Universal Logistics Holdings, Inc. (ULH) Q4 2018 Earnings Report, Transcript and Summary

Good morning. My name is Marianna, and I will be your conference operator today. At this time, I would like to welcome everyone to the Universal Logistics Holdings, Inc. Fourth Quarter 2018 Financial Results Call. [Operator Instructions]. Thank you. I would now like to turn the call over to Jeff Rogers, CEO of Universal Logistics. You may begin your conference.

Thanks, Marianna. Good morning. Thank you for joining the Universal Logistics Holdings Fourth Quarter 2018 Earnings Call. Fourth quarter continued the record-breaking trends set in 2018 with the fourth quarter in a row of record revenue and earnings. As a matter of fact, it has been four quarters in a row of double-digit year-over-year increases in revenue and earnings. Consolidated revenue increased over last year $72.3 million or 23% to $386.4 million. Fourth quarter adjusted operating income of $24.9 million, excluding legal reserves, increased 90%. Adjusted earnings per share of $0.55, excluding legal reserves and losses on our marketable securities portfolio, increased over last year by 150%. Jude will provide a reconciliation of these adjusted operating income and EPS numbers here in just a minute. The fourth quarter was a fitting end to the record-breaking year of 2018. The Universal team executed well. As I take a quick look back at 2018, Universal accomplished some pretty good things. In addition to record revenue, operating income and earnings per share, Universal completed 4 intermodal acquisitions in key strategic locations, all of which have proven to be accretive, as we said they would be, and are performing as well or better than expected. Each acquisition brought new customers and new opportunities as we build out our nationwide intermodal drayage network. Jude and the finance team closed on a new credit facility that gives us plenty of dry powder and flexibility to continue investing in our business as well as continuing with our M&A strategy. Speaking of investment in our business, our equipment is very close to our desired average age for our owned tractors and trailers and is in the best shape from an average age in our history. Obviously, this is a good thing and very important from a safety and driver retention perspective. We saw our percent of total revenue from automotive decrease from 43% back in 2016 to 36% in 2018, not because we're getting less automotive, but through acquisitions and organic growth outside that vertical. The team worked hard on improving our operating margins while growing the top line. Our 2018 adjusted EBITDA margin of 10.1% was the best since 2013, and the adjusted OR of 93.7% was the best since 2015. And I have a lot of reason to believe that 2019 will be our best ever. Several areas of our business did not go as expected. Our dedicated unit, while profitable, did not meet our return expectations, as I have talked about on several previous quarters due to contract commitments that were below market. We have completed several negotiations with key customers and expect dedicated to meet our margin goal in 2019. The truckload agent business overall grew revenue and operating income in 2018, primarily due to a strong rate environment, but we continue to lose drivers throughout 2018 in the over-the-road irregular route portion of that business. The truckload team is focused on improved planning for our drivers to optimize their day and week. We fully expect to deploy new technology by the end of 2019, which will greatly enhance visibility, administrative processes and planning, so that the drivers day-to-day experience with Universal will be better than ever. Now shifting to the current view on the remainder of 2019. The economy is strong and the environment remains pretty good. I would expect 2019 to be a really good year with normal seasonality. While spot pricing has softened compared to what we experienced last year, contract rate increases are holding in the mid-single digit range for truckload and are a little stronger for intermodal. There is still plenty of freight and overall capacity is still tight. Our sales pipeline remains over $0.75 billion. Our relationship with our key customers has never been better, and we are having continual strategic conversation about how supply chains are changing and how Universal can meet those needs because of our robust capability, our diversified service offerings and our proven track record of solving their problems. As I have said many times, very few companies can do what Universal can do. A perfect example is our recent win of Dedicated Transportation with an automotive OEM that has an annual run rate of over $23 million to provide short-haul capacity. And for the first time, the automotive customer agreed to fixed and variable pricing to secure capacity that they so desperately need, but could not find in 2018. This piece of business will be operated close to an assembly plant where we already do substantial value-add business. We believe this will be a blueprint for additional dedicated opportunities within automotive that clearly is a win for us and our customer. Our goal to own the plant continues to materialize. Automotive saw our forecast for 2019 remain near 17 million units. Class A truck production forecast 2019 to be a record year. As I said, the economy is still strong, the consumer is still spending and we are positioned well to continue our strong performance. Jude will now give you more color around our financials as well as reiterate our 2019 expectations. Jude?

