Brad Jacobs – Chief Executive Officer Scott Malat – Chief Strategy Officer.
Chris Wetherbee – Citi Matt Reustle – Goldman Sachs Ravi Shankar – Morgan Stanley Scott Schneeberger – Oppenheimer Allison Landry – Credit Suisse Amit Mehrotra – Deutsche Bank Kevin Sterling – Seaport Global Brandon Oglenski – Barclays Todd Fowler – KeyBanc Ariel Rosa – Bank of America.
Presentation:.
Welcome to the XPO Logistics Q3 2018 Earnings Conference Call and Webcast. My name is Rob, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. Please note that this conference is being recorded.
Before the call begins, let me read a brief statement on behalf of the company regarding forward-looking statements and the use of non-GAAP financial measures.
During this call, the company will be making certain forward-looking statements within the meaning of applicable securities laws, which by their nature involve a number of risks, uncertainties, and other factors that could cause actual results to differ materially from those projected in the forward-looking statements.
A discussion of factors that could cause actual results to differ materially is contained in the company’s SEC filings.
The forward-looking statements in the company’s earnings release or made on this call are made only as of today and the company has no obligation to update any of these forward-looking statements, except to the extent required by law.
During this call, the company also may refer to certain non-GAAP financial measures as defined under applicable SEC rules. Reconciliations of such non-GAAP financial measures to the most comparable GAAP measures are contained in the company’s earnings release and the related financial tables.
You can find a copy of the company’s earnings release, which contains additional important information regarding forward-looking statements and non-GAAP financial measures in the Investors section of the company’s website. I will now turn the call over to Brad Jacobs, Mr. Jacobs, you may begin..
Thank you, operator, and good morning, everybody. Thanks for joining our third quarter call. With me in Greenwich are Scott Malat, our Chief Strategy Officer and Tavio Headley, our Senior Director of Investor Relations. As you saw yesterday, we maintained strong momentum throughout the quarter.
Our revenue, net income, EPS and adjusted EBITDA were all third quarter records. We generated robust organic revenue growth of 10.5%, and we signed up another $918 million of new business in the quarter, which was up a whopping 43% from a year ago. We entered October with a new business pipeline of $3.7 billion; that’s up $400 million year-over-year.
We again grew our profitability faster than revenue. We generated adjusted EBITDA of $415 million, despite a $16 million headwind from a customer bankruptcy in Europe. Looking at our lines of business, contract logistics was the standout once again. We grew our logistics revenue year over year by 13%, with e-fulfillment ramping up globally.
In North America, we grew our logistics business in the quarter by 18%. We implemented 26 contract logistics startups in the quarter, bringing the year-to-date count to a record 90 startups through September. Freight brokerage was another highlight.
We grew our North American brokerage revenue by 18%, and notably, we increased brokerage net revenue by 46%. We launched XPO Connect from scratch in April. Three months later, 6,000 of our carriers had opted in, and in the three months since then, we’ve expanded to over 13,000 carriers.
We expect the count to keep climbing fast; these are quality operators in our core network. In North American LTL, we’re continuing to create a more profitable customer mix and the investments we’re making in sales and operations are showing results.
We’ve improved adjusted operating income by 220 basis points in the third quarter, and we expect our fourth quarter operating ratio to improve even more. Company-wide, we’re continuing to make investments in secular drivers such as our proprietary technology and XPO Direct, our shared space distribution network.
We have a collaborative sales force sharing large customer relationships across geographies. In Last Mile, we completed the expansion of our network to 85 hubs ahead of plan. And in contract logistics, our labor planning tools powered by machine learning are continuing to get results. We’re seeing productivity gains of between 2% and 5%.
These are some of the things that Fortune looked at when they recently named us to their Fortune Future 50 list of companies best positioned for breakout growth. We’ve updated our full-year 2018 target for adjusted EBITDA to approximately $1.585 billion. The revised target reflects the impact of the customer bankruptcy I mentioned earlier.
