Universal Logistics Holdings, Inc. Q2 FY2020 Earnings Call

Hello, and welcome to Universal Logistics Holdings Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. During the course of this call, management may make forward-looking statements based on their best view of the business as seen today. Statements that are forward-looking relate to Universal's business objectives or expectations and can be identified by the use of the words such as belief, expect, anticipate and project. Such statements are subject to risks and uncertainties and actual results could differ materially from those expectations. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Tim Phillips, Chief Executive Officer; Mr. Jude Beres, Chief Financial Officer; and Mr. Steven Fitzpatrick, Vice President of Finance and Investor Relations. Thank you. Mr. Phillips, you may begin.

Good morning. Thank you for joining Universal Logistics Holdings' second quarter earnings call. Before we start, I want to acknowledge the passing of our Founder and former Chairman, Matti Moroun. Matti was a significant innovator in the transportation and logistics industry, as well as a mentor and friend to many of us. His legacy will continue to inspire all of us who had the honor of working with him. Yesterday afternoon, Universal released its first quarter financial results, reporting $258 million in revenue and earnings of $0.23 per share, which included a non-cash holding gain of $0.02 per share from a marketable securities portfolio. Given the challenging operating environment, where much of the automotive and retail sectors were inactive for nearly two months, we are pleased with our operational results. We entered the second quarter facing a considerable amount of business inflow or shutdown due to the COVID-19 pandemic. Early in the quarter, we made difficult staffing and operational cost management decisions that turned out to be beneficial as business volumes decreased. We implemented a COVID-19 preparedness and response plan at the beginning of the quarter and continue to update it to comply with CDC and local guidelines. Our leadership team's focus and performance across all service lines have been commendable. Overall, our preparation and the collaboration of our associates have enabled the company to operate safely and effectively recently. Despite the challenging sales environment, we secured new business across multiple sectors. Our truckload group achieved several significant victories in food and beverage as well as consumer goods. Our logistics pipeline is robust, building on substantial successes from the first quarter. Our value-added and Dedicated Transportation service lines have garnered over $140 million in new business in the past six months. If production schedules hold for Q3, we anticipate an additional $15 million in revenue, increasing to $25 million in Q4 and Q1 of 2021. At full run rate, the new business is expected to generate $40 million per quarter by the second quarter of 2021. We are continuously refining our sales strategy. We have been collaborating across different lines to identify existing customers with multimodal and value-added needs. Our customer portfolio, both organic and through acquisition, is strong, with numerous opportunities to enhance our supply chain solutions across multiple platforms. The decline in freight volumes during the second quarter allowed us to expedite the integration of six intermodal acquisitions made over the past two years. We have fully integrated three of those acquisitions and combined operations from our two Southern California acquisitions, which we expect will lead to lower costs and improved productivity per truck. As we move into the third quarter, we approach it with cautious optimism due to the uncertainty caused by the COVID-19 pandemic. We believe the automotive sector we serve is poised for growth due to depleted inventory levels and strong demand for pickup trucks and SUVs. Our retail relationships show positive trends ahead as order volumes increase and imports rise to meet upcoming seasonal demand. Truckload rates remain strong, and we are hopeful that the improvement in industrial production will positively affect our expanding flatbed operations for the rest of the year. The main challenge we face is the current unfavorable brokerage market in the industry; we are actively re-evaluating customers and lanes to ensure profitability in that service line. I want to express my gratitude to all Universal associates for their hard work and dedication over the past few months. Their commitment to getting the job done safely and on time for our customers during these challenging times demonstrates resilience and professionalism. We appreciate everything you have done and will continue to do for Universal. I will now turn the call over to Jude.