Thanks, Jeff. Good morning, everyone. Universal Logistics Holdings reported net income of $9 million or $0.32 per share on total operating revenues of $386.4 million in the fourth quarter of 2018. This compares to net income of $24.4 million or $0.86 per share on total operating revenues of $314 million in the fourth quarter of 2017. Universal's results in both the fourth quarter of 2018 and 2017 includes certain adjustments that need to be reconciled to determine our normalized operating margin and earnings per share. Let's start with 2017. If you recall, Universal's reported net income of $24.4 million included an $18.1 million tax benefit due to revaluing our deferred tax liabilities resulting from the Tax Cuts and Jobs Act legislation signed by President Trump in late 2017, as well as $500,000 of unfavorable tax adjustment. On a per share basis, these adjustments netted an additional $0.62 per share in the fourth quarter of 2017. On a normalized basis, EPS in the fourth quarter of 2017 was $0.22 per share. In Universal's fourth quarter of 2018, we reported net income of $9 million, which also included a couple of items we already have mentioned. First, we incurred a $7 million charge related to the settlement of a previously disclosed accident, which was the equivalent of about $0.19 per share on an after-tax basis. The total cost of settling this accident was $9 million, $2 million of which was recorded in the third quarter of 2018. The second item was a significant decline in Universal's stock portfolio in the fourth quarter of 2018, which experienced $1.6 million of holding losses or approximately $0.04 per share. Together, these 2 items negatively impacted the quarter by $0.23 per share. After adding these adjustments back, Universal's adjusted EPS for the quarter would be $0.55 per share compared to the adjusted $0.22 per share in the fourth quarter of 2017. Universal's fourth quarter of 2018 operating margin, excluding the $7 million legal settlement, was 6.4% versus the 4.6% reported, and adjusted from income from operations was $24.9 million compared to $13.1 million in the fourth quarter of 2017. Adjusted EBITDA increased $11.8 million to $38.4 million in the fourth quarter of 2018, which compares to $26.6 million 1-year earlier. Our adjusted operating and EBITDA margins for the fourth quarter of 2018 are 6.4% and 9.9% of total operating revenues. These metrics compare to 4.2% and 8.5%, respectively, in the fourth quarter of 2017. Looking at our segment performance for the fourth quarter of 2018, in our transportation segment, which includes our truckload, intermodal, NVOCC and freight brokerage businesses, operating revenues for the quarter rose 31.6% to $260.5 million compared to $197.9 million in the same quarter last year and income from operations increased $12.1 million to $19.4 million compared to $7.3 million in the fourth quarter of 2017. In our logistics segment, which is comprised of our value-add services, including where we service the Class A heavy truck market and our Dedicated Transportation business, income from operations increased 22.4% to $5.2 million after excluding the $7 million settlement charge on $125.5 million of total operating revenues compared to $4.2 million of operating income on $115.8 million of total operating revenue in 2017. On our balance sheet, we held cash and cash equivalents totaling $5.7 million and $9.3 million of marketable securities. Outstanding debt net of $2.7 million of debt issuance cost totaled $400 million at the end of the period. Capital expenditures for the quarter totaled $9.4 million. For the year, Universal's CapEx totaled $63.6 million, while generating $34 million of free cash flow. I would also like to remind everyone that on February 4, 2019, Universal released its 2019 financial outlook. We continue to expect total operating revenues for 2019 to be in the range of $1.6 billion to $1.7 billion, operating margins between 7% and 9%. Capital expenditures are expected to be in the range of $65 million to $75 million, and total interest expense between $15 million and $17 million. On Wednesday, our Board of Directors declared Universal's 10.5% -- $0.105 per share of regular quarterly dividend as well as a special dividend of $0.11 per share based on our 2018 results. This quarter's dividends are payable to shareholders of record at the close of business on March 4, 2019, and is expected to be paid on March 14, 2019. With that, we're ready to take some questions.

[Operator Instructions]. Your first question comes from Chris Wetherbee with Citi.