And we’ve reaffirmed our target for approximately $1 billion of cumulative free cash flow over 2017 and 2018. Given our strategic positioning, we expect to continue to outpace the market in any macro environment and we’re looking at some exciting opportunities to accelerate that growth through acquisitions.
Now, as you saw from yesterday’s release, Scott will be leaving us in December. I’m grateful to Scott for the major role he’s played in growing the company. We’ve worked side by side since the beginning of XPO and we’ll sorely miss him and we wish him the very best.
And I’m very pleased that Matt Fassler will be joining us as our new Chief Strategy Officer. Matt is a well-known retail analyst and business unit leader at Goldman, and we’re looking forward to introducing him to you. With that, I’ll ask Scott to review the third quarter numbers in more detail.
Scott?.
Thanks Brad, and thanks for the kind words. I’m very proud to have been part of the growth of XPO these last seven years. On our personal note, my family and I are moving to Europe and we’re looking forward to spending some quality time together. I have no doubt that XPO will continue to outperform for many years.
I happen to know Matt Fassler well, having worked closely with him at Goldman. He’s an incredible talent. He’s going to add a lot of value to the team. Now looking at the quarter. We kept up the momentum across our operations. I’ll walk you through the numbers and the operating environment by business unit. Starting with our transportation segment.
We increased revenue by 11% to $2.9 billion. We grew operating income by 34% and adjusted EBITDA by 20% to $327 million. We generated our strongest transportation growth in freight brokerage. We increased revenue by 18% and improved our net revenue margin by 370 basis points to a record 18.7%.
Within freight brokerage, the tight truckload market worked in our favor. We grew our truck brokerage revenue by 30% and we did that with roughly the same headcount as last year. A large benefit came from our proprietary technology.
We’re able to manage more growth with lower costs by using automated load tracking; predictive analytics, automated load assignment, and XPO Connect, our digital freight marketplace for shippers and carriers. Market tightness has eased a little in October, with lower volumes being offset by higher net revenue margins.
A strong holiday season could change that quickly. We’ll know more over the next few weeks. We also grew our intermodal business with double-digit revenue increase for the second straight quarter. The market dynamics for intermodal were favorable through the quarter and into October due to the delayed effect of what has been a tight truck market.
In North American Less-Than-Truckload, we grew adjusted operating income by 24% and improved the operating ratio to 85.4% from 87.6% a year ago. We increased the amount of business with higher-margin local customers in our LTL mix, and the salespeople and dock workers we hired are becoming more productive.
We expect our fourth quarter operating ratio to improve at an even faster rate than the third quarter. Pricing on contract renewals in LTL was up a strong 5.3%. Revenue per hundred weight excluding fuel was up 1.9% reflecting higher weight per shipment and shorter length of haul.
Our LTL tonnage declined 1.5% due to our decision to selectively target more profitable freight , partially offset by a 3% volume increase in higher margin local freight. We were able to further reduce our purchased transportation costs by increasing the utilization of our owned trucks to offset inflation.
Purchased transportation made up 26% of our linehaul miles in the quarter, versus 33% from a year ago. We still have plenty of runway to optimize our LTL network. We’re working on a number of technology projects that have the potential to add approximately $100 million to operating profit over the next two years.
For example, we just launched phase 1 of our new linehaul bypass model. This creates truckloads dedicated to direct freight shipments, instead of having the trucks stop at multiple service centers. So far, this change has shown an approximate 2.4% increase indirect loads. In Last Mile, we grew revenue 12%, $271 million.
Our net revenue margin was 28.2% in the quarter, below last year’s margin of 29.5%. This was due to an increase in direct postal injection, which has a lower net revenue margin, as well as to the higher cost of capacity. In September, we completed the planned expansion of our Last Mile hubs in North America. We’re now at our goal of 85 hubs.
It puts our Last Mile footprint within 125 miles of 90% of the U.S. population. We’ll report almost $1.1 billion in Last Mile revenue this year. Our coverage and scale give customers a cost-effective national solution for heavy goods home delivery.
