Hub Group, Inc. (HUBG) Q3 2021 Earnings Report, Transcript and Summary

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 answer session will follow the formal presentation. In order to everyone have 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 these 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 the refrigerated products. This is an acquisition that Phil has worked on for several years with Choptank’s owner Geoff Turner. We share our 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 to shelves persists. On the second quarter call, we related that we believe that 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 that this imbalance will continue through most of the first half of 2022 and very likely throughout most of the year. Today there are many issues negatively impacting customers’ supply chains. Among the issues are labor shortages and port congestion resulting in network imbalances. Our focus continues to be on supply and 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, in particular off of west coast and we anticipate receiving all of our newbuild 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 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 and final miles. We see continued opportunities for growth ahead as we provide our clients creative solution to reduce cost and enhanced service. 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 have shared 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 over $1 billion in brokerage revenues and we believe enable 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 cost, M&R expense and our tank capacity cost. 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 that 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 as 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 as 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, 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 is driving the need for our customers to restock. For the year, we expect cost and expenses of $365 million to $375 million, which reflects incremental operating cost 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 continued to need cost efficient solutions that offers consistent levels of service. The fourth quarter is off to a solid start that we believe that the momentum will carry through much of 2022. And with that, we will open up the call to any questions.

[Operator Instructions] 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 had some one-time cost, legal settlement not really recurring as well obviously the acquisition expense. Those two pretty much are washed with our gain on sale for the quarter. So there – those kind of two or three items net out. 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 kind of 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 go through 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 ex 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 as well expected days early next year. So, early bid season indications are very strong in continuation of the current trend. And we are anticipating a strong bid season. Shippers need to lock in capacity and we’ve really stepped up by – a lot of our clients to – and be able to take advantage of that next year. So, feeling very good about our opportunity 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, get more fluidity back into the network. And so, that’s really our focus is 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 get more price.

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 this, do you expect gross margins will continue to increase from here as rates moves higher?

Yes. Yes. So, we – we’ll start with yes, we do have very good visibility into our rail cost increases next year and we do be 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. Appreciated.

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 driver 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 cost and certainly drayage cost both internal and third-party. But prices is very big driver of margin for us and that would be – that was the driver of the increase.

And I would just highlight, I think, with this segment we are seeing strong performance there, nice improvements in our transportation management margins and a nice sequential improvement in CaseStack as well. Our final mile business is I think going to see some sequential margin improvements and 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 the cross-sell, 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. And we just need to stay focused on great operational discipline and continuing to enhance our pricing.

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

Correct. Yes, and we would also believe that we are going to see improved volumes next year to fluidity, one we get our containers fully onboarded and two, we see some improved fluidity. We are excited to see some sequential improvements in fluidity and turn time. We didn’t see that from Q2, Q3, but here in Q4, we are seeing some of that sequential improvement and as that continues and we maintain strong pricing 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 runrate. As we move into next year, what are some of the moving pieces, I was thinking incentive comp would be one. A full runrate for Choptank, but what are the other things we need to think about on the expense line for 2022? Thanks.

Sure. Those are going to be the big drivers. Obviously, we’ve got personnel cost is 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, from an earnings perspective, the expansion in our profitability is probably going to come more from price and from volume. And so, that means not a lot of incremental headcount add kind of, 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-digits 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 a great deal of investment in chassis which has been one of the larger bottlenecks that we’ve seen this year. And that will really help from a terminal fluidity perspective and not having trains really stack up. So we think that’s going to hugely benefit hopefully the actions that are being taken what we do additional staffing. I think we’ve done a nice job of really stemming, driving losses on our end and successfully adding third-party capacity. And so, that could be a great upside factor for us next year if we are able to continue that trend of driver that will really help us in maintaining fluidity and control with service products. Our goal is going to be grow next year. We don’t have any hard numbers yet. But, yes, with fluidity and us continuing to add drivers and the investments that are being made in chassis, we think we are going to be in a good position to do that. So, it has been a bit of a challenging here from fluidity, but we are seeing those – some improvements actually.

And Tom, I would add that the macro conditions continue to look very favorable both from the demand side and we see truckloads continuing to be constrained which is a great set up for us going into next year being 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 is 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 you that the West Coast port situation is not going to be resolved quickly or easily that we are going to see continue to see congestion at least through the end of the year and I would suggest you beyond. So, there is just is not enough warehouse capacity. The 24/7 is really not going to work, I mean, it still needs skilled labor to be able 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 is there for a while. And this is not – there is no one switch to turn it off and on.