I wanted to touch base a little bit on the guidance, particularly the margin guidance. Obviously 7% to 9% is a pretty meaningful step-up from where you finished 2018. Could you help us, sort of, bridge the gap a little bit? What is the walk that -- what are the key drivers to get that step-up from a margin perspective as you look across your book of business -- your portfolio businesses?

Right. I can help with that, Chris. So if you look at where we went through -- and it was a little bit choppy as you go through the year. But if we look at where we're at from a logistics to value-add space, we're getting back to normal margins. So if you just project that forward, that helps into 2019. With the acquisitions on intermodal, those margins are higher than our existing margins within intermodal. And intermodal -- our legacy intermodal continues to get better all the time, which is very good for us. So if you just play that out into 2019, that's a big part of what the margin improvement is from those 2 areas. We also feel there's a lot of strength in the other areas of our business from dedicated, which has not been where we needed it to be in 2018 or actually 2017 either from a margin perspective, but that was a pretty big drag. So if you take the $90 million to $100 million that we expect in dedicated in 2019 and get it back to that 8% to 10% margin in that business, and we feel we can do that based on all the renegotiations on pricing and what we see going forward, that's a pretty big step-up because our margin there was basically 1% to 2%. So that's the big step-up as well there. So if you take those 3 areas, that's really what gives us to the 7% to 9% range, and we feel pretty comfortable with that.

Okay, that's helpful. And then when you're thinking about the intermodal business, specifically we've seen some nice acceleration in profitability. Some of the intermodal players are -- that are out there that, could you talk a little bit about what you are looking at in terms of rate expectations for 2019? How do you think, sort of, the early stages of going through contract bidding has been? And sort of what you think that could shake out for the full year?

Yes. I was just talking to Tim Phillips, our President or head of that intermodal area. And we're still seeing -- intermodal is still a little bit stronger from a rate than truckload. Everybody knows truckload rates are starting to soften up a bit. We're still seeing, what I would call, mid-single digits on the truckload side. Intermodal's may be another 1 point or 2 point higher. The contract rates that we're getting are in probably that 5% to 7%, maybe even up to 8% in one -- a case or two. So I would call it a little bit stronger than truckload, but still pretty darn good from an intermodal perspective. So we feel pretty good about that.

Okay. And it's an interesting dynamic because we've heard other folks talk about the prospects for intermodal rate increases just sort of outpace truckload rate increases. Can you talk a little bit about sort of the sustainability of that dynamic? I think there is sort of the view that it's hard to see that maintained over the course of maybe an entire year. Maybe it could be sort of a temporary dislocation. But obviously, we're looking at some really great rate increases from 2018 that you're comping against. So any sense about how we think about the sustainability of that outperformance of intermodal relative to truckload?

Yes. It's hard to say what's going to happen by the end of the year. Everything we're seeing in from a customer perspective, we're not getting any pushback at all when we're going with a 5% to 7% to 8% increase, depending on the customer. And if you look at what's going on from a precision railroading perspective where everything is going on. The railroads are still extremely congested. The ports are extremely congested. So at the end of the day, what we do is drayage. So customers are willing to pay that higher rate because they've got to get that stuff out of either the port or the railhead. And so, I think, from a drayage perspective, we feel more confident that that's more sustainable than maybe the domestic intermodal piece. And that's why we're playing there, and that's why our acquisitions are really targeted with drayage because we think the sustainability in that space of intermodal is better.

Okay. That makes sense. One specific question on the Class A side. So you had mentioned, obviously, that we're seeing spot rates kind of tick down pretty meaningfully here. Contract rates probably decelerating a little bit too on the truckload side. There's going to be a big build year in '19. But how do you think about sort of the normal cyclicality of the Class A production cycle relative to the rate cycle? I just want to make sure I understand what your thoughts are. Is there possibility that as we get into the tail end of '19 those numbers could be looking a little bit different from a production standpoint, just to kind of get a sense of how that plays with your business there?

