David P. Yeager - Hub Group, Inc. Donald G. Maltby - Hub Group, Inc. Terri A. Pizzuto - Hub Group, Inc..

Scott H. Group - Wolfe Research LLC Justin Long - Stephens, Inc. Michael Triano - UBS Securities LLC Todd C. Fowler - KeyBanc Capital Markets, Inc. Brian P. Ossenbeck - JPMorgan Securities LLC Bascome Majors - Susquehanna Financial Group, LLLP Van Kegel - Barclays Capital, Inc. Matthew Brooklier - The Buckingham Research Group, Inc.

Rick Paterson - Loop Capital Markets LLC Diane Huang - Morgan Stanley & Co. LLC.

Hello and welcome to the Hub Group Fourth Quarter 2017 Earnings Conference Call. Dave Yeager, Hub's CEO; Don Maltby, Hub's President and Chief Operating Officer; and Terri Pizzuto, Hub's CFO, are joining me on the call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

In order for everyone to have an opportunity to participate, please limit your inquiries 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 words such as believe, expect, anticipate, and project and variations of these words. Please review the cautionary statements in the release.

In addition, you should refer to the disclosures in the company's Form 10-K and other SEC filings regarding factors that could cause actual results to differ materially from those projected in these forward-looking statements. As a reminder this conference is being recorded.

It is now my pleasure to turn the call over to your host, Dave Yeager, you may now begin..

Good afternoon, and thank you for participating in Hub Group's Fourth Quarter Earnings Call. With me today are Don Maltby, our President and Chief Operating Officer; and Terri Pizzuto, our Chief Financial Officer. Hub Group had a strong finish to 2017 with revenue growth of nearly 20% in the Hub segment and 11% in the Mode segment.

Intermodal volume was up 3% due to prioritizing price and network benefits while adhering to customer commitments. As we indicated in our third quarter earnings call, capacity was tightening and pricing was strengthening. These conditions gained momentum through our peak resulting in one of the tightest capacity markets that I've seen in decades.

The strong peak was in large part due to the growing economy, the restocking of depleted inventories, the tight truck market and rail service disruptions. Intermodal market tightness was largely due to an uptick in demand, but in addition, rail service deteriorated, thereby shrinking available capacity.

Thus far, we're effectively working with our customers to minimize the impact of the rail service issues. Rail service is nonetheless slower year-over-year and that has resulted in a longer turn time for equipment in a high-demand market. Despite capacity being extremely tight during peak, Hub did meet our equipment commitments to our customers.

In fact, Hub won more carrier of the year awards in 2017 than in any other year in our history. That is a testament to our exceptional customer service. In addition, we also provided limited capacity to targeted customers that have been left without equipment by their other contracted carriers.

Now that we've created a foothold in these accounts, we're convinced that we'll be able to gain share with reasonable prices and margins. We believe there will be several trends that will carry through 2018 and into 2019, the first of which is a strong Intermodal pricing environment.

As we previously expressed, in 2016 and most of 2017, we experienced tremendous downward pressure on our rates. The direct result of this pressure was a decrease in margins to an unacceptable level. This year we're focused on increasing Intermodal yields through a combination of price increases and optimization of our network.

Although we're confident we'll be able to realize a mid-single-digit price increase, much of the resulting revenue will go to higher driver and rail costs, but we are committed to increasing prices to outpace the driver wage and rail inflation in order to secure reasonable margins that will allow us to reinvest in our Intermodal product.

Another area of focus in 2018 is to recover of accessorial costs. We're in the process of renegotiating unsustainable accessorial agreements made in past with a focus on enhancing overall margin. The Dedicated acquisition that was closed on July 1 of last year continues to move forward according to plan.

We're very pleased with their focus on safety, customer service, and profit as the cultural alignment between our organizations is excellent. And lastly, our thesis of cross-selling Dedicated services to Hub's customers has exceeded expectations.

Hub remains committed in its desire to acquire businesses that will diversify our service offerings and create value to our existing business lines. In all instances, we remain focused on acquisitions that have a strong management team, is culturally aligned with Hub, is not a fixer-upper and is immediately accretive.

And not to steal Don's thunder, but Brokerage did have a stellar fourth quarter while Unyson continues to complete the migration of both existing customers and new customers to our Oracle technology platform. Lastly, Hub reached a major landmark with revenue exceeding $4 billion in 2017.

With that, I'll turn the call over to Don to go into more depth about the specifics of our business segments..

Thank you, David. As Dave mentioned, this peak started earlier than anticipated and continued through the end of the year. To help us better prepare for peak, we started our planning process earlier than normal to establish peak plans with each of our key customers.

This open dialogue and process allowed us to manage through this volatile period and provide our customers capacity and multi-modal solutions. In addition to the established customer demand plan, we were constantly managing the flows of our network and having continual communication with our clients, establishing real-time demand needs.

Throughout the quarter we focused on servicing our customers and standing by our commitments. While doing so, we were also able to improve price across all of our service lines for volume that was not committed on contracted business and that spiked beyond anticipated demand.

As the demand continued, our teams pivoted quickly to offer our customers capacity and solutions, while at the same time providing market pricing. This peak was by far the best performing in Hub's history from both a customer service and yield improvement perspective.

Throughout 2017 we were recognized by our customers for service, despite deteriorating rail service in the fourth quarter.

