Earnings Call Transcript - FWRD Q1 2020

Operator, Operator

Ladies and gentlemen, thank you for joining us for the First Quarter Earnings Call 2020. This conference is being recorded. Thank you for being part of Forward Air Corporation's first quarter 2020 earnings release conference call. Before we begin, both the press release and presentation for this call are available on the Investor Relations section of Forward Air's website. This morning, we have CEO Tom Schmitt and CFO Mike Morris with us. You should have received the press release announcing our first quarter 2020 results, which was submitted to the SEC on Form 8-K and distributed yesterday after the market closed. Please note that during this call, we will be making forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These statements will address our business responses to COVID-19, including impacts on our various businesses, the suspension of our 2020 guidance, future plans for our pool business, measures to enhance our liquidity, and our outlook for the second quarter and fiscal year 2020, including expectations for revenues, tonnage, and free cash flow, as well as the anticipated effects of growth and strategic initiatives. These statements rely on current information and expectations, and are subject to risks and other factors that may lead to actual outcomes differing significantly from the anticipated results. For more details about these risks and factors, please refer to our SEC filings, the press release, and the presentation for this earnings call. The company has no obligation to update any forward-looking statements based on new information or future events. Now, I'll hand the call over to Tom Schmitt, CEO of Forward Air. Please go ahead, sir.

Tom Schmitt, CEO

Thank you, Roxanne, and good morning to all of you on the call. First things first, I thank all of our teammates and our independent contractors. I've never been prouder of you. Whether you're in operations buildings, on the road, or working from home, you are moving America forward, and you're keeping lives and livelihoods going. So thank you for that. And especially, thank you for doing this with our own brand of Precision Execution at the same time. We are operating under a CDC-plus standard across all of our operations, and you are supported by 1,000 of us who, within a few weeks, moved to productively working from home. So that's what I call Precision Execution in these times. Another first, Mike and I typically sit across from each other in our Atlanta support office for a call like this one. Well, we do sit across from each other at our virtual table now, both safely working from our Atlanta homes, just a couple of miles apart. From the health of our people, which always comes first, let me talk to the health of our business. As you can imagine, late 2019 and early 2020, we were preparing for a slowing economy months before you or I could even spell COVID-19. As imports were going down, there were signs of a freight recession. The price of fuel was going down. So we were getting ready for a slower economy. Then COVID-19 showed up, this black swan that impacts so many teams, and it impacts our Forward Air team tremendously. As you know, we have heavy ties to airfreight from Asia, heavy ties to ocean freight from Asia. Typically, those things work tremendously well for us; well, not the past couple of months. Through our retail pool business, we have heavy ties to the mall business. Last year, we actually did well in a shrinking retail mall pie. In 2019, our pool business was better than 2018, but it's hard to win in a temporarily nonexisting pie. We are primarily moving business-to-business, nonessential goods. This COVID-19 tragedy, that's a human and humanitarian tragedy, first and foremost, has impacted us tremendously. Fortunately, as a leadership team, we always look to reset, refresh, and look around the corner in our quarterly sessions. In fact, our next session scheduled for May was our 'black swan' session, where we were about to examine all the scenarios that we weren't even conceiving could exist. That session came a bit faster than planned, and it became much more real than we planned. On the positive side, our DNA of being agile and acting fast serves us well. We have an asset-light model to begin with. We cut costs quickly, and we also deferred CapEx surgically where it made sense. As Mike will talk about in a few moments, we flexed up our liquidity significantly. Behind the scenes, we calmly, firmly moved forward with steadfast confidence. Last year at Investor Day in New York, we celebrated 25 years on NASDAQ and unveiled our beyond 2019 strategy. We are firmly executing this strategy. We've implemented our Expedited Freight segment, Truckload and LTL collaborating better than ever, and are outlining together. Local pickup and delivery LTL and the Final Mile business are working together, sharing facilities. Our Truckload business is stretching with enhanced brokerage. Across the board, our Expedited Freight segment is collaborating in a way that we conceived a year ago, and we're executing firmly now. Thank God for our dual-growth approach between organic and M&A in Final Mile; it’s working beautifully. We had two acquisitions last year and are also growing organically. When I mention Final Mile, I should mention the human side. An extra shout-out to our teammates on the Final Mile team, the contractors, our teammates, who safely go into homes right now, installing essential appliances. I can tell you, my own personal experience the last six weeks—I’ve never used the washing machine or a fridge as much as I have the last six weeks. Intermodal was the rock star last year. We actually had a double-digit margin and growth rate in Intermodal. So, I would venture a bet they will get there again. A lot of organic M&A growth, collaboration, just as we conceived it last year, we’re executing forward. Our support teams have never been more focused. We’re deploying first-class standards across the board. On the revenue side, we consistently leverage our fastest network; we are transitioning more into essential goods, small and medium enterprises, B2C, and new verticals. Right now, we are still primarily a nonessential B2B company. However, this reinforces there’s nothing written that this is all we shall be. My final point before turning it over to you, Mike. In the release, we mentioned we are evaluating strategic options for our pool business. To clarify, pool does fit our narrative; it’s about a timely delivery of goods. However, we determined in our beyond 2019 strategy process that the asset intensity of the pool business does not align with the high-velocity, asset-light nature of our portfolio. We have been in a sale process, supported by Raymond James for several months, interrupted by COVID-19, and resuming that sale process fully. We will continue serving our current pool customers and look for additional customers with the first-class service they deserve. We started to stretch into other verticals last year, such as hospitality and industrial. We have a clear intention to turn our first-class business over to a next owner who can take it to the next level. Overall, we are executing our game plan with precision execution, moving firmly forward with tons of confidence. So with that, over to my virtual roommate here, Mike.

