labor as well. We're rolling out engineered standards for everything that we do. We're starting with, we have 750 logistics warehouse facilities around the world, and we're monitoring the ones that function at the most efficiency, the most productive, satisfying customers the most, where we have customers delighted with our performance, and the financial performance is great.

And then benchmarking those to all the rest of them, and then bringing up the lower performers to the higher performers. We're doing the same thing with our 450 or so cross-dock facilities in LTL, both in Europe and the United States. We've had a lot of people flying back and forth from places like Michigan to France, and vice versa, in comparing notes and comparing metrics and comparing KPIs. So transferring these best practices all around the world, training people on these new standard work instructions, benchmarking them, rewarding people for meeting them. Those are the kind of things that we're very excited about in terms of increasing the profitability of the company and also pleasing our customers more.

Rob Salmon (Analyst)

Makes a lot of sense. Well, keep it up. We're seeing it show up in the bottom line. I'll turn it over to someone else. Thanks again for the time.

Brad Jacobs (CEO)

Thank you, Rob.

Operator (participant)

Our next question comes from the line of Scott Schneeberger with Oppenheimer. Please proceed with your question.

Scott Schneeberger (Analyst)

Thank you. Good morning. I wanted to start off with, within LTL, obviously, you've been doing a lot of repricing. I'm curious, could you just speak anecdotally to the behavior of the customers that are going through this with you, and just what you're seeing as an overall behavior?

Brad Jacobs (CEO)

Well, generally speaking, customers get it. They understand that we've got an excellent product, and we have to charge a fair price for that. Now, there's many customers that we already have a fair price, so we're not trying to renegotiate those prices. We have a fair price. It's operating profitably for us, and everyone's happy. There's still a fair amount of, particularly our national account customers, that we're operating at a loss on, or operating on a very measly margin, that we're having a very respectful discussion with of saying, "How can we turn this money-losing business into a profitable business, or at least a break even, break-even business for us?" And we want to keep the relationship. We have other ways we can help those customers on the supply chain besides just their LTL business. But we don't want to lose money.

It's as simple as that. So people get that, and business people don't want to show a loss. They want to show a profit.

Scott Schneeberger (Analyst)

Thanks. And Brad, just to specify the question a little bit more, I think you've been most aggressive with the large national accounts. Are you losing a lot of them in the process, or how does it go post-discussions?

Brad Jacobs (CEO)

Well, we have three categories of LTL customers. On the large national accounts, we have stopped doing business with some of them. That's part of what you see in the tonnage going down, and those were primarily customers that we were just losing too much money on and couldn't find a way to bridge that gap, at least get it to break even. So for the time being, at least, we've turned away that business, or they've gone somewhere else where they could get a deal, at least for the time being, that satisfies them. On the 3PL and the local account business, that's a different story. That business is profitable, and that business has been flat to growing.

Scott Schneeberger (Analyst)

Great, thanks. Just one more to follow up. Going over to Europe, it sounds like the transportation business is performing very well. Could you elaborate, I guess, on a regional basis on what you're seeing there? Thanks.

Brad Jacobs (CEO)

So in Europe, although this morning, U.K. suddenly got better than it already was because of the actions of the government in lowering the rates more, U.K. has been strong, Spain has been strong, France has been not so great, not so bad, kind of flattish. They've had strikes, they've had terrorism. It's been a tough few months for the French. But the business is holding up. The business is resilient, even in the face of this adversity. Those are the three biggest countries that we're in in Europe, and overall, as you saw from the numbers, our European businesses performed well.

Scott Schneeberger (Analyst)

Great, thanks, and nice job on the execution.

Brad Jacobs (CEO)

Thank you.

Operator (participant)

Our next question comes from the line of John Larkin with Stifel. Please proceed with your question.

John Larkin (Analyst)

Good morning, everybody. Thanks for taking the questions.

Brad Jacobs (CEO)

Good morning.

John Larkin (Analyst)

On the LTL business, Brad, initially, you had talked about the notion that, excuse me, the high-service LTL product that you currently offer only addresses about one-third of the LTL market, and the other two-thirds is more of a generic, lower price, lower service alternative. Have you changed your thinking about the timing on when you may begin to roll out a service offering to attack that two-thirds of the market that you're currently not serving?