As we stated on our last call, we have been communicating these service challenges to our customers and increasing transit times accordingly; however, this not only harms our competitive position versus truck, but also adds unnecessary costs to our operation and reduces our fleet utilization.

As we enter 2018 with the ELD mandate in place, new tax laws that should improve the economy and our results, along with a very tight truck market, we believe we are positioned well for success. Now let's talk about the businesses.

As Dave mentioned, Truck Brokerage had a great fourth quarter coming in with an impressive growth of 22% for the quarter and 23% for the year. This is its sixth straight consecutive quarter of volume growth.

Our strategy has been and will remain to provide multi-modal solutions and expand the breadth of our services to include contract, transactional and value-add. We, like many, believe 2018 will be a challenging capacity market.

We expect the ELD mandate and impending enforcement to reduce overall capacity, creating extreme volatility throughout the year and bringing about new opportunities where we are well-positioned with our customers and carrier base.

In 2018, we will continue to work with our strategic carrier base to further support our key markets and align with our customers to provide value-added services. Logistics demonstrated strong top-line growth of 19% in the quarter and 18% for the year.

This was driven by new accounts secured and onboarded throughout 2017 as well as strong growth from existing customers. During the quarter, we supported our customers with multi-modal capacity while enhancing margin opportunities.

In 2018, we will continue focusing on process and operational improvements, investing in our TMS technology, working to enhance our pipeline for future growth, and creating savings and operational efficiencies with our existing customers. Mode had strong top-line growth of 11% and for the first time reached $1 billion in annual revenue.

Mode experienced revenue growth across all service lines led by truckload, which was up 16%, and logistics up 20%. For the year, Mode revenue rose 8%. This growth is attributed to a strong IBO network and a technology platform which allowed Mode to meet the challenges of the market and position the company for growth in 2018.

Now I will turn it over to Terri to review the results..

Thanks, Don, and hello everyone. I'd like to highlight three points. First, operating income grew 33% in the fourth quarter. Second, Intermodal pricing accelerated as the quarter progressed and we're encouraged that this is a solid foundation for margin growth in 2018.

Third, Truck Brokerage had a very strong quarter with gross margin up 23% on a tough comp. Now, let's take a more in-depth look at our fourth quarter performance.

The fourth quarter includes a $75.2 million or $2.25 a share decrease in income taxes resulting from our estimate of the change to our deferred tax liability at December 31, 2017 caused by the reduction of the federal tax rate, which is part of the recently enacted Tax Cuts and Jobs Act.

Today, I'll focus on the results, excluding the impact of tax reform. Hub Group's fourth quarter revenue increased 19% to $1.2 billion. Hub Group's adjusted diluted earnings per share was $0.74, compared to $0.55 last year. That's an impressive 35% increase over last year.

Now I'll talk about details for the quarter, starting with the financial performance of the Hub segment. The Hub segment generated revenue of $904 million, which is a 20% increase compared to last year due to organic growth of 12% in all three service lines and the addition of Hub Group Dedicated in the third quarter.

Taking a closer look at our business lines, Intermodal revenue was up 8% due to a 2% increase in loads and an increase in fuel revenue and freight rates. Mix was favorable. Local East volume was up 8%, Transcon was up 6% and Local West volume was down 4%. Truck Brokerage revenue was up 22% after being up 46% in the fourth quarter of last year.

The growth comes from increases in transactional business. Truck Brokerage handled 2% more loads on top of a 33% increase of loads in the fourth quarter of last year. Fuel, price and mix combined were up 20%. Logistics revenue increased 19% due primarily to new customers onboarded this year. Hub Group Dedicated revenue was $57.8 million.

Hub's gross margin increased by $16.9 million or 19% due to Hub Group Dedicated and growth in Truck Brokerage and Intermodal margin, partially offset by a decline in Logistics margins. Gross margin as a percentage of sales was 11.7% or 10 basis points lower than last year.

Intermodal gross margin increased because of price increases, lower Hub Group Trucking drayage costs and higher volume. Drayage costs at Hub Group Trucking are down because of improvement in loaded miles and lower insurance and claims costs because of our continued focus on safety, including using in-cab cameras and the technology in our trucks.

Partially offsetting these increases in margins were higher repositioning costs and slower box churn. These factors drove a 20 basis point decline in Intermodal gross margin as a percentage of sales. Truck Brokerage gross margin increased 23% primarily because of more spot business.

Spot business was about 30% of total loads this year compared to 20% last year in the fourth quarter. Truck Brokerage gross margin as a percentage of sales increased 20 basis points because of changes in customer mix. Logistics gross margin decreased due to changes in customer mix and higher purchased transportation costs.

These same factors contributed to a 240 basis point decline in Logistics gross margin as a percentage of sales. Costs and expenses increased $6.8 million to $71.3 million in the fourth quarter. The primary reason for the increase is Hub Group Dedicated.

In addition, medical claims were up about $1 million, salaries are up about $1 million and IT and consulting costs increased about $700,000. Offsetting these increases is a $6.8 million decrease in bonus expense.

Finally, operating margin for the Hub segment was 3.8%, which was 60 basis points higher than last year and the highest that it's been all year. Now I'll discuss results for our Mode segment. In the fourth quarter Mode's revenue was $286 million, which was up 11% from last year due to an increase in revenue in all three service lines.

Revenue breaks down as $139 million in Intermodal, which was up 6%; $92 million in Truck Brokerage, which was up 16%; and $54 million in Logistics, which was up 20%. Mode's gross margin increased $800,000 year over year due to an increase in Logistics and Intermodal margin, partially offset by a decline in Truck Brokerage gross margin.

Gross margin as a percentage of sales was 11.3% compared to 12.3% last year due mostly to a 270 basis point decline in Truck Brokerage yields resulting from higher purchased transportation costs. Mode's costs and expenses went up $600,000 compared to last year because of higher agency commissions.

Operating margin for Mode declined slightly to 2.3% compared to 2.5% last year. Turning to head count for Hub Group, we had 2,030 employees excluding drivers at the end of the year. That's down five people compared to the end of September. Turning now to the balance sheet and our cash.

We ended the quarter with $28.6 million in cash and $303 million in debt including capitalized leases and $45 million of borrowings on the revolver. Our leverage ratio was 1.5 to 1. Cash generated from operating activity for the full year was $125 million or 22% higher than 2016.

We spent $34.6 million on capital expenditures this quarter, mostly related to containers, tractors, technology and trailers. That brings 2017 total capital expenditures to $74.5 million. Now I'll discuss what we expect for 2018. We believe that our diluted earnings per share will range from $2.30 to $2.40.

A comparable adjusted earnings per share for 2017 would be $2.18 which factors in adding back $6.1 million of one-time costs and using a 25% effective tax rate. We estimate high single digits to low double-digit revenue growth for the year. By service line at the Hub segment, we expect 7% to 11% revenue growth in Intermodal.

1% to 5% growth in Truck Brokerage revenue, and a 2% to 5% decline in Logistics revenue. We project Dedicated revenue for the year will be between $255 million and $265 million. We expect consolidated gross margin as a percentage of sales to range from 11.9% to 12.2% for the full year.

We believe that our quarterly costs and expenses will range from $104 million to $109 million, and will be highest in the fourth quarter and lowest in the first quarter. We estimate that operating income will increase between 17% and 22% compared to our reported operating income of $96.6 million in 2017.

We project that our effective income tax rate will be about 25%. From a cash perspective, we don't expect to pay any federal income taxes due to the immediate expensing of eligible capital expenditures. We estimate we will pay several million dollars in state income taxes.

Capital expenditures are expected to range from $150 million to $170 million in 2018. We will execute on our strategy, investing approximately $120 million to $130 million for equipment and between $30 million and $40 million for technology.

Included in this equipment spend is between $65 million and $75 million for Hub Group Dedicated related to customer contract renewals and new customer wins. That wraps up the financials. Dave, over to you for closing remarks..

Great. Thank you, Terri. Hub's fourth quarter results are a very positive note with which to transition into 2018. Not only was demand exceptionally strong and capacity tight, but all of our operating units executed at a very high level.

We believe that the tight capacity in the fourth quarter has created a positive pricing environment for the upcoming bid season as shippers are reminded that focusing solely on cheap prices without solid capacity commitment does not get their product to market. And with that, we'll open up the line for any questions..

Thank you, sir. From Wolfe Research we have Scott Group. Please go ahead..

Hey. Thanks. Afternoon, guys..

Hi, Scott..

So, wanted to kind of ask on the guidance, so if we take a look at the fourth quarter and look at the tax rate and sort of just look at normal seasonality, it sort of implies a run rate of earnings right now of $3 plus, and obviously you guys are guiding a lot lower than that for 2018.

So maybe just help us understand if there was something unsustainable in the fourth quarter, or what you think is changing and getting worse to help us get to your guidance a little bit?.

Yeah. Sure, Scott. A couple of things really. First of all, fourth quarter was a very strong peak season for us, very robust holiday season and we capitalized on our opportunities with pricing and peak season surcharges for those customers who went over their volume allotment.

So and similarly on the Truck Brokerage side, we had a lot of spot business, which helps the margin, and that we have no bonus in the fourth quarter even though we did such a fantastic job. Our bonus expense was down $6.8 million year-over-year.

So for next year, if you look at – so that's a really strong quarter, all-in, and it doesn't have a lot of costs in there for bonus..

Right..

If you look at next year and you say well, what will happen, we plan on having bonus next year. So if you were to say, well, why are your costs and expenses up from the fourth quarter of 2017 until the first quarter of 2018, the biggest reason would be an increase in salaries and benefits. That's for a couple of different reasons.

Number one, we have increases for people. That's a couple of million dollars. We also have – we're planning on earning a bonus this year, because we're planning on doing well. That's about $3 million, $3.5 million. And then we have additional expense of about $1 million for restricted stock in the quarter.

And then our G&A cost does ramp up a little bit in Q2, Q3 and Q4 for additional IT costs, because of our IT investments..

Yeah. The other thing to that, Scott, is don't forget the Intermodal pricing with regards to bids. 30% of those bids are in the first quarter, 33% the second quarter. So as price goes on throughout the year, we're going to take it as we reprice our bid business..

Right. And then, in the first quarter, the other couple of costs that we have is we did – we want to attract the best and brightest drivers and we put a driver increase out there to attract and retain more drivers. We've also enhanced our recruiting efforts. And so we think that will be a benefit, but it's additional cost.