Thanks, Tim. Good morning everyone. Universal Logistics Holdings reported consolidated net income of $6.2 million or $0.23 per share on total operating revenues of $258 million in the second quarter of 2020. This compares to net income of $20 million or $0.70 per share on total operating revenues of $383.2 million in the second quarter of 2019. Consolidated income from operations decreased $19.9 million to $10.8 million compared to operating income of $30.7 million in the second quarter of 2019. EBITDA decreased $18 million to $30.2 million in the second quarter of 2020, which compares to $48.2 million one year earlier. Our operating margin and EBITDA margin for the second quarter of 2020 are 4.2% and 11.7% of total operating revenues. These metrics compare to 8% and 12.6% respectively in the second quarter of 2019. Looking at our segment performance for the second quarter of 2020, in our Transportation segment, which includes our truckload, intermodal, and freight brokerage businesses operating revenues for the quarter declined 26.2% to $185.8 million, compared to $251.8 million in the same quarter last year, while income from operations decreased $3.3 million to $10 million, compared to $13.3 million in the second quarter of 2019. In our Logistics segment, which is comprised of our value-added services, including where we service the Class 8 heavy truck markets and our dedicated transportation business, income from operations decreased $16.6 million to $800,000 on $71.8 million of total operating revenues, compared to operating income of $17.3 million on $131.2 million of total operating revenue in the second quarter of 2019. On our balance sheet, we held cash and cash equivalents totaling $8 million and $7.2 million of marketable securities. Outstanding interest-bearing debt net of $1.9 million of debt issuance costs totaled $403.7 million at the end of the period. Excluding lease liabilities related to ASC 842, our net interest-bearing debt to reported TTM EBITDA was 3.38 times. Universal's short-term target total leverage ratio stands at two times to 2.5 times EBITDA. Capital expenditures for the quarter totaled $9.6 million. For the full year, Universal has revised its capital expenditures forecast and is now expecting capital expenditures to be in the $100 million to $110 million range, as we complete two of our supercenter projects and invest in the equipment to service approximately $140 million in annual new business wins in our value-added and dedicated transportation service lines. Interest expense for the year is expected to come in between $14 million and $16 million. For the third quarter, if the current operating environment remains as it is today, we expect top-line revenues to come in between $325 million and $350 million and operating margins to be in the 6% to 7% range. We expect to face a couple of headwinds during the third quarter. Margins in our contract brokerage business are currently under pressure due to an upside-down market as well as the planned shutdown for three weeks in August of one of our Class 8 customers for retooling. Universal remains committed to returning capital to shareholders while balancing the near-term cash flow requirements for the company. With limited visibility as to the strength of the general economic recovery, our Board of Directors has decided not to declare a dividend during the quarter, but will revisit the topic at its next regularly scheduled meeting in October. With that, Tia, we're ready to take some questions.

The first question will be from Chris Wetherbee with Citi. Please proceed.

This is William on for Chris.

Thanks, William.

So first I just wanted to start with revenue trends in your value-added services and dedicated operations. I know you discussed a little bit about business wins, but I'm just kind of wondering about the revenue that specifically ties just, call it, the legacy revenue tied to automotive and heavy-duty truck operations. And I'm wondering when you're thinking markets will start to recover? And do you think that revenue gets back to pre-pandemic levels?

Yes, this is Tim. Regarding the dedicated and value-added services in the automotive and truck industry, we are very optimistic about our recovery from the pandemic. We have been fully operational since June, and feedback from our customers indicates a strong demand for our products as inventories are low. We anticipate a robust performance in the third and fourth quarters, and we expect to surpass the revenue levels we experienced in the first quarter as we move into the third quarter.

Got it. And one other question about your margins here. So if we're just comparing year-over-year changes in operating incomes and year-over-year changes in revenue, it looks like you guys produced roughly a 16% decremental margin despite the plant shutdowns and costs related to COVID. So I'm just wondering how we should kind of think about the margins like you guys provided some context on the third quarter. But if we're looking forward to the fourth quarter, if you guys can just provide some additional context there about what some of the puts and takes would be?

