Hub Group, Inc. (HUBG) Q3 2008 Earnings Report, Transcript and Summary

Ed Wolfe - Wolfe Research Alex Brand - Stephens John Barnes - BB&T Capital Markets Todd Fowler - Keybanc Capital Markets Jon Langenfeld - Robert W. Baird

Hello and welcome to the Hub Group Third Quarter Conference Call. We will begin with the discussion of the financial results led by Terri Pizzuto, Executive Vice President, Chief Financial Officer, and Treasurer, followed by an overall business discussion to be conducted by Dave Yeager, our Vice Chairman and CEO. The company will make its prepared presentation followed by a question-and-answer session. Mark Yeager, President and Chief Operating Officer, will join us for the Q-and-A session. At this time, all participants are in a listen-only mode. Comments made by Hub Group employees during this conference call may contain forward-looking statements. Actual results could differ materially from those projected in these forward-looking statements. Our SEC filings contain additional information about factors that can cause actual results to differ materially from those projected in these forward-looking statements. Copies of these SEC filings may be obtained by contacting the company or the SEC. Now I would like to introduce Terri Pizzuto, the Chief Financial Officer of Hub Group; please proceed.

Thanks, Denise and thanks everyone for joining us. I want to begin by covering three things: first, we had a record quarter; second, Hub’s in a strong stable and safe financial position; third, we were happy to see all three of our service lines growing in this tough economy. Here are the key numbers: For the third quarter, Hub’s diluted earnings per share increased 7% from 2007 to $0.45. If we take out the one-time $1.2 million tax benefit from 2007, our earnings per share would be up 15%. The third quarter operating margin was 5.3%, that’s compared to 5.9% last year. At the end of September, we had $63 million in cash and no debt. Now, I’ll discuss details for the quarter starting with revenue. Intermodal revenue increased 22%. This change includes a 9% volume increase and a 13% price increase related mostly to fuel. Local east business was up 22%. What we mean when we say “local east” is freight that moves exclusively on one of the eastern rail networks, the Norfolk Southern or CSX. A few examples of lines would be Chicago to Jacksonville or New York to Atlanta. Part of this local east growth is due to freight that was converted from truck to intermodal. Truck brokerage revenue was up 29% due to higher volume pricing which includes fuel and mix. One of our fast growing truck brokerage customers in the quarter was a government contractor. That contractor had a surge in business because of the hurricane. They chose Hub because of our expertise and proven track record in finding surge capacity. One of our top five growing accounts is a manufacturing company who started doing business with us in July. This is a great example of a customer who left us a couple of years ago for price and then came back because of our superior service. It’s also an example of successful cross selling, since we won both their intermodal and truck brokerage freight. Logistics revenue was 20% higher than last year. This increase in revenue came from several new strategic customers that signed up with us in 2008. Our logistics business focuses on delivering saving, providing load visibility and ensuring carrier compliance. Customers want to drive savings and efficiency through their supply chains and we make that happen. For example we deliver savings by doing carrier bids for customers and then managing the carrier base. Hub’s gross margin grew by $5.7 million in the third quarter. The biggest contributor to the margin increase was intermodal followed by truck brokerage and then logistics. Hub’s gross margin as a percentage of sale decreased to 12.3%, compared to 13.8% last year. There are four major reasons for the margin compression compared to last year: Number one, intermodal pricing excluding fuel was down between 1% and 2%, that’s the same pricing trend we had in the second quarter. Number two, we grew with a number of large intermodal customers that have more challenging fuel and accessorial programs. Number three, truck brokerage yield deteriorated 100 basis points, compared to last year due to soft market conditions and competitive pricing on accounts where we have significant potential to grow. Number four, logistics yield went down 400 basis points, that’s because the mix of services that were providing changed and because we priced more aggressively to land strategic accounts. Hub’s total cost and expenses in the third quarter were $35.9 million, compared to $32.8 million in 2007. The major drivers of the cost increase in salaries and benefits are more employees, raises and higher bonuses and commission. General and admin expense is up due to a loss on sale of tractors, more marketing initiatives and driver recruiting costs. We have 1,112 employees excluding drivers at the end of September, that’s an increase of 26 people compared to the end of June. We added people in customer service, truck brokerage and at contracts. We’ll continue to critically evaluate all our costs. Hub’s third quarter gross operating margin was 5.3%, which is higher than the 4.9% we had in the second quarter. We are confident that we can improve our operating margin over the long-term by being more efficient with our intermodal and drayage operations, managing equipment more effectively and increasing margin on specific customer accounts. Cross functional teams meet every week to monitor detailed action plans to improve the margin on these customer accounts. Part of the reason Hub is in such a strong financial position is because we are resilient in any economy. We have an asset like model and a diverse customer basis. No one customer is more than 5% of our sales. Many of our customers are large stable companies. Products that we ship include toilet paper, soup, cereals, canned goods, baking soda, toothpaste and other staples that we will be consumed in any economy. Now turning to the balance sheet and how we used our cash. We had $63 million in cash and no debt at the end of September. Our cash is invested in Treasury security. Hub’s $15 million revolving credit agreement expires in 2010. Free cash flow for the third quarter was $10 million. During the quarter, we spent $5 million on capital expenditures, most of that was for tractors that contract. For the full year, we still think capital expenditures will be around $11 million. We now have all our 1,000 new 53 ft containers. These containers were financed with operating leases that have about a six-year term. We bought 38,800 shares of stock in the quarter for $1.4 million in connection with the share buyback plan. With the turmoil in the financial markets, we decided to cancel our share buyback plan in September, until things in the credit market settle down. There is $73.6 million remaining under our current share buyback authorization that doesn’t expire until June 2009. Now, I’m going to discuss 2008 full year earnings guidance. For 2008, we are comfortable that our diluted earnings per share will be within the current analyst range of between $1.65 and $1.70. Partly because of the economy we are estimating we’ll comment at the low end of this range. As a remainder, we had a one-time $0.04 a share tax benefit in the fourth quarter of 2007 related to resolution of the dispute with the IRS. The weighted average diluted shares will be about $37.5 million for 2008. To wrap it up, hub had solid performance in weakening economy. Our operating income increased over 10% in the third quarter. We’ve only just begun to wrap up our sales engines and take operational efficiency to the next level. We are looking forward to executing on our strategy and with that I will turn it over to Dave.