Then, we did have a rail and part of a rail increase go in during the first quarter..

Okay. That's very good color. Can I just – couple of just quick follow-ups to that.

Terri, is there any way you can maybe help frame how you think first quarter is going to look either from an earnings perspective or percent of the year? And then, maybe for you, Don, can you say what you think your Intermodal pricing is going to be up this year percentage-wise and what you think your rail costs are going to be up this year?.

Yeah. We're looking at increases to our customers as mid-single digits on price increases and we have visibility now into our rail cost increases for the remainder of the year. So we will – as Dave mentioned in the call, we are going to price our business with the spread of increased costs and price to our customer..

And in terms of the earnings growth cadence, Scott, that you asked about, Q1 maybe versus Q1 of last year, we think we will be at a higher EPS than last year. But as Don mentioned, about 30% of our business reprices some time during the first quarter.

Meaning that could be in February, it could be the very last day of March, so we're not going to get a lot of benefit from the price increasing until the year goes on.

And so we expect that in Intermodal, in particular, gross margin as a percentage of sales increases as the year progresses and that gross margin percentage is in fact higher than last year for the last three quarters of the year..

Right. Yes..

And that would be earnings growth with or without the tax rate? Or is that just?.

That's with the tax rate. Yes..

Okay. All right. Thank you, guys. Appreciate it..

Thanks, Scott..

From Stephens, we have Justin Long. Please go ahead..

Thank you and congrats on the quarter.

So maybe to follow up a little bit on the guidance to start, could you talk about the assumptions that you're using for Hub segment's Intermodal business within the 2018 guidance? I know you just mentioned the mid-single digit pricing, but I'm just curious what you're assuming for volumes and the percent change in margin for Intermodal as well..

Yeah. We're assuming between 3% and 5% volume growth. We think we can grow volume and price for the year. And it might even be higher than that. We're not sure. And we're building in, as Don said, mid-single digit price increases and that goes in 30% the first quarter, 33% the second quarter, 30% the third quarter, and only 7% in the fourth quarter..

Yeah, yeah. We're confident in our ability to take price and volume this year..

That's helpful.

So I'm guessing that all means that Intermodal margins are improving, but could you share just in terms of basis points how much of an improvement you're anticipating in 2018?.

Yeah, for the whole year, it's up about between, I don't know, between 50 and 70 basis points..

Okay. That's helpful. And then secondly, I wanted to ask about rail service.

I know you made some comments about that in the prepared remarks, but is there any way to put numbers around how much of an earnings hit that was in 2017? And as we go into 2018, what are you assuming in terms of the year-over-year impact from rail service?.

Justin, this is Dave. That is a little bit difficult to put an exact number on because it certainly, A, it does hurt our competitive stance against trucks. That's hard to measure.

In addition, it does add a certain degree of operating cost to us, particularly when in fact the service may be inconsistent, because there's a lot of rescheduling of appointments. You have to pull loads and then store them. There's just a lot of the additional costs which aren't necessary when the rails are really operating very efficiently.

So we talked about it and the numbers, but it's just very difficult, it's very soft to be able to put an actual to quantify it..

Yes. I would tell you too for the whole year, our utilization was about 15.6 days whereas last year it was 14.9. And so, basically half a day different, a little bit more than that, and a day of utilization for us is anywhere between $6 million and $8 million..

But that's just one component of it..

That's just one component, not the accessorial piece..

Right..

Right. Yes..

Got it. That's helpful. I'll leave it at that and get back in line. Thank you..

Thanks, Justin..

From UBS we have Tom Wadewitz. Please go ahead..

Hi. This is Mike Triano on for Tom.

Could you comment on the timing of the rail cost increases this year? Were there any at the beginning of the year, and how that progresses throughout the rest of the year?.

Yeah. We have a increase on January 1 and then also on May 31 we'll have both rails with increases, which we do I would say, we have relatively good visibility on..

Okay. And maybe another one. On the CSX domestic intermodal service changes.

Have you been able to secure some additional business from the service changes? Or is the freight just not attractive enough to deploy capacity to take on the business?.

It seems like an awful lot of the service changes that CSX made were in markets that we're not necessarily competitive with, Norfolk Southern, where they may not have service. So we have not seen I would say a big surge of business as a result of that, although certainly our Local East business is up.

If you look, I would suggest that possibly the Norfolk Southern has seen some amount of transfer of business just if you look at their numbers that are released weekly versus what CSX has seen in intermodal. It certainly appears to be the case..

Right. It's kind of hard to identify. We've seen some conversion more on the truck side than we have on the CSX side..

Right..

Okay. Thanks for the time..

From KeyBanc Capital Markets we have Todd Fowler. Please go ahead..

Great. Thanks, and good evening.

Dave, on the Intermodal pricing comments, is there a reason why Intermodal pricing couldn't be up more than mid-single digits in 2018? And I guess what I'm thinking about is the pressure that the Intermodal market has seen over the past couple of years, what's happened to your gross margins, and then really what we're seeing on the truck side where it feels like that pricing is probably going to be in the high-single digit range, and I understand that Intermodal is at a discount to that.

But is this something that you could see, something that materializes stronger than what you're expecting? Or why is mid-single digits kind of the right placeholder to be using right now?.