Customers tell us our services produce significantly higher customer satisfaction scores than our competition. We’re working with a number of large retailers and e-commerce companies to ramp up their volumes on our expanded network going into the holidays and 2019. In Europe, we had a solid performance from our transport operations.
Revenue was $703 million, up 12%; organic revenue growth, which excludes fuel and FX, was up 7.3%. This was the fastest organic growth in our European transport business on record. The UK was the leading driver, with significant revenue increases in both dedicated truckload and LTL.
Other highlights of the quarter include our brokerage operations in France and Spain, where we grew both revenue and profitability. The truck market is tight across Europe, and our Freight Optimizer technology is helping us gain share by improving our access to capacity while lowering SG&A. Turning to the logistics segment.
The underlying momentum continues to be very strong. We increased our global logistics revenue to $1.5 billion in the quarter, up 13%. In North America, we capitalized on broad demand across verticals and grew our logistics revenue by a record 18%.
The tailwinds came from double-digit growth in many of our verticals, including e-fulfillment, consumer packaged goods, technology, agriculture, industrial and healthcare. In Europe, we grew logistics revenue by 10%. If you exclude the impact of foreign exchange, our organic revenue growth and European logistics was 11.5%.
The most rapid growth was in the Netherlands, the UK and Italy. Our operating income for logistics globally with $60 million compared with $67 million a year ago, and our adjusted EBITDA was flat. These results reflect the bankruptcy charge from the one large customer Brad referenced earlier.
We’re excited about the growth path we’ve created for contract logistics. Customers are continuing to outsource to us at a rapid pace. They like our advanced automation, our deep vertical expertise, and our ability to secure talent. XPO is known in the industry as being a strong operator and the partner of choice for complex logistics.
Last month, we announced plans to deploy 5,000 more intelligent robots in our logistics sites through a strategic partnership with robotics manufacturer GreyOrange. These robots have helped our employees to be about four times more efficient while improving order accuracy.
We’ve also been able to increase the density of product storage and enhance workplace safety. Our XPO Direct shared space distribution network is ramping up fast. We now have 94 facilities in the network, up from 75 last quarter, with two more locations opening this month.
Last week, the total volume that ran through XPO Direct was approximately 20 times greater than what we shipped weekly during the summer. Most of this is coming from e-commerce and omnichannel customers, but we also have some manufacturers looking for flexible distribution capabilities.
We expect volume to step up again this quarter, followed by an even more significant increase in the beginning of 2019. We expect XPO Direct to be a $1 billion business over the next three years. That gives you an idea of some of the business drivers behind our momentum in the quarter. Next, I’ll comment on a few financial items.
Interest expense for the quarter decreased by 30% versus last year, due primarily to debt paydown and repricings. Given our recent ratings upgrades from both Moody’s and S&P, our term loan is now investment grade. We’ll continue to explore opportunities to optimize the terms and cost of our debt.
Cash flow from operations was $288 million and free cash flow was $173 million in the quarter, despite higher levels of working capital and CapEx to support our growth, as well as the customer bankruptcy.
We expect our free cash flow to increase in the fourth quarter, partly due to an expected seasonal inflow of working capital and initiatives to optimize our AR and AP. We remain on track to generate approximately $625 million of free cash flow this year, meeting our cumulative two-year target of $1 billion.
So in summary, we’re on a strong trajectory heading into 2019. We’ll continue to build on our leading positions and high growth sectors and gain increasing share in the trillion-dollar market where we operate. With that, we’ll open it up for Q&A.
Operator?.
Thank you. [Operator Instructions]. Thank you. First question comes from the line of Chris Wetherbee with Citi. Please proceed with your question..
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Our next question is from the line of Matt Reustle with Goldman Sachs. Please proceed with your question..
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The next question is from the line of Ravi Shanker with Morgan Stanley. Please proceed with your question..
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Thank you. This will conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation..