Hub Group, Inc. Q3 FY2021 Earnings Call

Hello and welcome to the Hub Group Third Quarter 2021 Earnings Conference Call. Dave Yeager, Hub’s CEO; Phil Yeager, Hub’s President and Chief Operating Officer; and Geoff DeMartino, 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 to allow everyone an opportunity to participate, please limit your queries 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 such words 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.

Good afternoon, and thank you for participating in Hub Group’s third quarter earnings call. Joining me today is Phil Yeager, Hub’s President and Chief Operating Officer, and Geoff DeMartino, Hub’s Chief Financial Officer. We had a solid third quarter as pricing continues to outpace rapidly accelerating costs, thereby creating record quarterly revenue and gross margins. And to kick off the fourth quarter, we’ve just closed on Choptank, a large truck brokerage operation specializing in refrigerated products. This is an acquisition that Phil has worked on for several years with Choptank’s owner, Geoff Turner. We share a common vision and culture, and we welcome the Choptank team to the Hub family and look forward to growing our collective business. Strong demand continues as inventory-to-sales ratios are at near all-time lows, while intense restocking of shelves persists. On the second quarter call, we indicated that we believe this strong and tight capacity market may extend through the second quarter of 2022. Nothing has really changed since that last report, and we believe this imbalance will continue through most of the first half of 2022 and likely throughout most of the year. Today, there are many issues negatively impacting customers’ supply chains. Among these issues are labor shortages and port congestion resulting in network imbalances. Our focus continues to be on supplying reliable capacity to our clients in order for them to deliver their products efficiently. And with that, I’ll turn the call over to Phil to discuss the performance of our business lines.

Thank you, Dave. We are very pleased with these results and the efforts of our team to support our customers during this dynamic environment. We delivered strong results in intermodal with a 17% increase in revenue and 530 basis point improvements in gross margin percentage year-over-year, which was offset by an 8% decline in volumes after an 11% increase in the third quarter last year. For the quarter, Transcon volumes declined 1%, local East was down 7%, and local West was down 10%. Although the intermodal network is more congested than the global rail transit, extended customer and loading times and more limited available drayage capacity, our team has done a great job offsetting those challenges with improved on-time performance to our customers, stronger pricing, a better balanced network, and improved cost recovery efforts. Demand continues to be very strong, particularly off the West Coast, and we anticipate receiving all of our new build containers this year, which will help us capitalize on that opportunity. We anticipate another strong bid season and improving network fluidity into 2022 given the strong demand backdrop and the need for shippers to lock in capacity. Logistics performed well with 17% revenue growth and a 100 basis point improvement in gross margin percentage year-over-year. We continue to have strong revenue growth from our consolidation of final mile service lines, which was offset by lower revenue but improved yields in our outsourced transportation management offer. We’ve had many strong new wins across all of our solutions, including exceeding our cross-selling synergy targets in final miles. We see continued opportunities for growth ahead as we provide our clients creative solutions to reduce costs and enhance services. Brokerage posted strong results again with 28% revenue growth on 3% lower volumes and a flat gross margin percentage year-over-year. We continue to see strength in the spot market and are bringing on new clients to our growing sales force while maintaining strong efficiency. We are also very excited about the addition of Choptank to our brokerage. We share values and believe that along with their aggressive sales culture, they will bring an improved technology platform, a new specialized service offering, and a large cross-selling opportunity. This acquisition will result in over $1 billion in brokerage revenues and we believe it enables long-term sustainable growth. Dedicated revenue declined 7% with a 450 basis point decline in gross margin percentage year-over-year. This decline was driven by increased insurance costs, maintenance and repair expenses, and higher tank capacity costs. We are executing on customer renewals, onboarding new, more profitable wins, and continuing to enhance our systems and processes to help offset these challenges. Looking ahead, we believe we will see a strong demand environment, and Hub Group is in a great position to provide solutions to our clients and drive profitable growth. With that, I will hand it over to Geoff to discuss our financial performance.