No, as always, Todd, we're a bit conservative. We certainly feel as though there's a lot of upside with Intermodal pricing this year as I said in my final comments. Really it was the fourth quarter was kind of a perfect storm, created a lot of capacity tightness, a lot of demand.

And I think that customers realize that being just procurement-focused, that that's not going to work for them over the longer term. So, yes, we're certainly striving to get as much price as we can. There's certain clients candidly which are very low-priced and we'll be looking at 15% increase..

Right..

And there's others which have been more working with us that would be less than that. But yeah, I would say that mid-single-digits is a good conservative number, and – but certainly we have targets and goals which can be a bit higher than that..

And to Dave's point, we're also pricing it to the market, right? So we're looking at our network to make sure in these bids that we're pricing to the right markets and then we're not repositioning those boxes out. So it's a balance, right? But we are pushing that price envelope.

It's early in the bid season, but we're testing the waters and pushing it every time we can..

Okay. That helps, and that makes sense. And then I think you had some comments on your visibility into your rail cost increases.

Can you just talk about what your experience right now is with the dray capacity? And it sounds like there's some efforts to recruit drivers both on what you might have to do with your own cost structure? And then availability to get third-party dray capacity, given some of the capacity constraints especially with ELDs coming or at least enforcement of ELDs early in the second quarter?.

Right. And to that point, we've had ELDs in all of our tractors, owner-operators as well as company drivers for at least 15 years. So we're very used to it. It's not going to have any changes for our operating. But drivers are certainly scarce right now. It's a function of you look at the unemployment levels. They're very, very low.

Construction is booming, and as a result of that a lot of drivers or potential drivers may select to be in the construction industry. So we are making a concerted effort.

We're combining the recruiting groups of both Dedicated as well as our Intermodal to dramatically expand our driver base this coming year, and that's why we did take a wage increase that became effective I believe just last week..

Yes..

So it's a very competitive market as you know for drivers. Retention is a key. We actually went below 40% on our turnover most recently. So, yeah.

It's an ongoing focus, and it really is going to be – it's a constraining factor I think for obviously the trucks, that they have a lot of idle tractors right now, but as well as Intermodal and the constraint on that. So we're very focused on that issue, and we feel as though we've got a good handle on it, and we need to execute.

But there will be a cost associated with that, but that as we've said in the past it's our focus that we will in fact be able to manage the driver costs and the rail inflation costs and get priced at a premium to those two numbers..

Okay. Good. That helps. Very nice quarter here. Thanks for the time..

Thanks, Todd..

From JPMorgan we have Brian Ossenbeck. Please go ahead..

Hey. Good evening. Thanks for taking my question. So I just wanted to come back to the pricing just for a clarification really.

Does the mid-single digit in Intermodal, does that include what you were talking about earlier about going after recovery of accessorials? Or would that be a separate item and you're just talking about core pricing?.

That would actually be on top of that. So our mid-single digits is our planned price increase. We also plan to increase our recovery of accessorial costs, and we've got pretty good traction doing that. If we don't get there with a particular customer, then we'll increase the price, and it could be up more than the mid-single digits..

We're finding that most of our customers that may have accessorial agreements, which really aren't very fair, that in fact the accessorials are really under their control. So instead of taking an increase plus an accessorial increase from us, we're finding that they are willing to take control of the accessorials and have a reasonable agreement.

Because again, it is within their control..

Okay. Got it. So it sounds like you have some recovery of accessorials baked into your expectations, but customers are able to mitigate some of that, which I assume would help you on the optimization or the utilization rather of your speed of your assets..

It certainly helps us on returning equipment..

Absolutely..

Yeah, and it might be not as much price, like Dave says. It's reduction of the costs, because the customers and us work together to try and bring them down..

Right. We've had a lot of meetings with customers about how to take the cost down and it's either in the price of what we're going to bake in or the accessorial agreement..

Okay. Thank you. Terri, you gave us information on CapEx already. I don't think I heard anything on containers or chassis or anything like that.

If you could give us a sense of how big the fleet was at the end of the year and what you might be planning to add to it this year?.

Sure. We are adding about 3,500 containers gross and our net add will be about 1,600, so our container fleet will be up to about 36,000 and that's a 4% increase..

Okay.

And are those weighted throughout the year kind of on a ratable basis?.

Yes. They come in during the year but before peak..

Right. We try to get a lot of them in right around peak, because of course they do disembark from the vessels in Los Angeles or Seattle..

Got it. Okay. Thanks for the time..

Thank you..

From Susquehanna Financial we have Bascome Majors. Please go ahead..

Yes. You broke out a lot of different components of your CapEx budget.

If we were to label it just growth and kind of a maintenance maintaining number, how would you break out that $160-ish million?.

Yes. Well, I can tell you that $37 million is for containers. $17 million of that's for growth and $20 million is for replacement. Our tractors at HGT are about $25 million. That's mostly for growth. And the $70 million for Dedicated tractors and trailers, that's about 45% for growth..

Thank you..

And then technology investments will be ongoing. We're going to continue to have technology investments. Those are about $30 million..

Well, I appreciate that. And kind of taking a step back to some of the earlier questioning, I mean, clearly you're guiding the earnings growth versus where you end up last year. But if you compare this outlook to what you initially guided 2017 last February, it's actually a few cents less.

I mean, since then, you made an acquisition, you got a tax tailwind from the U.S. corporate rate reduction, and we've seen what could be the best surface transportation pricing environment over a decade.