Michael Morris, CFO

Thanks, Tom. As a result of our strategic intent to divest pool, we will begin reporting pool as a discontinued operation, starting with our second quarter earnings release and 10-Q filings. For those on the call who are not familiar with a discontinued operation, it is an accounting term that describes how we will report pool’s financial results due to our commitment to a divestiture. In the real world, this does not mean we are stopping or discontinuing Pool Distribution activities. We will continue to serve our current and additional pool customers as demand improves, and we will make investments to enhance pool’s profitability and prepare it for an efficient separation. As discussed in our earnings release, we have suspended guidance due to the significant uncertainty created by COVID-19. But let me share our perspective on the months to come. We expect April to be the most challenging month. Reduced U.S. demand for nonessential freight and its effects on air and ocean freight volumes will adversely impact Expedited Freight and Intermodal revenues. Within Expedited Freight, network revenue will probably be pressured by lower fuel surcharges with diesel prices down over 20% year-on-year, partially offset by increased Final Mile revenue driven by our FSA and Linn Star acquisitions. In total, we could see Expedited Freight and Intermodal revenues down 10% to 15% in April. Pool will be hit much harder. Temporary retail closures and stay-at-home orders have nearly wiped out pool's April revenue, driving it down roughly 95%. At these low sales levels, pool cannot cover its fixed costs and operates at a loss. However, as we enter May, we are cautiously optimistic that we are turning a corner. Weekly LTL tonnage, down around 30% by mid-April, is now down roughly 15%. Our customers are preparing for the economy to reopen, and we are beginning to see increased activity in Expedited Freight and, to a lesser extent, in Intermodal. Pool could improve more slowly as retail malls gradually open across our footprint, but we expect pool's May revenue to be better than April's. Our path through the balance of the quarter will largely be determined by the timing and impact of loosening stay-at-home orders and whether the gradual reopening of the economy drives increased demand for nonessential goods. We have limited visibility, but our base case assumption is a slow sequential recovery throughout the rest of the quarter. We currently estimate that pool's results will lead to a discontinued operations loss of $10 million to $15 million for the second quarter, which we expect will be big enough to cause a consolidated second quarter operating loss for Forward Air, although on a continuing operations basis, we expect to have positive operating income, though margins may be very low. While many of us are sheltering in our homes to ride out the worst of COVID-19, Forward Air will rely on its balance sheet. Our cash balance of $104 million, coupled with $75 million of availability on our credit line, gives us a total liquidity position of $179 million, almost nine times our historic target cash level. Our accounts receivables are being collected with no significant deferrals or defaults. On a consolidated basis, we expect to be free cash flow positive every quarter this year and plan to pay a dividend every quarter. We believe that our financial flexibility, along with the incredible people who make up team Forward Air, will allow us to weather this terrible COVID-19 episode and emerge a stronger competitor. With that, Roxanne, let’s open the line for Q&A, please.