William, this is Jude. So yes, I mean, we have between 70% and 80% variable costs in most of our service lines. Our agent business is about a 15% variable or 85% of variable cost model. So we just expect that to continue. I mean, we came out of the COVID pretty strong, did some cost-cutting and rightsizing of our operations. So we would at least expect those incremental margins to be at their historical rates if not just a little bit better.

Got it. And just a final question here. Can you talk a little bit about the truck market starting to show some improvement? I'm wondering how we should think about load growth and revenue per load growth in the second half, given that loads were down about 40% in the second quarter.

Yes. And this is Tim. And related to the truck market, yes, if you look at what the predictions were this year for production, it was definitely negative year-over-year. Some of the customer conversations we have had in the service lines and customers we deal with have given favorable outlooks to the third quarter and fourth quarter. So we're fairly optimistic that we will see a good second half of the year in the truck market.

All right. Thank you for taking my questions.

Thanks, William.

The next question will come from Bruce Chan with Stifel. Please go ahead.

Yes. Good morning, gents. Appreciate the time. Just want to start out here maybe on the truckload side. I know that managing the fleet has been somewhat of a headwind for the past couple of years. Just want to see what your experience has been like recently. What you're doing to bolster the fleets? And what maybe capacity trends look like as we come out of 2Q and then move into the back half of the year?

Sure. This is Tim. In the truckload market during the second quarter, we extensively utilized our core strengths in the flatbed sector. Our industrial products, particularly steel and metals, faced significant challenges due to the manufacturing and automotive shutdowns. While we did experience some loss in capacity, we managed to retain most of our owner-operators and company drivers. We feel confident moving forward, although we will need to focus on recruiting as we expect an uptick in demand. However, steel and metals on the flatbed side have been slow to recover, even though we are starting to see some improvement in industrial products. Therefore, our priority will be to recruit additional capacity, and we anticipate that those who temporarily left the market due to government subsidies will return as freight volumes increase. As we exit the third quarter, we believe we will be well-positioned with a solid operational plan.

Okay, that makes sense. To elaborate on that last point, I know many are anticipating changes in the capacity environment due to the expiration of the subsidies. Have you noticed any signs of that so far as we approach the end of July?

On the owner operator side, overall, yes, I think that because the work is coming back, because we continue to bring some new work on that they've jumped back in their trucks. So, I'm happy with where that's going. On the company driver side, we lost far fewer company drivers than we did owner operators. So, we were pretty cool coming out of it. We did some things to help through the second quarter. We're pretty cool coming out of with the company drivers. I think that space right there will be very challenging to grow because of just the market as a whole—the demand for company drivers as well as those that are laid off right now. Do they continue to get supplemented unemployment? So, we're still waiting to see that. So, my answer to that is yes, it's a little bit of wait and see, but I think yes, it will be not difficult, but you'll have to work to get your new drivers.

Okay, great. Appreciate that. And then just on the brokerage side, Jude, you'd mentioned that the market was a bit upside down right now. Certainly that's something we've seen from others out there in the business. Just want to get your take on where you think we are in that pricing cycle, whether you're seeing customers being receptive to increases? And then, if I could just ask how much of the business gets repriced in the back half of the year versus the first half of the year next year?

This is Tim. If you've been following other earnings calls, it's clear that the current environment is challenging. We saw a surge in business in April and May, but now we're reassessing our top 25 customers. While there are some hurdles, our goal is to both serve our clients and maintain profitability. The long-term viability of the current rate structures is proving to be quite difficult. We plan to engage with our customer partners to provide them with an accurate picture of the market. We will share data from our capacity procurement efforts and highlight that the rates established last year are no longer sustainable. We intend to have these discussions, and while others in the market may have approached their clients, I don't believe there's a widespread acknowledgment yet that these rates can't continue. However, we know we need to revisit our rates with our top 25 customers, and we are ready for those challenging conversations. We expect capacity to tighten further, and it's essential for us to position ourselves for success. Additionally, as we approach the end of the third quarter and into the fourth quarter, some of our contracts will become available for rebidding, allowing us to address some of these challenges. It’s a tough time, and I certainly did not anticipate the difficulty in sourcing capacity at favorable rates back in April.