Great. Thank you, Terri. Despite a sluggish economy, we posted another record quarter, generated impressive intermodal growth and also saw double digit gains in both truck brokerage and logistics revenue. Our intermodal business performed very well during the third quarter. As Terri said, intermodal revenue was up 22% with volume growing at 9%. This is the highest volume growth in well over five years. The structural changes we made a year ago were key factors in achieving this volume increase and it positions us well for future growth. We are particularly pleased with this performance given the slow economy. Although, our retail customers were down for the quarter, we were able to overcome that sectors declines by adding new customers and growing our business in all other segments. Intermodal service was quite good during the third quarter. Our metric showed service improvements in many of our heaviest shipping lanes. The rails have made significant investments in their infrastructure and these investments have resulted in quicker and more consistent rail transit. Intermodal capacity is generally been adequate. As expected, we did see capacity tighten considerably of the west coast as we entered peak season; although, the peak did start a little bit later this year than in ‘07. We also saw an improvement in the availability of ISO containers nearly end of the third quarter. These ISO containers were scarce earlier in the year, but currently are accessible in most markets. Our container fleet is now over 15,600 units and will grow to 15,900 by year-end. Despite our slightly larger fleet our utilization to get improved in the third quarter through a combination of the improved rail service and our own improved equipment management. Fuel prices drop considerably in the third quarter. Even with lower fuel prices intermodal still has a significant price advantage over truck. We expect there will be interest in converting from truck intermodal for the foreseeable future, particularly in the soft economic environment where companies are eager to save money. Since it is more fuel-efficient, intermodal is also more environmentally friendly than truck. The US environmental protection agency recently awarded Hub Group its SmartWay Environmental Excellence Award. We earned this award because of our continued efforts to convert business upper highway to intermodal. This conversion results in reduced greenhouse gas emissions in the environment. Hub Group was one of only three logistics companies to receive this award and we do intend to continue the partner with our customers to help them to reduce their carbon footprint by converting over-the-road business to the environmentally friendly intermodal product. We continue to be very positive about the future of intermodal and its potential growth. We expect to see continued intermodal volume growth in the fourth quarter. We did see faster volume growth at the beginning of the third quarter than at the end, primarily due to the economic slowdown. As a result of the slower economic environment, we do not expect to particularly long peak season this year and given these economic issues and tougher comparables in ’07, we expect our intermodal volume to grow between 3% to 6% in the fourth quarter. Our brokerage business grew impressively during the third quarter with revenue up 29%. We continued to generate new brokerage business with some of our existing intermodal customers and have been successful in generating interest from some customers they are completely new to Hub. In some markets, truck capacity was tight during the third quarter, but overall truck capacity was better than we had expected at the time of last call. We continued to see capacity exiting the marketplace, but with the slower economy there is also less freight to handle and as a result, capacity as we speak is generally plentiful. Our Unyson Logistics business also a had nice quarter with revenue up 20% as we completed the on boarding of two significant new pieces of business during the quarter. Unyson recently won the Quest for Quality Award from Inbound Logistics Magazine. This prestigious award is determined by customer survey data. We’re proud that Unyson, despite being quite bit smaller than some of the competition was the number one ranked 3PL as we believe that our top ranking demonstrates the value, Unyson is bringing to its customers. As I’ve said earlier, our growth has been helped by the changes we made in our sales organization one year ago. Since this change, we have had 15 sales people leave the organization and we’ve added 18 new sales professionals. We’ve also added a layer of professional managers, whose job is to help our sales people understand our customers, our product and our network needs. We’ve also create in an enterprise sales group, which is made up our top performing sales people whose job it is to focus on multimillion dollar opportunities and develop collaborative relationships with these large customers and finally, the realignment of our pricing group within sales rather than yield has helped us price more strategically. In conclusion, we are proud to deliver another record quarter. We grew our intermodal volume by 9%, our truck brokerage revenue by 29% and our logistics revenue by 20%. We have a more directed and energetic sales force and with our flexible asset laid model we are well position for the future. We look forward to continuing our growth as we finish 2008. And at this point in time, we’d like to open it up to any questions that you may have.