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

It actually – for the domestic intermodal actually flows quite well, because they don’t need a limited amount of capacity both dray, container, as well as rail ramp capacity. So, actually there is almost metering in of products actually is probably beneficial and allows us to supply more capacity to our clients because the train is fresh out.

I would just add I think that tightness from international box capacity is going to continue to drive more trains loading into domestic and I don’t see that trend really changing anytime soon. I think that’s going to continue to be a driver of more growth for domestic intermodal off the West Coast and there is going to continue to be a high level of demand for imports there. But even as we look at other locations, we still going to get a lot of growth opportunity for us. If you look at Port of Savannah, that’s going to be a big growth opportunity for us this year and I think that will continue as well.

Yes. Certainly seems like there must be 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 the shipment need to lock in capacity a couple times. And just thinking about that in the context of dedicated. Obviously, higher cost 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’s been our primary focus. What I would highlight, I think with dedicated is that, we were not fast enough to get wage increases in with our customers to be able to go out and recruit and see trucks. And 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 make sure that with our clients we are adjusting language where it might not fit with a standard dedicated time with fixed and variable sort of charges. So, I think we’ve done a nice job of that through the vast majority of those changes. We are still always going to be trying to make sure that we are working with our clients to set up a mutually beneficial agreement. But we certainly see opportunity in demand out there for us it’s about making sure we are going after the right contracts with the right customers and the right set of charges. So, feeling good about our disciplines there and 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 ecommerce. 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 vein.

Yes. So, with our big ability kind of 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 ecommerce customers. So, we are feeling very good about the growth opportunity ahead regardless of if there is a little bit of slowdown in demand. We actually have some – a little bit of a backlog in onboardings and going in that will move into Q1 of next year that will really be a nice ramp for us as we look ahead into 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 we think about the changes in volume and revenue for this quarter? How does this break out between contractual and spot?

Sure. So, this quarter, we were right around 49 – just under 50% or just over 50% contractual. So it did move down from about 51% last year Q3.

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

Sure. I would say, spot continues to be strong. We are doing our best to convert where there is opportunities to convert spot into contracts. That’s kind of where we played historically closer to 70%. We think we’ll get back there over time.

Okay. Great. And then, I guess, just as my follow-up, could you tell me what the split is between contractual and spot for Choptank?

Sure. Choptank is around – in this market it’s around 65% to 70% transactional. Historically, they’ve been closer to 50-50.

Okay. Great. Thanks a lot for the time.

[Operator Instructions] And 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 or how did you measure that beyond kind of a 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 that they have for that business and to the community that they are in. And how long they’ve been active, right, they get into start up a few years ago. There has been assets for 20 years and growing this business methodically you have a strategy and the way that they interact with their customers and most of their customers stick with them for the long-term, right. And that is different than a lot of brokerages. So, there is typically high level of customer turnover, a high level of team member turnover. That’s something that Hub Group really values is our folks and our clients and from that sort of long term relationship with those stakeholders we thought, along with all the qualitative and for the truck brokerage segment from a revenue and margin perspective sequentially if you exclude Choptank of the diligence process. So that was really indicative of a great alignment with our organization.

Thanks. And then, following up, I mean, others 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 excited. Our customers have been very excited. We’ve already got wins on the board actually and we are seeing a tremendous amount of opportunity to cross-sell. So, yes, very excited about even the progress through the weeks. So, feel great.

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 Transcom and Local West volume was 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 in rail service still needs to improve?

Yes, so, month quarter-to-date, so it really for the month of 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 and really going back to January. So we're encouraged by that. We do have new containers coming in. We expect we'll receive all of them by the end of the calendar year. And 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, the government contractors, we don't believe that that's going to have a direct impact for us right now. We are not a government contractor. If they do, if OSHO does come out with a mandate and forces truck drivers, it’ll have an impact. We're still working through it. But it will have an impact on the entire economy in my view, it’s because there will be a certain number of truck drivers that just feel strongly from a personal perspective that they don't want to take it. I am not an antivaxxer. I am vaccinated. I encourage people to. But if you try to mandate that to what can be a very independent group, I mean, it's, I hope the common sense prevails. And it's understood that realistically the truck drivers throughout this pandemic have been out there and getting product to store shelves and I hope, that that's taken into account and they do get an – we 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 adjusted 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, Jeff and Phil and I are available if in fact you come up with the different questions or 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.