Okay, great. And then, just a final question here. Obviously, a lot is still up in the air and uncertain. But, I think about your mid-term margin targets in each of the various segments. And looking at what's happened between last quarter, and then where we've come now, how are you thinking about those targets? Have we lost much ground in terms of getting to where we need to be? Yes, just want to get your thoughts there on how you're thinking about that?

Hey, Bruce, it's Jude. I believe we will see improvements in Q3. Since our costs are mostly variable, we are very sensitive to volume changes. As our volumes increase, we can gain the additional margin we've been working towards over the past few years. In Q3, we're guiding for a 6% to 7% operating margin target due to uncertainty about the volume environment in the latter half of the year. However, long-term, as we've indicated in our investor presentations, we expect to reach operating margins of 7% to 9% in a normal environment with growing volumes. Our long-term target margin for Universal remains at 10%. We will continue to work hard to achieve these targets, and if the economy strengthens and the market grows, Universal will perform well.

Perfect. Very helpful. Again, thanks for the time and nice job in a really tough quarter.

Thanks, Bruce.

We do have a response from Jeff Kauffman with Loop Capital. Please go ahead.

Here we go. Hey guys, how are you?

Good morning, Jeff.

So I wanted to get a little clarity on what you're seeing on the intermodal side? And I apologize if you hit this. It took me a couple of extra minutes to get on the call, so I missed the first three, four minutes. What trends are you seeing because your intermodal division outperformed the general intermodal industry in a very tough quarter? What does July look like? And you gave us thoughts on what dedicated value-added would be; you gave us thoughts on brokerage and truckload. Can you talk a little bit about intermodal?

Sure, Jeff. This is Tim. Yes, we experienced what we would consider a difficult second quarter, but I thought we were pretty resilient in how we approached it. And I think all signs looking at what we've seen so far in July are very positive. And I believe they'll remain positive. So if we look at some of the things that we’re in a deep trough in the second quarter which was some of our retail clients, we see really good signs over the next month or two of that really picking up. And some of it's cyclical, sure, it's going to happen every year, but we see a nice runway into the fourth quarter on that. We also had some—what I would call—decent intermodal sales wins in a very difficult sales environment. So we're pretty happy with where the portfolio is positioned. The good billed weather is in Southern California and we're definitely seeing our load count over the last couple of weeks ramp up in Southern California. So I would expect us to pick up speed. I would expect July to be up year-over-year on a load count basis and it will definitely be up on a sequential basis if you take the second quarter average. So I think on that end of it from a gross revenue standpoint that we'll see intermodal perform well in the third quarter.

Okay. Are you noticing any improvement in the intermodal rates? I understand that some truckload markets are showing strength, but the brokerage services division may face challenges in the near term due to the cost of purchased transportation.

Well no there hasn't been any drastic change on the intermodal rate side. Our customer base is still battened down the hatches and we're holding true to that. We've had to over the first part of the year even take some rate reductions to make sure that we kept the volumes because it's a volume play for us in the intermodal space. So there's been no what I would call incremental rate increases in the intermodal space.

Okay. Then I switch to Jude, how big an increase was your revised CapEx spend? And just looking at some of the projects that you're going to be spending on now in the second half of the year, where is that going to take depreciation in the second half and maybe as we look to 2021?

So we started the year with $96 million of CapEx. We then revised during COVID that number down to about $76 million. And then we're up to the $110 million basically due to the fact that we won $140 million of business related to value-add and dedicated. So we have to buy the material handling equipment and the tractors and the trailers and all the stuff associated with that. So not all of this depreciation will be hitting this year. Some of the projects on the real estate side will be either complete late in the fourth quarter or early in the first quarter of next year. So from a—I would just use an incremental increase in CapEx maybe an additional $500,000 to $750,000 a quarter in Q3. And then we'll revise that in Q4 as we have more runway on when those real estate projects will come to completion.