Yes, that's interesting. If you look at where we're at, because we had a great year from a production perspective in 2018, but there was a lot of disruptions from the supply side, because suppliers couldn't produce enough parts to keep the production at the high level. I think some of that's been corrected. Some of it maybe not as we go into 2019. So -- and I think you've hard that from just about everybody. You may have ordered tractors in 2018, but they didn't get delivered, and there's still some production carrying over into 2019. I think 2019's still going to be a bigger year from a production schedule, at least the forecast from our OEMs are telling us that. I think the supply chain is going to be better. I think people have figured it out now, and they have increased their capacity. So I would expect 2019 to really be very robust from a production schedule. 2020, I think, is a different story, but we'll have to wait and see. If they can keep up, you may have some carryover from '19 into '20, which may make '20 a whole different picture than what they're seeing right now. So we'll just have to see. But I just think there's so much pent-up production that just didn't happen in '18, '19 is going to still be a really, really good year. We expect it to be the best year from a forecast perspective than ever.

Okay, okay. That make sense. And then the last question is just when you think about some of the macro trends that we're looking at -- and curious if you feel like there was some evidence across your networks, whether it be on the value-added side, warehousing or otherwise, intermodal of a pull forward of volume activity ahead of any trade or tariff-type issues, maybe that was in the fourth quarter, maybe it's sort of early in the first quarter. Do you think you've seen any of that, number one? And then number two, does that potentially lead to a little bit of a hangover or a low in volume as you look into the second half of the first quarter, maybe early second quarter?

I'll answer it by what we know and what we saw, and what we talk to our customers because we -- obviously, with the acquisitions there in Southern California, we've got some very, very large retail customers. And the few very specific ones that we talked to did not pull anything forward, because they didn't have warehouse space to hold the extra inventory. So would it cost more to try to figure that out than pull forward? Now I do know that there has been pull forward, but not specifically to us. We just have seen that from our customer base. We are -- January was extremely strong on the intermodal side. February is starting to soften a bit because of the Chinese New Year, and that period of time comes right in right now. So there's going to be some weakness, I think, because of that for the next couple weeks going forward. But right now, from our perspective, I didn't see anything from a significant basis that says there was a whole lot of pull forward with our customer base.

Your next question comes from Bruce Chan with Stifel.

Just a couple here on the value-added services side. And I think you've discussed this in the past. But can you just remind us what's driving the continued headcount declines on the value-added services side?

Yes, one specific was Mexico. Remember, we talked about Mexico a year ago where we really struggled, and that was a much larger project than it is now. So there's significant heads reduced in our Mexico operation, which is in value add. The rest of it is really just cost control and squeezing that margin. Back to the question that Chris asked about what we're seeing from a margin improvement is just squeezing out the heads, because, over time, at the end of the day, it's like anything else. You get a little bit smarter, you get a little bit better. And when you hold these pieces of business for multiple years, you should start seeing reductions in headcount over time.

Okay, great. That's helpful and certainly good news. And I know that you've discussed aerospace as being a big opportunity on that value-added services side. Just want to see if you can give us an update on where you are in terms of that sales cycle and opportunity?

Yes. I think we picked up a couple of small little pieces of business additionally last year in the aerospace vertical. We absolutely are trying to be aggressive and grow that faster. It's a very long sales cycle with aerospace, as you might imagine. They want to -- just extremely expensive and they are very risk-averse, so they want to make sure they are picking the right partners. We have a very good relationship with the OEM that we're doing business with now, and we expect more business coming forward. Matter of fact, we just got word yesterday of an ark fee that we're going to be included on -- off with them going forward. So we feel pretty good about that.

Okay. And then assuming that you do hopefully win some of that business, is there a substantial investment that's got to be made in order to bring that business online in terms of what you have to do to get it? And kind of what's the typical lag on the margin in terms of startup costs?

The cool thing about aerospace, which is a little bit different than what we have found with the automotive guys, is typically, one, all of -- whether it's capital investment is all in the price. Whether you pay it, whether they pay for it upfront or it's in the piece price over the life of the contract. So far, our experience with aerospace is they typically pay upfront. So we wouldn't be too concerned about that being an extra cost for us on the capital side. There's always start-up costs and there's always additional costs when you start these big projects or any project, but it's really covered within the contract, whether it's a 3-year, 5-year or whatever. So that's typically -- you'll see some extra cost there, but with aerospace guys it's actually kind of cool they pay for a lot of it upfront.

