RXO Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 15 speakers on the call.

Operator

Welcome to the RXO Q3 2023 Earnings Conference Call and Webcast. My name is Sindu, and I will be your operator for today's call. Please note that this conference is being recorded. During this call, the company will make certain forward looking statements within the meaning of federal securities laws, We are pleased by their nature involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those 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 as well as in its earnings release.

Operator

You You should refer to a copy of the company's earnings release in the Investor Relations section on the company's website for additional important information regarding forward looking statements and disclosures and reconciliations of non GAAP financial measures that the company uses when discussing its results. I will now turn the call over to Drew Wilkerson. Mr. Wilkerson, you may begin.

Speaker 1

Good morning, everyone. Thanks for joining today's earnings call. With me today in Charlotte are Chief Financial Officer, Jamie Harris and Chief Strategy Officer, Jared Weitzfeld. I'm pleased with RXO's performance in the Q3 and what was and continues to be a soft freight market. We've seen this part of the freight cycle before and know exactly what actions we need to take to fuel our Continued growth and set us up for long term success.

Speaker 1

In the Q3, we accelerated our brokerage market share gains While maintaining strong brokerage gross margins, brokerage volume grew by 18% year over year. For the first time, we've broken out brokerage volume performance between truckload and less than truckload for you. Both grew significantly. Full truckload volume grew by 13% year over year and less than truckload volume grew by 55% year over year. We service our full truckload customers exceptionally well and those customers continue to award us LTL freight, which is mostly contractual And highly automated.

Speaker 1

We expect continued growth in our LTL business. When LTL reaches full scale, It will add a meaningful source of earnings to our business and will be a platform for continued growth. In addition, total volume, quarterly loads per day and monthly loads per day during the month of September all set new records. All major brokerage verticals grew on a year over year basis, and loads per day grew every month as the quarter progressed. The most important driver of that growth was contractual volume, which grew 30% year over year, faster than the 19% year over year growth This result speaks to the significant trust our customers have in us.

Speaker 1

Securing contractual volume positions us to win even more spot volume and project loads when the market influx. We expect to grow brokerage volumes again in the Q4 on a year over year basis. Jared will walk you through our volume trends In more detail shortly. Our market share gains continue to be profitable. We leverage our cutting edge AI enabled technology to improve our buy rates and our sell rates.

Speaker 1

The year over year decline in revenue per load in the 3rd quarter eased when compared to the revenue per load decline we saw in the 2nd quarter. Brokerage gross margin was Strong at 15.1 percent in the quarter. We also saw momentum in our complementary services. We achieved another quarter of synergy load growth in Managed Transportation and secured additional new business wins that we'll onboard in 2024. Within Last Mile, we continue to take action to improve our profitability and still expect Last Mile to grow EBITDA year over year For 2023, the strategic pricing actions that we took earlier this year helped contribute to 90 basis points of year over year margin The investments we've made in our cutting edge AI enabled technology Help fuel our business results.

Speaker 1

In the Q3, 97% of our loads were created or covered digitally, Up from 81% in the Q3 of 2022. The team is executing very well And is growing our core truckload business, expanding and investing in additional services And capitalizing on powerful trends, including nearshoreing. Let me give you some more details about how the quarter played out. Early in the Q3, we experienced a squeeze on gross margin. This is typical for this part of the cycle.

Speaker 1

We believe July was the low point for brokerage gross profit per load for 2023 and that the 3rd quarter Mark the low point for adjusted EBITDA this year. The freight market and RXO's performance improved each month as the Q3 progressed. Many of the industry metrics we look at also improved. The load to truck ratio increased from less than 2:one earlier in the year To approximately 3 to 1 at the end of the Q3. Industry wide tender rejections also moved higher To approximately 4%, and carrier exits continued, although at a slow pace.

Speaker 1

We also continue to hear from our retail and e Commerce customers, the inventories are in a much better position heading into this year's holiday season. While I'm optimistic about the improvements we're seeing, the industry still faces some challenges, including uncertainty around consumer demand Heading into the holidays and the rise in interest rates and increased fuel prices. That brings us to the month of October, Where we did see some softening, many bid activity increased and brokerage volume grew year over year, But the volume growth was at a slower rate in the Q3. However, despite the softening in the market, our brokerage gross profit per load Remain resilient in October and was roughly flat compared to the month of September with a strong Gross margin of 16%. Even though the pace of the recovery is uncertain, we will continue to run the playbook we've talked 1st and most important, we'll continue to stay close to our customers to ensure we can react Quickly to the ever changing market dynamics.

Speaker 1

We'll remain focused on the long term and continue to make strategic investments. In the Q3, we added new team members to fuel continued brokerage growth, introduced new technology to support our customers And our people and expanded the services we provide to customers. All of these investments increase the stickiness with our customers, And they're an important part of our strategy. So you'll hear both Jamie and Jared talk more about them later in the call. Many of the largest shippers continue to increase their share of wallet with RXO because we have a team That has delivered results for their transportation and logistics departments.

Speaker 1

Our exceptional service is supported by the best people, The best technology, a broad array of services and a strong financial position. Our strategy is to invest across all parts of the freight cycle, and that's uncommon in our industry. While investing during the down cycle negatively impacts short term profitability, it delivers outsized returns when the market improves. This is not the first time we've run this playbook. This was a winning strategy for us during COVID when we invested aggressively in our sales force.