Just really high level, why aren't we seeing more leverage in the business? And is it a timing issue, or something more structural that investors maybe just missing?.

Well, I believe it is a timing issue..

Right..

If you look at it, again – if you look at the bids, the way that they fall in there, 30% is in the first quarter, 33% Q2, and 30% Q3, and so it will gradually improve.

We do believe – as you said, this is a very positive rate environment, where we were able during the fourth quarter to realize surcharges based on peak capacity, but that's not the case in the first quarter nor the second quarter.

And so it'll be – and, again, we do – to Don's earlier point in his prepared remarks, we live by our commitments to our clients, both from a capacity perspective and what we commit to a price. So it will be gradual, but we do think that this window may be a very wide window and very well could reach into 2019..

I appreciate that color.

So kind of taking what you said in there about the timing of the pricing increases and what you said earlier about incentive comp being a fairly large headwind on a year-over-year basis, is it – I mean, is it fair to assume that the leverage in the business could actually be better in 2019 than 2018 as long as pricing doesn't roll over?.

Yes. Yes. I think that's a good assumption..

Thank you..

Yes..

From Barclays, we have Brandon Oglenski. Please go ahead..

Hi. This is Van Kegel in for Brandon. Thanks for taking my questions. Just wanted to go back to rail service.

I guess, given the focus on productivity and growing volume faster than head count by many in the industry, could you talk a little about how some of the conversations have gone with rail partners and what kind of service expectation it's at with regard to your volume forecast of 3% to 5%?.

Well, we do have weekly operational calls with both of our rail partners updating us and looking for how, in fact, they feel as though they can overcome some of the existing service deficiencies and improve back to what are more historic levels.

In addition, we do meet with the top of the house as well regarding that, and I think at this point, the way that – and in all candor, I don't view that we're going to see an immediate shift back to normal rail service levels.

It seems as though the combination of having too few assets in certain places coupled with the winter weather, coupled with just volume surges that the overall service levels we do believe will improve throughout the year, but we're not going to be at 2016 levels, I don't believe in 2018..

I agree..

And we haven't planned that we would be in our budget..

Right. Yes. Yes, we didn't assume for any improvement..

Right..

Understood. Thank you. And then on Brokerage, I guess with some of the transactional market strength during the fourth quarter.

Can you just talk about what kind of expectations are baked into guidance in terms of additional tailwinds from that throughout the rest of the year?.

Well, for the year, we've always traditionally been more contract than transactional. And in the fourth quarter of 2016 and the fourth quarter of 2017, our transactional business has really risen. We expect our transactional business to be a higher percentage in 2018 simply because there's more need for that service..

And in fact, it was in January and so like Don says, we're really good at that and capacity is tight, and so it's a good market for us..

It's a very good market for that..

Appreciate it..

From Buckingham Research we have Matt Brooklier. Please go ahead. Matt, your line is open..

Yes. Sorry. Mute. So I just had a – good evening. Follow-up question on the Truck Brokerage side of things. I guess when I look at your revenue guidance, and granted we're coming off a difficult growth comp, but you just talked to having more transactional volume in 2018 versus 2017.

And it feels like given market tightness there's a lot of volume moving in that particular side of trucking.

I'm just curious, why such a low revenue growth guidance for the year if you may have mix at your back, and most likely price?.

Yes. Two things. One is obviously being a heavy bid season on the Truck Brokerage side also we're going to be selective in who we grow with, and be selective on where we can manage that business in a tight market.

As you might have known, around three years ago we went to a market where we would service certain markets very well, and we've stayed with that strategy. So, you know, we're conservative in nature, but I think we're comfortable with the guidance of what we've given you on Brokerage..

Yes. I mean, part of the reason we beat in the fourth quarter was Truck Brokerage, that we just didn't anticipate all the business that we got. And to guess on what this year is, so we took our best shot and we'll update it as we need to throughout the year..

Yes. Throughout the year, and you're also seeing too on the Intermodal and Truck side, although this peak season started earlier than anticipated and was intense, the end of it was very strong, especially on the Truck Brokerage side, I mean up through Christmas..

Okay. And then you mentioned putting through some driver wage increases in first quarter.

Is that just on the drayage side? Or is that also for Hub Dedicated?.

That's on both..

That's on both sides.

Can you give a little color in terms of the magnitude?.

It's single digits, but it varies by market..

Okay. And then just given Hub Dedicated's new to the model, maybe you could talk about how that business reprices. When I think about dedicated trucking, longer term contracts, potentially not all that business repricing in a given year. Maybe just walk us through kind of the dynamics of Hub Dedicated's contract business.

And I guess what percentage of the total book of business do you think you can reprice in what is going to be most likely a really strong price year?.

Yes, we're able to reprice, especially when we have to the driver market on all of our Dedicated contracts. So while the contracts are three years, they do have escalators built in them for the driver wage increases..

They do, yes..

Yes. So we're able to recover our driver wage increases from our customers..

And then the new business that we've been pricing at the pipeline, we've priced it with obviously with price increases going in place for our drivers..

Okay. So I guess it gets to my, kind of where I'm headed with the question, driver wages moving up on the Dedicated side of things, but your ability to take up reset pricing in contracts and then it sounds like some of this newer business you're pricing at market currently.