Thank you, Phil. Q3 featured all-time record revenue and profitability levels with total revenue growth of 16%. Gross margin was $158 million or 14.7% of revenue, which is an improvement of 300 basis points compared to last year and 240 basis points higher than Q2. Gross margin performance and our focus on operating efficiency led to operating income of $60 million or 5.6% of revenue. Salaries and benefits increased primarily due to higher incentive compensation and commission expense compared to last year. General and administrative expenses increased compared to last year due to legal settlements and expenses related to the acquisition of Choptank, which were partially offset by higher gains on the sale of transportation equipment. Our diluted earnings per share for the quarter was $1.28, which is 73% higher than the prior year. We generated $92 million of EBITDA in the quarter and had over $230 million of cash on hand at quarter end. In October, we invested approximately $130 million in cash to purchase Choptank. We continue to have a conservative capital structure with net leverage of approximately 0.5 times EBITDA, which provides us with ample flexibility to continue to invest in the business through capital expenditures and additional strategic acquisitions. We are raising our 2021 EPS expectation to $3.90 to $4 per share, up from $3.50 to $3.70 that we announced in July. For 2021, we expect revenue will grow in the high teens percentage range, with intermodal volumes approximately flat. We forecast gross margin as a percent of revenue of 13.3 to 13.7 for the year, growing as a result of rate increases, partially offset by higher costs for rail transportation, third-party drayage, and driver wages. We continue to see strong consumer demand and low retail inventory levels, which drives the need for our customers to restock. For the year, we expect costs and expenses of $365 million to $375 million, which reflects incremental operating costs for Choptank. We expect our tax rate to be approximately 24% for the full year. Our 2021 capital expenditure forecast is $150 million to $160 million, down somewhat as compared to our prior guidance as 150 of the trackers that we ordered this year will be delivered in early 2022. We expect to receive our full order of 3,000 containers this year. Last quarter, we introduced our long-term revenue and margin targets. The acquisition of Choptank is a great step towards achieving these targets and is indicative of the type of strategic investment we will make in the business, adding scale while also introducing a new service offering with significant cross-sell potential. Dave, back to you for closing remarks.

Great. Thank you, Geoff. Demand continues to be strong in all of our business lines as our customers continue to need cost-efficient solutions that offer consistent levels of service. The fourth quarter is off to a solid start, and we believe that the momentum will carry through much of 2022. And with that, we will open up the call to any questions.

And the first question comes from Justin Long from Stephens. Your line is open.

Thanks. Good afternoon and congrats on the quarter.

Thank you.

So, Geoff, I wanted to start on the cost and expenses in the third quarter. There was a pretty substantial step-up on a sequential basis. It sounds like there were some moving pieces with legal costs and acquisition expenses. So, anything that you would consider one-time that won’t be ongoing? And then, maybe could you help us think through the contribution from Choptank you are assuming in the fourth quarter from both a revenue and OpEx perspective as we think about your guidance?

Sure. Yes, in Q3, we did have some one-time costs, legal settlements that are not really recurring as well as the acquisition expense. Those two items pretty much net out with our gain on sale for the quarter. The real driver of the increase sequentially from Q2 has a lot to do with the compensation expense and commission expense. So as we earn more throughout the year, we’ve been booking more of those expenses, and that was incumbent in our guide throughout the year. Going forward, we can do the math on the guidance, but you can expect the Q4 number to be basically the Q3 number plus the incremental for Choptank, which is about $8 million on the OpEx line. For revenue, it’s approximately $80 million of incremental revenue for the last two months of the year.

Okay. That’s really helpful. And maybe looking at the fourth quarter guidance, could you talk about what you are baking in for the Truck Brokerage segment from a revenue and margin perspective sequentially, if you exclude Choptank? And then, last one from me is just on thoughts around intermodal pricing in the 2022 bid season?

Sure. The brokerage in Q4 excluding Choptank is going to be largely consistent with the Q3 levels and then Choptank obviously is a delta.

Yes. This is Phil. We continue to see strong demand on the brokerage side. Great cross-selling opportunities there, and we are taking full advantage of the spot market as well. So, feeling very good about the results there. As we look ahead with intermodal pricing, we are feeling very good about the early stages of bid season as we kind of enter that now. Some of that pricing was on the lower end, given how we see rates continue to go up throughout 2021. So those renewals will be consistent with what we’ve seen in the past, and we expect that to continue into early next year. Early bid season indications are very strong, indicating continuation of the current trend. We are anticipating a strong bid season. Shippers need to lock in capacity, and we’ve really stepped up to allow a lot of our clients to take advantage of that next year. So, feeling very good about our opportunities looking ahead.

Okay. Great. I appreciate the time.

And the next question comes from Scott Group of Wolfe Research.

Good afternoon. This is Jake on for Scott. Thanks for taking my questions.

Sure.