That certainly is nice. Then just one last question here on the logistics side. One of your competitors talked about introducing payment factoring and said that, that was something that's fairly common place in the business. Is that the case for you? Is this factoring something that you all do? And maybe, more broadly, are you seeing any pressure on the working capital side in that business line?

Bruce, it's Jude. No, we've never done factoring. We hit collections pretty hard. I mean, I personally meet with our collections group every two weeks. Our DSO has been very stable between 45, 48 days since I got here in 2015. So I mean no, we don't really see -- we don't really have a lot of drama with collections, the OEMs. They pretty much stick to their payment terms as long as the bills are right. So if you focus on getting the invoices right upfront, you really don't have a lot of problem on the back end, get the money in the door. Plus, we're not willing ever to shave -- plus, we'll never shave off additional margin points to factor receivables. That doesn't make any sense in this business.

Okay, that's super helpful. And then just one last one before I hop off and give someone else an opportunity. Jeff, you talked about getting your average fleet age down to record levels for your owned equipment. Just want to know how that's trending on some of the kind of independent owner-operator side and square it with some of these production numbers that we're seeing and maybe some of the insurance results? And what the implications are for potential claims? Are you seeing that small fleet count, fleet age come down or is it still kind of up there?

Well, keep in mind, there's difference between the owner-operators, because I don't control what they do with their equipment. They choose to get in track or not. So I couldn't really tell you what's going on with the average age of that fleet. I just know that we want to get our tractors to an average age of 2 to 3 years. And we're very close to want to get trailers to an average age of 7, and we're very close there. And that's been -- obviously, a lot of capital investment over the 4 years that I've been here that was different than previous. So we're going to get through a consistent capital spend, and that's the whole goal.

Okay, that's helpful. And I guess really what I was just trying to do was get an idea of where we're seeing a lot of these Class A orders go, and it's something that we've been talking about all year. We've heard some people say that small fleet growth is increasing a lot faster than large fleet growth. So just wanted to know if you had any color on that front as to where again some of this capacity is going.

Well, it could be. I mean, again, as we say, we're replacing, and there's a little bit of growth here and there, especially like the point I just made on that dedicated piece of business we picked up. We're going to actually have gotten by some additional equipment for that, but it's very, very specific piece of business. I do know that where we see some of the driver defections in our irregular route business, they are going to smaller fleets, because most large fleets are very similar in what we do, how we -- what we offer the drivers. So those guys are going to some of the smaller guys that, one, may not force ELDs and depending on the age of the tractor or the mileage that they run. So there's some issues there where some of the drivers are going to the smaller fleets because of some of the ELD requirements that we've heard. But that's about the only thing I can really add to that. I really don't know exactly what's going on with all the small fleets.

Your next question comes from Jason Seidl with Cowen.

Couple quick questions here. Want to talk a little bit about the margins in the dedicated side. You said it was due to some contracts under market. Did you guys had an inordinate amount of contracts that were in their sort of final year, if you will, in 2018?

Keep in mind, a lot of the automotive guys, which is predominantly all of our dedicated in the past, we are growing some nonautomotive now. But for the most part, it's been automotive. And those were almost always on a one year cycle or a two year cycle. So if you think about -- if we locked in something like at the beginning of '18, the market was significantly different by the end of '18. If you locked in -- so it's really just dependent. But I can tell you that the vast majority of those now have been dealt with. I think, we've got 1 more fairly large one that we're working with now that ends in June of this year that we'll get figured out and bring it to market. So we feel -- that's why I feel very confident we'll get the margins that we need in dedicated this year.

So basically you got all but one settled in terms of the contract?

All but one big one. I mean, keep in mind, there's always lanes that change day-in and day-out. But for the most part, the program, the big large programs with a specific OEM, we've got really one more big one to deal with. And we've already had a lot of discussion. It's just a matter of accepting what we're asking for.

That's always the case. Speaking of the automotive next thing and, obviously it's come down for the last couple of year, but 36% is still pretty high. Just sort of the goal when you're looking at future acquisitions sort of 2 branch out away from automotive?

As I've always said, I really don't have a specific number in mind because I'm not sure what that number would be. All I can tell you is we're going to continue to -- one, if we continue to acquire in the intermodal space, which our plan is, yes, we're going to continue to do that. That's going to be nonautomotive, so that will help those percentages. And we're going to continue to try to grow in verticals outside of automotive. I've also said in the past, it's always tough to do that because the automotive guys are constantly giving us more business, which is a good thing. But it's always good also expand another vertical. So I just can't give you a good number because I really don't have one in my head that I'm shooting for.