Everything combined, should we assume that margins do expand in this business? Do you think they're more flat? Like what are your thoughts there?.

In terms of the gross margin as – the margin dollars themselves should go up significantly. We've been very successful with some of our cross-selling efforts. Our best guess is gross margin as a percentage of sales stays fairly similar to what it was for this past six months of the year..

Okay. That's helpful. I appreciate the time..

Thank you..

Yes..

From Loop Capital Markets, we have Rick Paterson. Please go ahead..

Thank you. Nice quarter and another question for Dave on railroad service. Now the degradation in service we've seen over the last six months, it seems to be excessive relative to the challenges the routers have faced with regard to volumes and weather.

So from your vantage point, have you noticed any fundamental changes in how the railroads are running their businesses over time that might explain this?.

I don't think that we've really seen any fundamental changes. Of course, we have one of the Eastern carriers, of course, has had some operational issues, which has in fact been widely publicized. And very frequently the U.S. railroads, they are in fact individual networks, but there's an awful lot of interline business that takes place.

And usually and we've seen in the past, if one rail gets a cold, so does everybody else. So I think that's partially it and has exacerbated as some of the changes were made at CSX, but I would agree. Winter does have a tendency to – we have it every year in Chicago. It shouldn't be a surprise.

I do think that in the Southeast may have and the Northeast may have been hit a little more severely than normal, but nonetheless we are hopeful that they'll be able to recover from this relatively quickly. And although not get back to the 2016 levels of service, at least get close and make progress towards that..

Do you think they're trying to run leaner in terms of parent crews now versus say five years ago, for example?.

That's a good question and I really can't comment to that. I don't know. One way or another, that's a better question for the senior management of the rails..

Okay. Very helpful. Thank you..

Thanks..

We have a follow-up from Scott Group. Please go ahead..

Hey. Thanks, guys. So just a couple follow-ups here. So I think you had good Logistics growth in the quarter. I think you're guiding to down Logistics revenue for the year.

Can you just explain that?.

Sure. Yeah. We are really going to concentrate on migrating our existing customers over to our new technology this year. We want to do it right and we want to do it carefully.

In connection with our technology transformation and the other component of Logistics revenue being down is we did get rid of some lower-margin business, and so that won't be in our revenue base. But our margin we think will go up year-over-year..

Right..

Even though our revenue is down..

Right. So, Scott, we had such a big onboarding year, right? So we've decided to focus on the customers to improve margin and we still have a very strong pipeline for the Logistics piece, but we really are focusing on enhancing the margin..

Okay, makes sense. So, I mean, I guess if I look at the guidance for overall gross margin, you've got Logistics gross margin improving. I guess, there's a mix benefit with a full year of Dedicated.

Maybe can you comment, do you think Intermodal gross margin percent is better, worse, flat, 2018 versus 2017?.

Yes. I think we commented earlier, that it would be better and our guess is maybe 50 to 70 basis points better..

Hey, Scott. Back to what we said before, throughout the year, right? So as these bids come up throughout the first, second quarter, we'll build momentum as the year goes on..

Okay. I mean, I guess I'll go back to my first question. Like we've got volume, we've got price, we've got margin, and if we take the guidance excluding the tax and the Dedicated deal, you know, there's not much underlying EPS growth here. I guess it's just a little.

Is the message that we're being really conservative? Or maybe we're missing something on just the operating expense side..

No, I think, well, the operating expense side, you know we talked about the bonus a little earlier, and that is going to be up, like as I mentioned, about $3.5 million a quarter over what 2017 was. And then we have our investment in IT that we think is going to give us a competitive advantage.

It's going to allow us to do a better job from an efficiency standpoint, a visibility standpoint, freight taking the right multi-modal selection. So that too is in our cost guidance, and we didn't have as much of that then..

Right. So as we move towards implementing OTM across our network, you're going to see the IT expense for this year, and next, and probably the year after that would be higher than you've ever seen at Hub..

Okay. And then just last one real quick. I think you talked, Dave, that drayage was a net positive in fourth quarter. Other guys are complaining about drayage. Maybe just talk about what you're seeing differently in drayage? And how you see that playing out in 2018..

Well, I think that we've been able to attract a few more drivers. I don't know. I do think that drayage is going to continue to be a differentiator. I think that we're going to be, you know, we're continuing to focus on building it. But it's actually – we do see that it's better in January more so than the fourth quarter.

And our current pipeline, I looked at it for this week we've got probably the highest number of drivers that are being trained at this point in time are going through our processes this week than I think any time in the last probably six months.

So we're seeing some positive impact and then partially that may be due to the driver wage increase that we took. I think that partially it just could be the beginning of the year and people have a tendency if they're going to switch jobs to do it then..

One other point too with Dave is the third-party training that we use in certain markets, we actually act like a shipper and commit to those third-party carriers throughout the year. So as we flex up, we ask for them for help..

But it sounds like you're seeing a mix towards your own internal dray.

Is that basically what's going on here?.

Actually last year was relatively flat..

Yes..

So we're still – but what we are seeing is we're seeing fewer owner-operators and we've seen growth in the company drivers. So we're watching that model change very closely to see if that's going to continue. But no, it's actually – the internal drayage was within a couple hundred basis points, the same as in 2016..

Yes..

Okay. Thank you, guys, for the time..

Thank you..

Appreciate it..