Can you break out how much of the pricing growth was driven by higher asset royalties compared to how much was driven by higher base rates?

Yes. This is Phil. I appreciate the question. We’ve seen very strong base pricing, and that’s going to continue from an asset schedule change. Obviously, our preference is to be moving more volume to get more fluidity back into the network. And so, that’s really our focus - working with our clients there. It is not a huge determinant of our margin enhancement. Obviously, somewhat beneficial, but not anything that would outweigh the benefits that we see from moving more volume and continuing to get more pricing.

Got it. Thanks. And then, how much visibility do you have on rail cost inflation next year? Do you expect more than this year? And if the market remains as it is, do you expect gross margins will continue to increase from here as rates move higher?

Yes. We do have very good visibility into our rail cost increases next year, and we believe that we are going to be able to attain rate increases in excess of our cost inflation.

Got it. Thanks for taking the time. Appreciate it.

And the next question comes from Todd Fowler from KeyBanc. Your line is open.

Hi, great. Thanks and good evening. On the step up in gross margins here, both in the third quarter for the guidance, can you talk a little bit about the drivers behind that? And then, can you also talk about the sustainability of gross margins at these levels, which you really haven’t seen for a while as we get into 2022?

Sure. Really, this is Geoff. So the biggest driver of gross margin is going to be our rates and the surcharges we have in place. We do have incremental transportation costs that are going up sequentially and year-over-year. Rail costs and certainly drayage costs, both internal and third-party. But prices are a very big driver of margin for us and that was the driver of the increase.

And I would just highlight that with this segment we are seeing strong performance and nice improvements in our transportation management margins and a nice sequential improvement in CaseStack as well. Our final mile business is expected to experience some sequential margin improvements, and I am pleased with what we are doing there. I think with brokerage, Choptank is an addition that’s going to be a nice driver of incremental gross margins, and we are seeing a lot of opportunity on cross-selling as well. But to Geoff’s point, intermodal is going to continue to obviously be a large driver of that. We think that the margins are going to be sustainable. We just need to stay focused on great operational discipline and continue to enhance our pricing.

So, Phil, moments ago, the comments that you made to Justin about intermodal contract renewals being positive and thinking about prices being a big driver for the gross margins. That would suggest that going into 2022, as long as you are able to see that positive pricing, that you can run at somewhat these levels, obviously with some seasonality and some other factors moving through the numbers.

Correct. Yes, and we would also believe that we are going to see improved volumes next year with improved fluidity once we get our containers fully onboarded and as we see enhanced fluidity. We are excited to see some sequential improvements in fluidity and turn time. We didn’t see that from Q2 to Q3, but here in Q4, we are seeing some of that sequential improvement, and as that continues and we maintain strong pricing, it could really create a nice benefit for 2022.

Great. And then, just for my follow-up on the operating expense question. Geoff, it was helpful for the fourth quarter, and we kind of get a sense for the run rate. As we move into next year, what are some of the moving pieces? I was thinking incentive compensation would be one, a full run rate for Choptank, but what are the other factors we need to consider on the expense line for 2022? Thanks.

Sure. Those are going to be the big drivers. Obviously, personnel costs are the big chunk of overall OpEx. We are putting together our budget for next year, where we certainly are going to be growing. I think overall from an earnings perspective, the expansion in our profitability is probably going to come more from price and from volume. That means not a lot of incremental headcount additions, and we will have more to say on that when we announce our Q4 earnings.

Okay. Understood. Thanks for the time tonight.

Thanks, Todd.

And the next question comes from Tom Wadewitz from UBS. Your line is open.

Yes. Thanks for the questions and for the time, and congratulations on the strong results. What – you sound pretty optimistic on the transition to volume growth and it’s interesting you are seeing some recent improvements. What else do you think that you can do? Any sense could you give mid-single-digit growth? Can you do higher than that as you look to next year? It seems like with the container additions you’d be positioned for that. I guess, what we are hearing from the railroad seems kind of cautious, and I’d refer to Norfolk Southern’s comments about they want to hire more people, but they are just seeing higher attrition. So, maybe, I guess, some more detail on your views on capacity and how that might constrain what you do next year on volumes?