(Operator Instructions) Your first question comes from Ed Wolfe - Wolfe Research. Ed Wolfe – Wolfe Research: Could you talk a little bit about the change in the model, if you look at the last two quarters instead of the focus being on operating margin improvement, the focus being on volume growth obviously? How much of this is kind of planned and how much of this kind of taking what the markets gives you and when we look out it what point do you expect to start to see margin improvement as well as growth?

That’s a very fair question Ed, I think that first of all, we had become more aggressive in trying to grow our overall volumes and that’s really in all segments of our business. So you have seen us to grow that, we are at the same time we are working towards margin enhancement, well that may not be reflected quite as obvious with the numbers that we just posted. We are being very aggressive. We are having meetings on a regular basis to expand the margins. Anytime we take on large new customers, a lot of times it maybe at smaller margin levels, but those again are something that we worked at this before, we’ve been able to expand the margins overtime, as we better learn the business, as we get better balance in certain markets and segments, as we find new carriers who maybe interested in the highway business and so, this will be an ongoing process and I’m hopeful that we’d be able to reap some benefits from this pretty quickly. Ed Wolfe – Wolfe Research: The intermodal volumes up 9% what’s the visibility as you’re going forward, you were obviously last quarter that I’ve got great visibility we feel like this is outside in the market and we’re comfortable. How comfortably are you the world slowdown again that you can continue to grow volumes like this?

We think the three to six range in the fourth quarter certainly very reasonable, our retail business was down 1% again in the third quarter. Despite the fact, that we did add, we actually gain some share and added a significant retailer to our overall portfolio. So, it’s a very tough market for that, which is a very large business segment for us, but we’ve been able to make it up in consumer products, etcetera. So, we do feel very good about the growth where we are right now despite the fact that retail is down and we’ve also had some market deterioration in handling another transportations companies business. Ed Wolfe – Wolfe Research: Just the share repurchase, I was little confused by the comments, have you temporally frozen it or is the $73.6 million remaining being weight out and you’re going to get reauthorization in order to startup again at some point?

No.

No. We that still out there Ed, what we had 10b-5 plan in place that we canceled in September, we saw the market turmoil, but our $75 million authorization that we had originally still out there and there $73.6 million remaining on its. Ed Wolfe – Wolfe Research: And are you still using that, or is that frozen temporarily?

No. That’s not frozen, we have a board meeting coming up, the authorization is not frozen, we have a Board meeting coming up November 4th, when things will discussion this share buyback, but the plan itself that we had in place got canceled.

When we saw credits markets begin to freeze and it was right on September 29, it was falling below the mark that we had for our plan and so we just stepped in and thought it would not be a prudent use of cash at that time to be purchasing shares until we understood better where the credit markets were and everything else.

Your next question comes from Alex Brand – Stephens. Alex Brand – Stephens: Terri, can you give us the some of the industry vertical growth rates for decline as you have in previous quarters?

Sure. Our retail as Dave said, was down 1% and Q2 was down 13% that was predominantly because we added some big new retail accounts in grew with some existing accounts. Consumer products was up 15% in Q3 and it was only up 7% in Q2 that was predominantly food companies and then durable goods was up 8% where it was only up 4% in Q2, primary drivers of that are electronics and white goods and then transportation, which was up 32% in Q2 of ‘08, was only up 13% in Q3 of ’08. Alex Brand – Stephens: Okay. So, what percentage now is retail? Is it under 20% now?