Operator, Operator

That question comes from the line of Jack Atkins with Stephens. Please go ahead.

Jack Atkins, Analyst

Well, first off, thank you for the additional color and insight on the business trends. I think that's all very helpful. And obviously, I think we all know things can change pretty rapidly. So, if we could dig into the current business trends just for a moment, could you provide a little more detail specifically around the improvement you've seen over the last week or two in the expedited business from a tonnage perspective? Mike, are there any specific end markets or geographies that that's tied to? Just some additional color on that would be helpful, as it’s encouraging to hear that you've seen a recovery.

Tom Schmitt, CEO

So Jack, as you can tell from my accent, this is not Mike responding, but I'm going to go first, and then Mike will follow up and correct me. No, seriously. Over the last two to three weeks, I mean, to some extent, this is the beauty of refocusing and reshaping the type and way we work. I spoke to all of our largest 20 customers one-on-one recently. I obtained our insights and numbers along with their perspectives, which are equally or even more important. First, Jack, LTL volumes have been much better this week and the last week than the first two weeks of April. I’d describe this progress like a U. If we follow that curve of April, the first half of the month was likely the left-hand side of the U and we are on the right-hand side, slowly moving up from the bottom. In percentage terms, Jack, LTL volumes with any benchmark from last year are probably 15 percentage points better than in the last two weeks. The second encouraging thing—geographies—West Coast and Northeast were both hit hard but are coming back, especially the West Coast. I was there just in early March, and it was beginning to slow dramatically. It’s starting to come back, which is very encouraging. Additionally, we’re currently producing record LTL service; our on-time service numbers have never been better. Our customers recognize this. They, too, have seen a downturn, but I'm confident that if you're talking about a slice of pie game, we’re winning. These customers are making decisions in favor of partnering with us. This might not show immediately in the numbers for April, but I’m optimistic about what it indicates for the future as we provide industry-best service. I’m hearing good things. Speaking with them one-on-one, I'm seeing positive signs, especially in the hard-hit West Coast, and the numbers coming out are substantially better than two weeks ago. Mike, do you want to add or make any corrections?

Michael Morris, CFO

No, that was pretty good, Tom. Jack, the only thing I would just add is that against that backdrop, we are continuing to make progress in organic growth on door-to-door deliveries. Last quarter, our 3PL daily tonnage was up over 85%. That initiative is still smaller in the big picture, but it continues to progress amidst this larger backdrop of decline.

Jack Atkins, Analyst

Okay. Got it. That's all very helpful color. So along those same lines, how are you thinking about managing costs, given how dynamic the environment is? Could you discuss some of the cost-containment actions you are taking broadly? And how are you managing capacity, particularly since cutting an owner-operator can be difficult?

Michael Morris, CFO

So I'll answer that in reverse. On the capacity side, the fleet is in a very good place. I think we mentioned in the 8-K that it’s the best it's ever been. One of the things that’s been helpful on the capacity side is the integration of the Truckload and LTL fleets together. That opens up new opportunities that didn’t exist previously. These form one fleet now; it’s basically finished. The next wave of this is the growth of our Truckload brokerage operation. I’ve spent time talking to the team running that, and it provides us a better understanding of how the brokerage operation can help reposition drivers in our LTL network, and find opportunities for owner-operators who may be idle. So we feel pretty good about where our fleet is in terms of operating efficiently now, and also recovering as demand picks up. As for overall costs, let me break it into two buckets to give you a clearer sense of where we stand. The most significant changes are in the pool segment, which is essentially in a hibernation mode. Given such low revenue, we’ve had to remove nearly all the variable costs and cut nearly all softer fixed costs across the structure such as labor and supplies. We’ve made workforce adjustments at pool, reducing the staff by about 1,485 people. Last year in Q2, OpEx was $44 million; we’ve probably cut that by $30 million on a run-rate basis. We're now down to about $10 million to $15 million in remaining variable costs to serve low volumes and fixed costs that we either can’t eliminate or are very reluctant to cut because we want to be in a position to reopen. Outside of pool, specifically for Expedited Freight (excluding Final Mile, which is growing), we’ve also reduced variable and semi-fixed costs. You can only do this if your PT and dock operations are running effectively. They are running well, and we have likely reduced PT costs by $21 million on a year-on-year basis. We may have reduced labor costs by about $6 million, with a significant portion at LTL. We’re integrated, and we can operate efficiently. If volumes pick up, we’ll pull some of that cost back in. If volumes stay soft or decline, we’re prepared to take further action. But we are actively working on this.