Yes, obviously, if our rail partners aren’t able to add, that could be a constraint on our capacity. I know that there have been adjustments to wages made. But there has been a great deal of investment in chassis, which has been one of the larger bottlenecks that we’ve seen this year. That will really help from a terminal fluidity perspective and not having trains really stack up. So we think that’s going to be hugely beneficial. Hopefully, the actions being taken will allow us to maintain additional staffing. I think we’ve done a nice job of mitigating losses on our end and successfully adding third-party capacity. That could be a great upside factor for us next year if we continue that trend of driving that will really help us maintain fluidity and provide control over our service products. Our goal is to grow next year. We don’t have any hard numbers yet. But yes, with fluidity and continuing to add drivers and the investments being made in chassis, we think we will be in a good position to do that. It has been a bit of a challenge this year regarding fluidity, but we are seeing some improvements.

And Tom, I would add that the macro conditions continue to look very favorable both from the demand side. We see truckloads continuing to be constrained, which is a great setup for us heading into next year. We are able to deliver value and service to our customers.

How do you – I guess, just a follow-up question. How does the – I mean, it’s obviously tremendous media coverage and increased heightened focus on the West Coast issue and logistics issues in general. How do you think about the kind of West Coast issue and the improvement in fluidity? How does that affect your outlook? Is that I guess, that’s something you assume gets better? Or do you think that even if there are still challenges at the ports and West Coast warehousing that you still can see a transition in nice volume growth?

Hi, Tom. This is Dave. I would suggest that the West Coast port situation is not going to be resolved quickly or easily. We are going to continue to see congestion at least through the end of the year, and I would suggest you beyond. There simply is not enough warehouse capacity. The 24/7 operation is really not going to work; I mean, it still needs skilled labor to load and unload those vessels. So, you are seeing some diversion to some of the East Coast ports, and people are trying the Port of Portland and other ports on the West, but the congestion will be an ongoing issue for a while. There is no simple switch to turn it off and on.

Are you tightly coupled for that, or is that something that kind of domestic can flow well even if international intermodal is not?

Actually, for domestic intermodal, it flows quite well because they don’t need a limited amount of capacity both for drayage, containers, and rail ramp capacity. So, actually, there is almost a metering of products that allows us to supply more capacity to our clients because the train is fresh out.

I would just add that the tightness from international box capacity is going to continue to drive more trains loading into domestic, and I don’t see that trend changing anytime soon. That will continue to be a driver of more growth for domestic intermodal off the West Coast, and there is going to be continued high demand for imports in that area. But even as we look at other locations, we still have a lot of growth opportunity for us like the Port of Savannah, which is going to be a big growth opportunity this year and likely continuing.

Yes. Certainly, it seems like there is a lot of pent-up demand out there. Thanks for the time.

Yes, Tom.

And the next question comes from Bruce Chan from Stifel. Your line is open.

Hey, thanks. And good evening, gents. You mentioned that shipments need to lock in capacity a couple of times. And just thinking about that in the context of dedicated. Obviously, there are higher costs there and issues with driver availability. Is there more business to exit in subsequent quarters, and at what point do we expect net growth there, especially as you start to convert that new business pipeline?

Yes. And I’ll tell you, I think it’s a great question. Yes, I would start with, I am very pleased that we are generating an improved return in the dedicated business, and that has been our primary focus. What I would highlight is that we were not fast enough to get wage increases with our customers to be able to go out, recruit, and see trucks. That led to some of the revenue loss that we saw. We’ve exited the majority of the business that we think is in non-compensatory contracts, and we are trying to ensure that we are adjusting language with our clients where it might not fit with a standard dedicated time with fixed and variable charges. So, I think we’ve done a nice job of that through the vast majority of those changes. We will always be trying to work with our clients to set up mutually beneficial agreements. But we certainly see opportunity in demand out there for us. It’s about ensuring we pursue the right contracts with the right customers and the right set of charges. So, feeling good about our disciplines and our ability to maintain a better return going forward as we bring on these investments.

Okay. Great. That’s super helpful. And then, just for my follow-up. You talked about strong residual demand for e-commerce. I am wondering how that translates for last-mile and some of these big-ticket goods as maybe some of these stimulus dollars expect to wane.

Yes. With our final mile and delivery, we have seen significant growth this year. I think even if there is a slowdown with some of the clients, we have been able to diversify the customer base quite a bit with our more traditional retail and e-commerce customers. So, we feel very good about the growth opportunity ahead regardless of a little bit of slowdown in demand. We actually have a backlog in onboardings that will move into Q1 of next year, providing us with a nice ramp for 2022.

Okay. Great. Thank you for the time.

And the next question comes from Charles Yukevich from Evercore. Sir, your line is open.