And we have a follow-up from Justin Long. Please go ahead..

Thanks for taking the follow-up. Just had a couple quick questions on the model. So, Terri, I think you mentioned consolidated gross margins are expected to be 11.9% to 12.2% for the full year.

Is there any color you can provide on the quarterly cadence throughout the year that we should be expecting? And then secondly, I wanted to get your expectation for interest expense as well?.

Sure. I'll take the second one first, and total interest expense will probably be around $10 million for this year. And in terms of the cadence of the gross margin as a percent of sales growth, as Steve mentioned, you know, as our business reprices, that will go up.

So we think it will increase as the year progresses with the strongest gross margin as a percentage of sales really in the fourth quarter after 93% of our business reprices..

And when you get to that point, do you think you'll be above that high end of the range, the 12.2%?.

Yes..

Okay. Great. Perfect. Well, I'll leave it at that. Thank you so much..

Yes..

And we have a follow-up from Todd Fowler. Please go ahead..

Great. Thanks..

Hey, Todd. Before you ask the question, what happened to – you traded the whole team today..

Don, unfortunately, with all these earnings today I've only caught bits and pieces of it but I think that LeBron had the GMs ear and I think that that's the results that you get but it's been a tough couple weeks here in Cleveland from a basketball perspective..

Yes, I hear you..

Once I get through these models I'll get caught up on that I guess, so. Hey, I just wanted to ask one last high-level question. Dave, you've got the $6 billion revenue target in the release here.

Can you give us some conceptual ideas about how you think about getting there, how you're thinking about what component of that should be organic and I'm kind of coming up with a high single-digit CAGR to get to that from a $4 billion run rate and then what you'd be thinking about from an acquisition standpoint to feather into that..

Right. No, you are accurate there that a lot of it is in fact going to come from acquisitions. We do believe we can continue to grow our existing lines of business at a decent pace, but in order to get to the $6 billion, there's no question it has to be outside acquisitions.

And where would we focus on outside acquisitions? I think that some of it is obviously businesses that might feed, additionally, our existing business lines. It could be another IMC.

It certainly could be transportation management companies or a truck broker that would bring technology to us but it could be other non-asset-based types of logistics operations. It could be cross-stocking and things such as that but we're active in the market.

Geoff DeMartino is doing a great job and there is a very full pipeline right now of companies we can look at. And again, we feel as though the Estenson Dedicated acquisition, that we've been able to manage that very well.

Our thesis that in fact we would see excellent cross-selling has come to bear and we've had a lot of opportunities and we expect a lot of success there. So if I looked at it on a percentage basis, how to get from the – up to the $6 billion, probably 60% or 70% is going to come from new acquisitions, the remainder from organic growth..

Okay. And then I don't know if you want to comment on this, but is there anything in the acquisition pipeline that you feel you're relatively close to? I mean, do you have – I know it can be lumpy but just from our planning purposes is there something we can expect sooner versus later? Or just kind of any comments around timing would be helpful..

Yes, there's nothing right now that's imminent. I mean, we're looking at multiple businesses but there's nothing I would say that's imminent at this point in time, but we'll obviously continue to update that with our earnings calls..

Okay. And Don, we'll just have to see if LeBron follows Isaiah Thomas to LA at this point..

Yeah, it's amazing – wait until you see the trades. You'll be amazed..

All right, guys. Thanks a lot..

Thank you..

Thanks, Todd..

We do have one more question on the line. Please stand by for just a moment. And we have Diane Huang from MS on the line. Please go ahead..

Thanks for squeezing me in. I have two questions, one on the Intermodal environment and a second is a modeling question.

My first question is can you comment on the Intermodal competitive environment? I know your competitors have different business models, but one TL carrier posted a very strong OR quarter in the fourth quarter, so wondering if you're seeing any standout behavior in the market?.

I think that after 18 months of downward pressure on pricing, we've seen a very – what I would call a normalized competitive environment where a lot of people are all looking to get better returns so that they can reinvest in the Intermodal product. So we've – it's been very rational pricing.

It appears to us that certainly the market is looking for price increases. Our customers are expecting them, and we in all candor, we need to do it to offset our inflation and driver wages and rail costs, as well as get our own margins up to a reasonable level. So I think it's from a market environment, it's very much looking to increase prices..

Got it. That's good to hear. And my second question is to Terri. Do you expect Estenson's revenue to grow at a 19% CAGR over the long term off the 2018 guidance that you gave? And how much EPS accretion are you expecting in 2018 from Estenson? Thank you..

Yeah, we had talked about I think about $0.20 of accretion and that's close to what we expect for this year. And in terms of their CAGR for the out years, we were very successful in cross-selling, getting opportunities in, in the fourth quarter. Some of those are done deals at this point. So we're excited about that.

We think there's a lot of room for growth there. But we think it'll be maybe mid-teens. We really haven't quantified how far out. We'll see how this year goes and then update the CAGR. But certainly for this year, we've already been very successful in bringing on new business in the first quarter..

Okay. Thank you..

Sure..

Thank you. We will now turn it back to Dave Yeager for closing remarks..

Great. Well, thank you again, everyone, for joining us today. As always, Terri, Don and I would be available if you have additional questions. But thanks again for joining us..

Thank you. Ladies and gentlemen, this concludes tonight's conference. Thank you for joining. You may now disconnect..