Tom Schmitt, CEO

Yes. Just one point to add, which may help illustrate the power of our driver pool right now. As we've been contracting volumes, we need to ensure our independent contractors get sufficient runs. We’ve pulled two levers: we stopped recruiting new classes, primarily due to challenges with testing and driving simulation. The second lever we pulled was to reduce PT. This helps our independent contractor pool still have runs since we applied those other two measures. We maintain our best drivers who know us best, delivering that record service. Our retention rates are at a record high, so I feel very positive about flexibly increasing hours for that core driver pool as customer demand resumes. We're currently seeing record retention levels and that serves us well.

Operator, Operator

Our next question comes from the line of Todd Fowler with KeyBanc Capital Markets. I'm sorry, I think he dropped from the question here. We'll go to the next question. That comes from the line of Ben Hartford with Robert W. Baird & Co. Please go ahead.

Ben Hartford, Analyst

Just to clean up the discussion around the owner-operator base. Have you made any changes to the compensation package for the existing owner-operator base? Have you had to make any adjustments?

Tom Schmitt, CEO

The answer is no. We maintain a fundamental principle that we applied universally. We rightsized and flexed our workforce in many areas. As Mike mentioned earlier, we’ve adjusted in five areas. We compensate our independent contractors fairly per mile; they earn every penny they receive.

Ben Hartford, Analyst

When you talked about the expansion into B2C and essential goods, this seems to reflect the strategy of expanding your addressable market, but also to gain visibility into that freight. So when you emphasize the B2C and essential goods strategy, is that in addition to what you previously planned regarding customer base expansion? Can you specifically target those verticals now? Has COVID accelerated this focus?

Tom Schmitt, CEO

Yes, that's a good point, Ben. We established an initiative last year called 'grow forward', aimed at retaining and expanding our customer base with surgical tools used to profitably grow. Two months ago, we intensified these efforts, describing it as 'grow forward intense'. In this area, we are focusing not only on new verticals, such as 3PLs and airlines, but also leveraging our CRM tools to address small- and medium-sized enterprises, which would have previously been below our radar. The framework we established last year allows us to execute our plans with additional intensity.

Ben Hartford, Analyst

Any thoughts on rebasing the fuel surcharge in the Expedited Freight LTL sector considering the changes in fuel prices?

Tom Schmitt, CEO

It’s an interesting point. I have spent a lot of time recently focusing on this topic. We want to ensure it’s appropriate and precise for our customers. We are examining if the surcharge structure we currently use is appropriate or if it's time to modify it based on variations among different customers. There’s a lot of intense discussion to ensure we leverage fuel correctly and surgically.

Ben Hartford, Analyst

With respect to the pool segment, you mentioned that you were exploring divestiture earlier this year. The process was paused due to COVID-19 and is now resuming. How close were you to completing a transaction before the outbreak, and how do you envision the timing of disposal given the current changes?

Tom Schmitt, CEO

We were very close. After our strategic review last summer in New York, we had very detailed conversations. In terms of time frame, it's definitely hard to predict. But I can say there is still active interest from parties, although they may not want to execute immediately, and we also seek more stable figures before proceeding. We have a pipeline with active interest and Raymond James supporting us throughout this process. We didn't have to start from scratch; we just had to hit pause and now resume. It’s hard to predict timing, but if Q3 reflects a significant uptick, we should have many positive options to execute upon by the end of this year or sooner.

Ben Hartford, Analyst

One more question. Amid the first quarter, can you assess how your growth in 3PL customers and door-to-door expansion measure against your long-term plans for building density in the network and its operating leverage?