Thank you for taking my question, and congrats on the quarter, guys. Focusing on truck brokerage and when we think about the changes in volume and revenue for this quarter, how does this break out between contractual and spot?

Sure. This quarter, we were right around 49% to just under 50% contractual. So it did move down from about 51% last year in Q3.

Okay. I guess, I was more focused on how locked-in contractual volumes grew this quarter? If there is any sort of color that you could give on that?

Sure. I would say that the spot market continues to be strong. We are doing our best to convert wherever there are opportunities to convert spot into contracts. Historically, we have played closer to 70%. We think we’ll get back there over time.

Okay. Great. Thanks a lot for the time.

Our next question comes from David Zazula from Barclays. Your line is open.

Hey, thanks for taking my question. I guess, for Dave or Phil, whoever wants to take it. I mean, you talked in the last call with Choptank about the good cultural fit that it made your existing businesses. I guess, I was curious, did you look at any kind of measurable metrics? How did you measure that beyond just kind of personality fit on how the business would fit in?

Yes, I would say we always really focus on culture and alignment, and you can see through the tenure of their team the commitments they have for that business and the community they are in. And how long they’ve been active, having established the startup a few years ago. There have been assets for 20 years and have been growing this business methodically with a strategy and the way that they interact with their customers, with most of their customers sticking with them for the long term. That’s different from a lot of brokerages. Typically, there is a high level of customer turnover and a high level of team member turnover. That’s something that Hub Group really values is our folks and our clients, maintaining long-term relationships with those stakeholders was really indicative of a great alignment with our organization.

Thanks. And then, following up, I mean, you have been integrating for a long time. I know you mentioned a cross-sell opportunity, but do you feel like you have made any progress since the announcement as far as moving the product on to existing customers?

Yes, we are very excited. I know that our sales team is very energized. Our customers have been very excited. We’ve already got wins on the board, actually, and we are seeing a tremendous number of opportunities to cross-sell. So, yes, we are very excited about the progress made over the recent weeks.

Thanks very much.

Thank you.

And the next question comes from Brian Ossenbeck from JP Morgan.

Hey, this is Kellen Curry on for Brian. Both Transcon and Local West volumes were down. So, number one, just what's been the sequential trend into the fourth quarter? And then, what's your expectations for the utilization level for the upcoming containers, given that congestion is still expected to last into the new year and rail service still needs to improve?

Yes, so, month-to-date for October, we are down around 9% year-over-year. Last year, Q4 was a very strong quarter for us. We are encouraged that we've seen sequential improvements as the month has gone on. We had our highest volume week this past week all year, really going back to January. So, we are encouraged by that. We do have new containers coming in, and we expect to receive all of them by the end of the calendar year. We are forecasting an improvement in our container turn times sequentially from Q3 into Q4.

Okay, thanks. And then, just last question for the follow-up. In terms of the vaccine mandate, based on your reading and understanding of the mandate, does it apply to you? If not, will you be impacted by the mandate in any indirect way that could impact operations in any way? Thanks.

This is Dave. Certainly, for government contractors, we don't believe that’s going to have a direct impact on us right now. We are not a government contractor. However, if OSHA does come out with a mandate and forces truck drivers, it’ll have an impact. We're still working through it. But I believe it will impact the entire economy, as there will be certain truck drivers who feel strongly from a personal perspective that they don't want to take it. I am not an anti-vaxxer. I am vaccinated, and I encourage people to do so. But if you try to mandate it to what can be a very independent group, I hope common sense prevails. I hope it’s understood that realistically, truck drivers have been out there throughout this pandemic, getting products to store shelves, and I hope that they get an exemption.

Got it. Thanks, guys.

Thank you.

And the next question comes from David Zazula from Barclays. Your line is open.

Hey. Sorry if I missed it, if somebody asked it earlier, but did you guys put out the employee year-over-year change?

We didn't. But we can do that. So we ended the year or ended the quarter at just under 2,000. We had around 30 or 40 more last year after adjusting for non-stop. So we are down slightly year-over-year.

Awesome. Thanks very much. Appreciate it.

And that concludes the question answer session. I'll turn the call back over to Dave Yeager for final remarks.

Okay, and thank you for joining us this evening. As always, Geoff, Phil, and I are available if you come up with any additional questions. So, thank you again for joining us.

Thank you, ladies and gentlemen. This concludes today’s conference call. Thank you for participating. You may now disconnect.