Okay, fair enough. And speaking of sort of about your intermodal business. How has been sort of the port congestion and sort of the interchange conjunction with the railroads? And what are you guys -- what have you been told to expect from any impacts from PSR from either three railroads not for implementing it?

I didn't hear the last part of that question. But we definitely are seeing congestion in any of the railroads that are shifting to PSR, there's quite a period of time where things just get gummed up. There's talk about closing different of the railheads or different terminals, but we haven't seen anything materialize yet to that effect. But it's really, I think, just the railroads kind of getting their act together where they want to be from a PSR perspective. And it just creates some real congestion for a while in the railheads.

Okay, fair enough. Last question. We've seen some large customers, sort of, in-house some more operations with Amazon, with XPO. Walmart starting to announce taking some INC business in-house, although that's still early on. Is this something that we should again look out for with you guys? You think maybe automotive companies might even start looking at this considering, sort of, Amazon and Walmart have been sort of a leader, if you will, in the shipper community?

Well, keep in mind, automotive has been in that space for a long time as far as just in time. So when you think about the e-commerce, whatever it's doing is they're building warehouses closer to the consumer. The automotive guys have done that for a long time. They built big warehouses right next to the assembly plant, so that we can deliver the parts just in time. So that's -- there's not going to be a change from how automotive does it because they've already done it, and we're a big part of that. We are having conversations with the customers that you just talked about, Walmart being one, where they are looking at difference because we do an awful lot of cross-dock business for Walmart. We have 3 of their cross-docks within their distribution network. So they're looking at how are they going to do things different. But I don't think it's going to be -- it's not going to be like we're going to lose the business. I think it may shift to a different type of arrangement, whether it's a bigger warehouse closer to where they want to have that distribution done or we're having great conversations with them to be part of a solution for them as they change their supply chain.

[Operator Instructions]. Your next question comes from Jeff Kauffman with Loop Capital Markets.

Solid quarter. Jude, just a couple detail questions. Tax rate was about 240 basis points below what I was looking for, a little bit below the part of the year. I know fourth quarter is always a true-up on the tax side. What caused the lower rates in 4Q? And what's the right way to think about tax rate in terms of your 2019 outlook?

Yes. So we suggest that you model between 24% and 25% going forward. Q4, we had the return to provision from '17, that was favorable. We did a cost-ag study, which allowed us to accelerate some tax depreciation. So we had a little bit of noise in the quarter that's not really run rate. So we just keep using that 24% to 25%, and we feel comfortable that's where it's going to land.

Okay, perfect. The new ASC 842 on leases, how does it affect you? Are we going to have to capitalize any of the operating leases? And is that in the guidance at this point or do we announce that in first quarter?

Yes. No, we're going through that right now. So we're still working through with our auditors how that's all going to shake out, so we'll have a lot more color on that in our Q1 call.

Okay. And then one final question for Jeff, because a lot of mine were hit in the earlier questions. You were talking about the challenges you're having with the OTR drivers, and that's an industry phenomenon. Is this something that higher wages or higher rates fixes or at any wage or any rate is this a structural issue, and it's more about reconfiguring the network for quality of life?

I would say the latter because I -- if you think about what those guys went through or what rates did in 2018, in some cases, 20%, 30% higher rates on revenue per mile. So those guys were getting paid more per load in 2018 than probably ever. But yes, the quality of life still sucked basically. So I think at the end of the day, it's really a shift in the supply chain and there's a shift in business models. And that's what we're wrestling with and working with our agents and the truckload groups to figure out, because at the end of the day, I don't think money solves that. I think it really has to be more of a regional-based approach, more of a opportunity for those guys to spend a little bit more time at home versus in the back of the sleeper berth. So I think it's just something that's got to change over time.

There are no further questions at this time. I will now turn the call back over to the presenters.

Great. Well, we appreciate you joining us. We appreciate your support and look forward to talking to you here in a couple months. Thanks, everybody.

This concludes today's conference call. You may now disconnect.