Now at 23.2% of our sales in Q3 Alex Brand – Stephens: Okay and then, I guess Dave sort of wrap all in to Ed question on profitability. I’m trying to understand the gross margin pressure, correct me if I am wrong on this, but it looks to me like your EBIT margin deterioration as really a function of your gross margin deteriorating and I just want to make sure that that’s not, because you’re pricing more aggressively. Is that more related to, it’s just take time for you to ramp up and you haven’t grown volume like this in years, as far as I can recall and so we should expect that that kind of work itself out, how are you guys thinking about that?

Well, Alex I think across all free business lines, you did see some significant ramp ups right and anytime you’re bringing on new business there cost associated with that. In addition you are not as effectively optimizing that mix as of yet. So, I think that is certainly apart to the component, I think you also have to look that enterprise accounts are up 19% for us in the quarter and enterprise accounts are inherently more competitive then smaller shippers normally would be. So, there is a need, when are you going to grow with enterprise accounts to price more aggressively. However, we are confident that over the course of time we’re going to be able to improve the performance of that new business.

Yes, it is difficult to manage the after [inaudible], so we need our operations and customer service team to be lock step communicating timely with the customer and we are initially bring it on a lot of new volume for customers that hard to get straight to first time we trying to get work through it. For example, we set up pools for certain customers setting up those pools we can well impose what an initial ramp up cost.

And then finding the right rate capacity, making sure you to providing the right equipment solutions, once you learn the behavior, you are better able to make sure you get the right fit for that particular customer and you know the same is truly we are finding capacity on the highway side and also with realizing savings on the logistics sides. So, anytime we’re started up mode generally speaking you’re cost are going to be a little bit higher and your margins are a little bit more narrow then when the business is maturely. Alex Brand – Stephens: Okay, I guess I’m trying to understand and it seems hard for any of us make bet on the volume growth continuing in ’09 in recession and it sounds like you guys are pretty confident that you can sort of go back to focusing on profitability until you get through this and grow your earnings and comment on that, if I am read that wrong, that’s what I am heard?

Well. In an ideal will do both. I think that, I do you think we feel is that we’re very well position right now from growth perspective, I think that the sales realignment and some of the changes we’ve made within that and within the pricing area I think it have been the effects are just being felt and I think that will continue to see improvement in that, but again at the same point in time Alex, I think we are not going to forget our routes, we’re going to be very aggressive on margin enhancement and figuring that how to create some operating efficiencies, so that in fact we get all the accounts up to a reasonable margin level.

Your next question comes from John Barnes - BB&T. John Barnes - BB&T: Follow up on your last comment there getting all of your accounts up to an appropriate a margin level. What percentage of your accounts do you believe fall below that right now?

There is lot fewer that are negative especially on the truck brokerage side. Right now, we don’t have any negative margin freight to pickup, so that did better. There is some freight we took strategically where we price it in order to get it and as Mark said earlier with those big enterprise accounts that we want to penetrate and so is that works into systems we should be more efficient on the cost side and so we think it will improve.

Yes, we don’t have a lot of customers that in the aggregate or under performing acceptable levels, but there are some lanes and there are specific transactions that certainly offer us some room improvement and lot of that is just getting to know that business better and understanding how to operated more effectively. So, I don’t have an exact number for you, it too much, no doubt we are going to work on it and we are working on it every day, but it’s also just an actual part of the on boarding process.

John Barnes – BB&T: Can you give us an idea of the average account that’s below the appropriate margin level; are we talking a couple of percentage points or are we talking we’ve got to double the margin in that business to get it where it needs to be; just on average how much improvement that we’re talking about?

It really depends on each customer, because everyone’s so different. So, like Dave said, we look at it globally more that….

There is no average, I would say that, there is some larger accounts we just broad on that we may want to double or even triple to margin, but again, if you startup with a small margin, it’s a much easier to get some kind of multiplier effect.

We do have a target margin for all of the low margin account that we have. We got a dollar amount that we are shooting forward to get.

But are they customers specific, because for example we would have a higher tolerance for shippers how are year around of the west coast in terms of what’s an acceptable margin versus somebody huge peak shipper may be out of Seattle for example, in October or a customer who is feeding the west coast, clearly our margin tolerance would be lower for them than what it might be for somebody whose during business with us on spot basis. John Barnes – BB&T: Okay, all right. Taking your comments about canceling the 10b-5 program and just trying to get a feel for the credit markets and that type of thing; has that changed your thorough process in terms of acquisitions at this point?