All right. And most of this CapEx is going to be spent this year? Is there going to be some drag on some of these projects into next year?

The only significant impact will be approximately $15 million related to our new Detroit supercenter project, with some of that potentially extending into the first quarter of 2021. However, I would estimate that at most the impact will range from $2.5 million to $3 million.

All right. So I'm going to go out on the limb here for you. So given your revised margin forecast, given depreciation, given the revised CapEx forecast it seems like you're kind of on target to throw off somewhere between $40 million and $50 million of free cash for the full fiscal year. Why still the trepidation with the dividend?

I think it's just because of especially where we live in Michigan, Jeff—I mean, they just shut everyone out of bars again last week. I mean our—I think we just don't really have a good feeling about what the governor is going to do and we're really nervous about that. So it's not that we don't want to reinstate the dividend. Obviously, we paid $143 million in dividends to shareholders over the years and we bought back $82 million worth of stock. So returning capital to shareholders is extremely important to us, but they didn't really feel that there was a lot of risk in delaying that one more quarter until we get a little bit more runway on the economy.

All right. Final question. You mentioned you're at 3.38% on the adjusted debt leverage ratio; your target is 2% to 2.5%. What time frame would you look to be back at your target range?

I think within the next probably 12 to 18 months that would be—I think we feel good about that. We just—the problem is when you keep winning business and the way the value-add business works is that those contracts are three, five, seven, and ten years. So I mean you're investing, so the $140 million or the $100 million that we're spending on the value-add stuff we're going to get that back over a decade. And so once again you're going to have years—you will have a lot of CapEx because you win a lot of dedicated value-add and then it will be more normalized in the $60 million range if we're just talking about replacement cycle of equipment that we already have.

All right. Well, thank you very much and congratulations.

Thanks, Jeff.

The next question will come from Mike Vermut with Newland Capital. Please go ahead.

Hi, guys. How are you doing? Great execution in this environment here.

Thank you, Mike.

Can you just go through on the new business wins that will be I guess fully up and running you said by Q2 of '21 or close to it?

That is correct.

Okay. And then how should we look at the margin profile on those new wins?

So we don't normally guide margins on a quarterly call, but I would just look at our investor presentations and look at what we guide those businesses to operate on a long-term basis and I'd say we're in the range of those margins. So that would be 10% on dedicated and 10% to 12% on value-add.

Perfect. Okay. And then I know you're thinking about coming in with the dividend which I strongly recommend, but we're also the one transportation company sitting here trading at eight times normalized earnings and far off on everything. When do the discussion switch to buyback versus dividend versus additional CapEx? There's really—there's nothing that stands out like we do right now, in our black sheep out there at this valuation; everything else is trading 25 to 30 times and we're done at eight times. So how does that discussion go at the Board?

Yes. I mean we did buy back stock in Q1. After we released our Q4 earnings, like we saw the valuation which was like the EBITDA was less than 5x. So we started buying back and where we bought back about $5 million worth of shares. So we were going to continue doing that actually, Mike, until COVID hit. But during—as Tim mentioned in his comments and I—during the first six months we had $140 million worth of business. So we're going to think about doing some additional capital allocation to buybacks in the latter half of the year, but we're probably going to have to postpone that as a result of the business wins that we currently have. But the stock has been a very attractive price right now.

For sure. Okay. All right. It will keep on executing here. So that was a great quarter for the circumstances. And I'm sure the next few will look good too. Thanks, guys.

Thank you, Mike.

Thanks, Mike.

And at this time there are no further questions.

Okay. Thank you all for calling in today. We appreciate it, and we'll talk to you soon. Thank you.

Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.