Brad Jacobs (CEO)

That's likely to roll out second half of next year. That's a big project that needs lots of engineering, lot of pre-programming, and has to go flawlessly when we roll it out. That's something that can't be done frivolously, but it's something we want to do. There's no question about that. There is a large market for an economy product where customers are not very sensitive to whether it gets picked up on Thursday or Friday or Monday, and are much more focused on price. That's not our product. Our product is one that picks up exactly when we say it's going to and gets delivered exactly when we say it is going to-

John Larkin (Analyst)

Mm-hmm.

Brad Jacobs (CEO)

and the damages are very, very, very low. That's a different, that's a different type of customer.

John Larkin (Analyst)

The idea would be to use essentially the same infrastructure, the same pickup and delivery network, and then engineer the line haul to be more flexible, especially with respect to the lower service alternative?

Brad Jacobs (CEO)

... That's correct. But a lot of work has to be done at the cross-dock, and physically, and a lot of work has to be done with the technology. So when the freight comes in, you've got to be able to read that on the, on the barcode immediately, saying, where, is that economy or is that priority? And then you have to have the right locations mapped out on the cross-dock, so it goes to the right location, and the communication with the trucks has to be very clear where it goes. It, it's a fairly complex process.

John Larkin (Analyst)

Got it. Thanks for the answer there. Also, originally, you endeavored to try and find a buyer for the asset-heavy truckload operation, and because the price you were looking for wasn't there, you decided to keep it and talked about some of the synergies that existed between the asset-based truckload and the sort of asset-light brokerage capability within your brokerage business. Have you seen that really play out, where you've got your asset-based operation handling sort of the base load volume for particular customers, and then the brokerage business sort of providing the flex capacity at the end of the month, end of the quarter, end of the year, et cetera?

Brad Jacobs (CEO)

We have definitely started to see some great synergies between truckload and LTL, and between truckload and brokerage. So brokerage is, it has visibility into the empty miles and is filling those trucks. One very interesting synergy that's come about is, about 80 of our repair and maintenance facilities in LTL, which previously had never been available to truckload, we've opened those up to truckload. So we don't have to go to third parties, we don't have to travel long distances, and of course, it, it's cousins, it's, you know, it's LTL and, and TL, so it's taken care of well. So that's something that we've been rolling out, too. This has the benefit of keeping maintenance down as well as, and we can extend the life of the trucks. Many best practices are being shared.

A lot of the things that we had been previously doing in LTL very well, like rate, price, pricing, like load optimization, like lane pricing, lane optimization, all those things now we're rolling out into truckload. That's a process that's going to take a few months to do. But I'm very optimistic in our ability to significantly improve the profitability of truckload. I think Tim Staroba is doing an excellent job down there.

John Larkin (Analyst)

Excellent. And then maybe one last one for, Scott. To what extent do you think the surplus inventories out there, particularly in the retail supply chain, are causing the softness in freight demand, not only in the U.S., but perhaps even in Europe? And how long do you think it'll be to sort of clear that up so that inventories get to normalized levels, and we'll see the pull-through to freight demand normalize? Is that a 2017 event, or when do you expect that to be happening?

Scott Malat (Chief Strategy Officer)

Well, it's always hard to tell. If you look at the macroeconomic indicators and the things we usually track, industrial production, we haven't seen as much freight as those macro indicators would imply. We don't see anything right now that looks like it's just tightening up the market in the back half of the year so much, and a big swell of volume. But we'll see.

John Larkin (Analyst)

Thanks very much.

Brad Jacobs (CEO)

Thank you. I see we only have about 20 minutes left till the market opens, so if we could try to limit questions to one and maybe one follow-up, that'd be great.

Operator (participant)

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

Allison Landry (Analyst)

Thanks. Good morning.

Brad Jacobs (CEO)

Morning.

Allison Landry (Analyst)

So you talked about U.K. exposure and contract logistics being relatively insulated from the macro. And putting the QE expansion this morning aside for a second, how do we handicap the risk to EBITDA if GDP does go negative in both the U.K. and broader Europe?

Brad Jacobs (CEO)

If GDP goes negative in the U.K. and broader Europe, that's going to be negative for us. So our businesses, some of them are economic sensitive, and some of them are less economic sensitive. So our e-commerce business, which is our strongest vertical in Europe, I would say that's not going to be too affected, but it might be, it might be affected, because even though the trend of purchasing goods online is increasing, the total amount of goods purchased may go down enough that that positive trend may not overcome it. Another big vertical for us in Europe is food and beverage. Food and beverage, I think people are still going to eat and drink a fair amount, and some of those countries in Europe, they actually might drink a little more if the economy turns out. I'm not as worried about the F&B over there.

Anything that's auto-related in a negative GDP environment would be negatively affected. But I'm not very pessimistic about recession happening in Europe. Europe's in a different part of the cycle than we are. Europe is not raising rates. They're not thinking about raising rates. The debate is on how much they're going to lower rates, as they did this morning. Unlike the United States. Unlike here in the States, in Europe, they're still doing quantitative easing. They're putting liquidity into the system. I just don't feel the likelihood of a recession in Europe being very high because of that. Now, if there's geopolitical events, if some massive terrorism, that's a different story.

Allison Landry (Analyst)

Right. Okay. That was, that was helpful. And then, just my follow-up question, you, you mentioned pushing some of the CapEx to the latter part of the year, you know, sort of to take advantage of some procurement initiatives. But I was wondering if you could elaborate on, on specifically what types of investment you were able to, to push and, and which segments that would relate to, and, if, if any of the spend was pushed to 2017 or if it's just to the back half of this year. Thank you.

John Hardig (CFO)

... Hi, Allison. Thanks for the question. Yeah, the nothing's been pushed into 2017, so we still expect our CapEx to be $475 million-$500 million. And the biggest category of that deferral, in terms of pushing back and taking advantage of procurement, was around the rolling stock, tractors and trailers.

Allison Landry (Analyst)

Got it. Okay, thank you for the time.

Brad Jacobs (CEO)

Thank you.

Operator (participant)

Our next question comes from the line of Brian Ossenbeck with J.P. Morgan. Please proceed with your question.

Brian Ossenbeck (Analyst)

Hey, good morning. Thanks for taking my question.

Brad Jacobs (CEO)

Good morning.

Brian Ossenbeck (Analyst)

So I had a question on European e-fulfillment. You know, back in April and May, there was a few announcements about EU single EU VAT, and also more concerted effort to facilitate a more cross-border e-commerce in Europe. So, you know, obviously, those are still early stages, but I didn't know how you saw that playing out, if that would be, if more facilitation would be beneficial for you, just to get more volume, or if that would somehow, you know, affect what you do on a day-to-day basis. Be curious to hear your thoughts there. Thanks.

Scott Malat (Chief Strategy Officer)

Just in general, anything that opens up the borders, anything that makes it easier to trade around Europe, makes it easier to grow e-commerce. And e-commerce for us has been very cross-border. That has been where we have more centralized auto, e-fulfillment, facilities, and we can distribute that across Pan-Europe. So we think it's moving in that direction.

Brad Jacobs (CEO)

Everything related to e-commerce, globally, is doing very, very well at the moment. That's either contract logistics, last mile, even the line haul. Anything that touches our big e-tail customers is growing very rapidly. And that's not just for us, that's for our competitors as well. We just happen to have a very significant portion of our business levered to that.

Brian Ossenbeck (Analyst)

Okay, and just one quick housekeeping. Can you give us the integration costs you expect for the second half of the year?

Scott Malat (Chief Strategy Officer)

Around $25 million in the third quarter, and then it'll moderate in the fourth. We still expect integration costs to be in the $75 million-$100 million this year, as we've always forecasted.

Brian Ossenbeck (Analyst)

Okay. All right, great. Thanks for your time.

Brad Jacobs (CEO)

Thank you, Brian. Operator, who's next?

Operator (participant)

Our next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.

Brandon Oglenski (Analyst)

Hey, good morning, everyone, and thanks for taking my question. And, and also thank you for the improved financial disclosure on LTL. That's helpful this quarter. On that question-

Brad Jacobs (CEO)

Partly, that more disclosure was partly in response to your request for it on the last call, Brandon, so thank you for that request.

Brandon Oglenski (Analyst)

Well, I, I think it helps a lot of your investors in analyzing the results here, too, so appreciate it. On that question of e-commerce, I think you guys mentioned about a few contracts that were helping in the quarter with both logistics and last mile. I was wondering if you could expand a little bit more on that. And also provide a little bit of thoughts on organic growth within logistics. I think you might have covered it, but I missed it. But just talk more broadly about how e-commerce is fitting into your various verticals, and how that could be a future opportunity or even risk from some of the bigger players.

Scott Malat (Chief Strategy Officer)

For e-commerce, it's really been a play on our e-fulfillment and contract logistics, and also in last mile, as you were saying. From organic perspective, Europe supply chain was a star in the quarter. It was very, very strong, and that is because of the e-commerce, as well as some customer wins on the consumer side. Last mile was also a big grower. It grew 18%, and that's including fuel, so excluding fuel was higher than that. And that is very much the e-commerce. We work with a lot of different brick-and-mortar retailers and e-commerce direct providers to provide e-fulfillment and last mile. And we do more things in the areas where we can add more value than anyone else. So in big and bulky, that's something we do extremely well.

It's something that we are the largest player. We have density. There's very specialized characteristics in what you need to handle that well. And in e-fulfillment, having the largest platform in Europe, we have very strong returns logistics, which is a very complicated part of the supply chain. So with e-commerce providers, we're handling things that are very specific, very complex, and adding a lot of value.

Brandon Oglenski (Analyst)

Okay. Appreciate that, Scott. And then maybe one, just very quickly on the balance sheet. So as you look forward to better free cash flow next year and into 2018, can you guys update us on where you're looking for target leverage and potentially any ability to refinance debt as you, you know, pay down some of that aggregate outstanding right now?

John Hardig (CFO)

Yeah, sure. You know, we're about 4 times leverage today based on 2016 EBIT, EBITDA. And obviously, you know, that's come down through the course of the year. We do expect leverage to come down again in 2017. And in terms of repaying debt, I mean, you know, we've said before that we want to run with about $300 million of cash on the balance sheet. That's an amount of cash availability that we're comfortable with. And anything in excess of that, we would use to repay debt.

We can't repay any of the term loan yet, because it's not callable without a premium, but we will, and, and we'll be able to do that in a few months, if that's something we should choose to pursue.

Brandon Oglenski (Analyst)

Okay, thank you.

Brad Jacobs (CEO)

Thank you.

Operator (participant)

Our next question comes from the line of Jason Seidl with Cowen. Please proceed with your question.

Jason Seidl (Analyst)

Thank you, operator. Good morning, guys.

Scott Malat (Chief Strategy Officer)

Good morning.

Jason Seidl (Analyst)

A couple quick questions. When we're looking at the Contract Logistics business, can you give us an idea about the pipeline, you know, sort of into the maybe back half of the year and into 2017, and what we should expect?

Scott Malat (Chief Strategy Officer)

Well, that pipeline's grown to about $1 billion overall. So far in Europe, we've closed, just in Europe, we've closed about EUR 265 million of, of new business. So we're very much, we're closing somewhere in the, in the range of 25% of, the business in that active bidding pipeline. And, and you're right to say that a lot of the things in that billion-dollar pipeline would start to impact us in 2017. So when we win our share of that, you'll see it ramp up maybe in the back at the end of this year, but more likely in 2017 and even the back half of 2017 for the contracts we're working on right now.

These are very complex, long-term, 5-10 year contracts, where the sales cycle is usually 18 months, and the ramp-up time could be 1 year.

Jason Seidl (Analyst)

Jason, when you look at the EUR 265 million new business won to date that Scott just mentioned, that contrasts with EUR 175 million this time last year. So EUR 175 million won has now gone to date. So my hat's off to Jean-Luc DeCloux and his team, who run the sales organization for supply chain in Europe. Just doing a great job.

Scott Malat (Chief Strategy Officer)

Yep.

Jason Seidl (Analyst)

Yep, clearly, they seem to do with those numbers. Also just want to piggyback on a previous question. Somebody mentioned that you guys, at one point, were looking to sell potentially Con-way Truckload. Now it looks like you're getting a bunch of synergies out of it. Is that completely off the table now? Are there so many synergies that you're finding that you'd rather keep it in long term? Or if the markets were to turn and you could get an adequate price for Truckload, that would be something that you would potentially revisit.

Scott Malat (Chief Strategy Officer)

We're not trying to sell truckload, we're trying to optimize truckload. We see lots of ways to take that $110 million-$120 million EBITDA business to $130 million-$150 million of EBITDA, and even higher net over a period of years. We're so we're improving it, we're increasing it, and we're making it a better business.

Jason Seidl (Analyst)

Okay. Those are my two now, guys. Appreciate the time.

Scott Malat (Chief Strategy Officer)

Thank you.

Operator (participant)

Our next question comes from line of Todd Fowler with KeyBanc Capital Markets. Please proceed with your question.

Todd Fowler (Analyst)

Great. Thanks. Good morning, Brad.

Scott Malat (Chief Strategy Officer)

Morning.

Todd Fowler (Analyst)

Good morning. Just on the guidance here, you know, I think historically, you've talked about the second quarter being about 26% of the total year EBITDA. You know, if I take what you did here in the quarter, it implies a run rate higher than what you've guided to. Can you help us think about, you know, maybe some of the strength here in the second quarter, and then how do we think about the EBITDA sequentially as we move through the back part of the year?

Scott Malat (Chief Strategy Officer)

Thanks, Todd. We did have a very good EBITDA quarter in the second quarter. I think third quarter will likely be in line with second quarter, with EBITDA. And then fourth quarter, we've always said, is a much lighter quarter. We would expect, given the strength, especially, so far this year, somewhere in the range of 24%-25% of the EBITDA for the year to come in the fourth quarter.

Todd Fowler (Analyst)

Okay. And so the thought process there is that the seasonality or the seasonality is offsetting some of the cost opportunity and some of the growth that you'll see as you move through the rest of the year at this point?

Scott Malat (Chief Strategy Officer)

Well, we'll continue to grow on a year-over-year basis, but there is significant seasonality. Our second and third quarters are very close together. Usually in LTL, seasonally, second quarter is the best quarter of the year, and in Europe, transportation, second quarter is the strongest quarter of the year, and the rest of the business, third quarter is the strongest quarter in the year. So they're very close, somewhere neck and neck. And then fourth quarter, as the seasonality at the end of the year, as shipments start to tail off, you will see a slowdown in mid-December, so that's a much smaller quarter than two and three.

Todd Fowler (Analyst)

Okay. That helps. Then just for my follow-up, can you remind us the difference between the depreciation that you report on the cash flow and then the other depreciation adjustments that you make? I mean, I've got the quarterly cash flow for the depreciation statement, you know, that $160 million range, but the total depreciation, when you do the add backs for the segments, is closer to $225 million. What's that $70 million difference in the D&A and the cash flow and what you do on the segments?

Scott Malat (Chief Strategy Officer)

you know, I'm not sure I follow your question on that, Todd. Why don't I reach out to you afterwards and follow up? Because I'm not following your math.

Todd Fowler (Analyst)

Okay, John. We can, we can follow up offline. I'm just trying to reconcile between when I do the segment EBITDA, and I add up all the segments to get to what you reported and the difference between, you know, what you report for depreciation on the cash flow. I know there's some reclassification coming out of purchase transportation, some of the other costs. I just wasn't sure why they show up in the segment EBITDA, I should say, versus the cash flow. But we, we can follow up offline if it's not, if it's not clear the way I'm asking it.

Scott Malat (Chief Strategy Officer)

We definitely will follow up and talk about it. Within the segments, we usually include footnotes where there's D&A included within our net revenue line.

Todd Fowler (Analyst)

Yeah. Okay, and that, that's the piece I guess I'm trying to reconcile, but let's do it offline at this point.

Scott Malat (Chief Strategy Officer)

Sure.

Todd Fowler (Analyst)

Okay. Thanks, guys.

Scott Malat (Chief Strategy Officer)

Thank you.

John Hardig (CFO)

Thank you, Todd.

Operator (participant)

Our next question comes from the line of Nate Brochmann with William Blair. Please proceed with your question.

Nate Brochmann (Analyst)

Good morning, everyone.

Scott Malat (Chief Strategy Officer)

Good morning.

Nate Brochmann (Analyst)

Hey, I wanted to talk a little bit in terms of, you know, when you originally set up these targets, in terms of how much you can cut out of the business, as well as obviously the recent acquisitions, how you establish that, that threshold in terms of not cutting too deep? Where we would either destroy service levels or maybe a year from now, we realize that we cut too much and then have to add a bunch back. What's kind of the initial thought process with that?

Brad Jacobs (CEO)

We never want to do anything that hurts customer service levels. First and foremost, we have to delight our customers. We have to keep our customers happy, we have to be listening, we have to be very, have lots of feedback loops to make sure that they're happy with our service, because customers have choices. We're not the only transportation logistics provider. In terms of headcount reduction, let's talk about the place where we've had the most headcount reduction, LTL. In LTL, every single metric of our service has gone up, and we do weekly customer satisfaction studies. In every single metric, we've improved our customer satisfaction. I would say it's not despite the headcount reduction, it's in part because of the headcount reduction.

When you run an organization more leanly, with clear lines of authority, clear reporting structures, with clear metrics, and you roll out P&Ls to every single unit, and you hold people accountable, and you have very clear objectives, you end up working more efficiently and more effectively for the customer. I think in large part, the headcount reductions and our ability to have to compete more effectively with a better cost structure has been a plus. We have not seen any degradation in customer satisfaction in any of the businesses that we bought. Every single one of the businesses we've bought has been improved since we've bought it. That's the thing I'm most proud of, what the team has accomplished over the last several years.

Nate Brochmann (Analyst)

Okay. And then, just for a quick follow-up, obviously, you've been benefiting a ton from the cross-selling opportunity. I'm just wondering how much of that is coming from, just customers who use that other service and then are using you for a portion of that spend, versus kind of the, you know, ongoing, slightly secular trend here of allowing, some of the more third-party providers to get a little bit deeper into their supply chains and overall operations, and just how you see that trend progressing and how that's benefited you.

Brad Jacobs (CEO)

It's both. There is a little of we, you know, inherited a customer with a certain acquisition, and a year or two later, we inherited the same customer with, with a different acquisition. So suddenly they're doing two services or three services instead of just one previously. But the majority of the cross-selling growth is the latter. It's proactive, it's going out and having a completely different level of discussion with customers. So who we meet with at our customers is a higher level as a result of the broad service offering that we have. We're meeting with global chief supply chain officers, we're meeting in the C-level suite, and we're looking not just at a specific mode, but we're looking at their $500 million or $5 billion a year of total transportation logistics spend globally.

Our role is, how can we take out $ tens of millions from that spend? That's our. That's what we're doing now. That's a completely different business model than just trying to bid on a commoditized basis for a specific service line. This is really forming a partnership, a strategic partnership with our customers to understand their supply chain and how they, how they can do what their bosses are putting pressure on them to do, which is to take out a couple of points or more of cost every year, continuous improvement of their supply chain, cost structure.

Nate Brochmann (Analyst)

Great. Thanks for the additional color there.

Brad Jacobs (CEO)

Thank you.

Operator (participant)

Our next question comes from the line of Bascom Majors with Susquehanna. Please proceed with your question.

Bascome Majors (Analyst)

Yeah, thanks for squeezing me in here. So, first off, congrats on the accelerated progress towards your multiyear targets on the EBITDA and the cash flow. Clearly, there's some external challenges out there, but you're doing well. You know, I was hoping in light of the improving margin and cash flow profile here, can you give us a fresh walk-through of your sense of downside sensitivities to EBITDA and free cash in a recessionary scenario?

Brad Jacobs (CEO)

Sure. The good thing about our model is that our CapEx is very flexible. So we can take down CapEx in time in downturns and maintain or actually increase our free cash flow. So in a deep, deep downside scenario, we can still cut our CapEx more than EBITDA, and then you get the money back on free cash flow. Different businesses react differently to the cycle. That's the power of the model. Some of our businesses, like contract logistics, do very well through a cycle. In actuality, sometimes we do better in contract logistics in a downturn, as some of our customers look to outsource more of their supply chain to variabilize their own costs. So you'll win a lot. You have a lot of opportunity to win new business.

And then in truck brokerage tends to do well through a cycle. Last mile with e-commerce trends is more secular, will do well through a cycle and has done well through previous cycles. Things like LTL and truckload and other parts of transportation, sure, that will be more hit on the EBITDA line than some of those other more resistant levels. But again, CapEx, especially within LTL, is very flexible. The trucks on the local pickup and delivery can last 10, 11 years or more in some cases, and you can delay purchasing for a number of years until you need to revamp that purchasing.

Bascom, if there's one single point that we'd like to communicate to you on this call, it's that the majority of the several hundred million dollars of improvement that we are executing on in profit over the next few years are company-specific actions that are independent of the macro. Regardless of what happens with GDP, I can assure you, we will be purchasing tractors and trailers at lower prices over the next few years than we are now. I can assure you, regardless of Brexit or recession or GDP, we will be purchasing tires at lower prices than we have been historically, and so forth and so on. So that's the main point we want to get across, that we have an amazing opportunity right in front of us to continue to execute on cost reduction and improvement and transferring best practices that are independent of the macro.

So I see now it's past the market open at 9:30 A.M. Let me conclude with the following. We started the call with saying that we're at a positive inflection point in our, in the evolution of our company, and that we're re- reaping the rewards of the last five years. We've built a very well-diversified, well-functioning global business that provides significant value to our customers, and the proof is in the pudding. Look at the numbers this quarter. We had record EBITDA, way above expectations. We had record cash flow from ops, way above expectations, record free cash flow. So we have a clearly defined action plan to go from $1.265 billion of EBITDA this year to our $1.7 billion target in 2018.

Thank you for participating in the call, and we look forward to speaking with you in three months.

Operator (participant)

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.