No, we were still actively presuming acquisitions. We very much would like to go in the direction. We just thought at the time because an acquisition obviously I think is going to be more accretive then just a stock buyback and we just felt with the turmoil that was taking place within the market, that it would be better to have some cash on hand, in all candor, because this turmoil could result in some decent acquisition opportunities arising. John Barnes - BB&T: Do you have anything in the pipeline currently?

I wish, I can say yes; no we don’t.

(Operator Instructions) Your next question comes from Todd Fowler - Keybanc Capital Markets.

Dave or may be Mark, can you talk about the impact of fuel here during the quarter and I guess, you may be just generally, I’m assuming that your plan to drill a lot of differential fuel surcharge with your customers then the real carriers, but as fuel net benefit or a negative in a declining fuel environmental like you saw during the quarter and then, any sort of context around the impact on margins would also be helpful?

Well, I think we’ve said in past conference calls about 70% of the fuel surcharges that we charge our clients are developed by our clients and so we made the decision years ago when this first became an issue to look at the customer in the aggregate. We have certain clients, which have very punitive fuel surcharges and so, when they do, what we do is we have very aggressive margin focus and price focus on them. So when we look at the aggregate margin on that accounts fuel is just one component of that cost and fuel is just a component more so than anything else.

Yes, and I think just to had to add that from a timing perspective, basically our costs and our fuel charges are closely linked from a timing perspective, most of them are adjusted on a weekly basis. We have some customers that have a lag at month or quarter so, obviously the fuel went down that would be benefit; there is one large real carrier that only adjust on a month, so that would be headwind in a declining fuel situation, but basically that the majority of our business our cost are moving with our charges.

Okay and so, if I kind of understand all of that basically, it’s difficult to really get the number, or quantified what fuel was doing during the quarter or may be it comes out in the wash and there’s not a significant impact one way or anther?

There’s not a significant impact.

That’s exactly right and we don’t, I think, you guys are aware, we don’t have any type of the below market, fuel deal with our underlying providers either.

Right and then, I guess I’m looking at growth in the local east, I would assume that because those are surely the pass that the margins of the shipments are little bit lower, I guess that fair assumption, and then also at this point what percentage of the overall your movements are local east versus the traditional trans candor moves?

Yes, the margin on those sides is pretty comparable to the margin on our other freight. So, its not any lower and I think it must fall 25%.

A little more than 25% this year.

25% in the third quarter.

A little higher than that, I think Terri, I’m doing the maths right now.

Okay. I think my next question is for Terri, so I’ll let Terri do the maths and then ask it?

Yes, it’s about 28%.

So, obviously, our mix is shifting longer towards –

Our average length of haul actually went down about 3%.

Okay, and then Terri you mentioned some hurricane relief during the quarter, was all that on the truck brokerage side and then any sort of quantification from a revenue standpoint or from an earnings standpoint, how they get impact that might have had?

Todd it was all on a truck brokerage side, and it was a couple million dollars in revenue.

Okay and then just lastly, Dave if you could, if you know, refresh your memory, if I remember correctly last year it seems like the peak season started the little bit later during the fourth quarter and in the prepared remarks you said the capacity seems a little bit tighter off the west coast, but it’s seems like little bit cautious about the outlook play rightfully. So, given what’s among macro environment, how to think about it in the changes of seeing a later peak and based on what you saw last year’s anything that would kind of lineup and give you indication and we could see a similar trend or it’s really the expectation. What we have seen recently as prior going to continued for the rest of the year?

As for as the peak you did, actually ’07 was a little bit delay but not a great deal versus ’06 and ’08 is even more delays in ’07. We start to see some fraction in the overall availability of equipment on the West Coast probably about three weeks ago and then late last week it actually capacity became quite available in the Port cities, which I think as just reflection of the very weak retail demanding that you have right now, the import just not coming in. So, we have that within our volume forecast, we‘re accounting for the retail and we don’t believe retail is going to still have a rebound by any stretch during this quarter or the first quarter of next year, so that’s all built in their. Yeager, lets talking to one where the executive and he mentioned that, he would understood that some other lines may began to be looking because fuel surcharges are dropping so much maybe looking to began to reduce some other all water service from the for East Coast, of course that could benefit us as well, but I think that as yet to be seen as far as what the outcome will be with the steamship companies.

We have no further questions in queue. I’ll now turn the call back over to Dave Yeager for closing remarks.

Okay, great. Well again thank you for joining us on the conference call. As always if there are any additional questions they come up, et cetera. Please feel free to call our Terry, Mark and myself. Again thank you very much for joining us.

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.