Tom Schmitt, CEO

I'll provide a headline, then Mike will clarify. Our focus has consistently been on the quality of our LTL revenue rather than solely on volume. The profitability of the door-to-door service still needs to approach that of airport-to-airport services, emphasizing partnership with domestic forwarders who use us for airport-to-airport business. I've never communicated more collaboratively with our core customers. Their feedback has been positive, indicating that our service is valued amid these challenges. The door-to-door service builds upon this strong base. We’re examining profitability on a period-over-period basis and while it's a work in progress, I like what I see. Mike, would you like to add anything?

Michael Morris, CFO

Ben, I’d just add that all freight and networks work together. If one freight type declines due to current circumstances, it is reassuring to see that despite the decline, our organic growth in door-to-door continues. This is promising as we regain typical freight levels; we want to ensure sustained progress. Optically, there might be limited visibility into the effect of freight mix on overall yield; the capacity of airport-to-airport versus door-to-door yield will likely influence our stated yields as recovery progresses.

Operator, Operator

Our next question comes from the line of Todd Fowler, KeyBanc Capital Markets. Please go ahead.

Todd Fowler, Analyst

A virtual hello, I guess. I’m sorry earlier about the technical difficulties. Mike, I appreciate your insights into the network. Can you give me an idea of what tonnage levels you foresee for April overall? Also, what were the monthly trends for the first quarter?

Michael Morris, CFO

When you consider all factors, April will likely finish down around 20% to 22%. In terms of our first-quarter trends, you'll see COVID’s impact: January was up 1.2%; February was down 2.5%, and we began to see a significant downturn towards the end of February. March was down 15.8%. So at a 15% week-over-week drop exiting March, we may be back to where we started in March based on recent developments. We’ve had good days, especially yesterday, as it was compared to previous weeks.

Tom Schmitt, CEO

As you saw, yesterday was the best day we had in six weeks.

Todd Fowler, Analyst

So there's some noticeable improvement there. Tom, when you consider your current environment and the initiatives in place strategically, while I understand the focus is on protecting the short term, how do you view sales in this context? Does this create new opportunities to contact customers you haven't worked with before? Or are you primarily servicing existing accounts until things normalize before expanding your footprint?

Tom Schmitt, CEO

On the commercial front, we have been as expansive as possible. We established a program called 'grow forward' to maintain what we have while expanding penetration into our existing customer base and reaching new territories. For instance, we’ve focused on organic growth in the customer segments as well as M&A. Last year, we made three acquisitions, and I maintain that there's no limit to that. We have a pipeline that enhances our capacity for good acquisitions. On the organic side, we're not only expanding, but we are also striving to grow our base through increased cross-selling. Previously, discussions about LTL rarely included intermodal, but now, those discussions are common. I’m executing these plans actively and offering our existing customer base greater access to our full portfolio.

Todd Fowler, Analyst

This sounds promising, especially since much of this was previously in place. Just two last quick questions. It seems that Final Mile is relatively unaffected by disruptions. Is that an accurate assessment, or should we expect some pressure, albeit less than in other segments?

Tom Schmitt, CEO

That's correct. From a results perspective, I wouldn't notice anything unusual about Final Mile; it's performing well. Fortunately, this service is essential since people are home during this period, and our high-value appliances are needed right now. Most jurisdictions allow this service. We’re also benefitting from a strong core business leading into the final mile; we underwent a positive transition from FSA and Linn Star acquisitions while enjoying the top-tier service. The customers I frequently communicate with appreciate that we’re their top choice. Mike, do you want to add anything?

Michael Morris, CFO

Additionally, we've integrated Final Mile with the LTL network, which provides synergy and expands our market coverage. We've been overlapping operations in six markets, helping us leverage both businesses more effectively. We’ve begun overlapping dock operations in key areas. So the integration between these units is progressing well.

Tom Schmitt, CEO

Ultimately, the collaboration in the Expedited Freight segment is proving that LTL, Truckload, and Final Mile are working together effectively.

Operator, Operator

That concludes Forward Air's First Quarter 2020 Earnings Conference Call. Please remember that this webcast will be available on the Investor Relations section of Forward Air's website shortly after this call. You may now disconnect.