Speaker 1

We see this down cycle as a similar opportunity to position us for robust growth over the long term. On the cost side, we'll continue to be disciplined. Doing so will provide significant operating leverage for us when the market influx. Jamie will talk more about the actions we're taking in a few minutes. We believe this playbook Will enable us to achieve the long term target we laid out for you a year ago at our Investor Day.

Speaker 1

We anticipate delivering between 475,000,000 And $525,000,000 in EBITDA by the end of 2027. We have a winning strategy, An experienced leadership team, proven technology and close customer relationships. RXO is in a Great position to exit the soft freight cycle even stronger than we entered it. Now I'll turn it over to Jamie, who will discuss our financial results In more detail. Jamie?

Speaker 2

Thank you, Drew, and good morning to everyone. In the Q3, we generated $1,000,000,000 in revenue Compared to $1,100,000,000 in the Q3 of 2022. Gross margin of 17.7 percent was down 190 basis Once year over year solid performance for this stage of the freight cycle, our adjusted EBITDA was $26,000,000 in the quarter Compared to $66,000,000 in the Q3 of 2022 and our adjusted EBITDA margin was 2.7%, down 3 10 basis points. The declines in these metrics were primarily due to lower freight rates and the moderation in brokerage gross profit per load. We continue to optimize our cost structure while investing for growth, positioning us well to drive substantial operating margin leverage when the cycle inflects.

Speaker 2

I'll touch on our year to date annualized cost savings shortly. Below the line, our interest expense for the quarter was $8,000,000 Our adjusted effective tax rate of 13% in the quarter was a function of an updated annual forecast of lower taxable income In addition to a small amount of discrete tax items, our year to date adjusted effective tax rate is approximately 19%. Adjusted diluted earnings per share for the quarter was $0.05 which includes approximately $0.01 of discrete tax benefits. You can find a bridge to adjusted EPS on Slide 7 of the earnings presentation. Moving to our lines of business.

Speaker 2

We continue to outperform the brokerage industry. We grew brokerage volume by 18% year over year. Brokerage gross margin remained strong at 15.1%, down 3.90 basis points year over year, while only down 30 basis points sequentially. Complementary services gross margin of 20% improved by 90 basis points year over year. Our last mile pricing initiatives were the biggest driver.

Speaker 2

Please turn to Slide 8 as we discuss cash flow. Our adjusted free cash flow over the trailing 6 months was impacted by lower profitability levels, Increased quick pay adoption by carriers and timing related to $15,000,000 of certain cash tax outflows, Including cash taxes related to prior periods. With respect to QuickPay, this service allows our carrier partners to get Faster access to their cash payments increases carrier retention and generates a strong return on capital for RXO. We have an opportunity to drive increased carrier adoption of QuickPay across our business and we're investing accordingly. While increased QuickPay adoption will be a net use of working capital, it is a good strategic initiative with our carrier base with a good return on investment.

Speaker 2

QuickPay is a win win for our carriers and RXO. Normalizing for the increased adoption of QuickPay In cash tax items, our adjusted free cash flow conversion over the trailing 6 month period was approximately 45%, Which we are pleased with at this point in the trade cycle. We remain comfortable with an annual adjusted cash conversion rate Between 40% 60% of adjusted EBITDA over the long term across market cycles. As we mentioned last quarter, accelerated growth as a cycle turns will result in a use of working capital. We continue to anticipate to use approximately 7% to 9% of each incremental revenue dollar.

Speaker 2

This can impact short term cash conversion depending on the Let's move on to our cash balance. We've also included a 6 month cash bridge on Slide 8. We ended the quarter with $104,000,000 of cash on the balance sheet. The largest headwinds to cash in the 6 month period were restructuring and spend related cash outflows in the amount of $12,000,000 We continue to expect Structuring and spend related charges to decline significantly in 2024. We also continue to settle RSU tax withholding obligations and cash to minimize dilution, which was an outflow of $5,000,000 in the period.

Speaker 2

Let's now discuss cash on a 3 month view. As you'll recall, in the Q2, we collected approximately $15,000,000 of receivables Earlier than we expected. But considering these earlier collections, the normalized starting cash balance for the Q3 was approximately $109,000,000 In addition to the use of working capital for QuickPay, we use cash of approximately $3,000,000 restructuring and approximately $3,000,000 for RSU tax withholdings. Turning to cost, we took out additional costs in quarter and achieved annualized run rate savings of approximately $3,000,000 We've now achieved year to date Annualized run rate savings of approximately $31,000,000 with associated restructuring charges of $12,000,000 a strong return. While the savings have been masked by the current freight cycle dynamics and the reduction in brokerage gross profit per load, They will create significant operating leverage when the cycle turns.

Speaker 2

We now expect lower restructuring and spend related costs Relative to our prior estimate, specifically, we expect 2023 restructuring and spend related costs Of approximately $30,000,000 to $32,000,000 compared to $35,000,000 previously. Additionally, we now anticipate cash Outflows associated with these restructuring and spend related actions of approximately $25,000,000 $5,000,000 lower than our prior estimate. As you can see on Slide 9, our balance sheet remains healthy with net leverage at a quarter end at approximately 2.1 times Trailing 12 months adjusted EBITDA. This is higher than the 1.6 times last quarter due to our cycling of prior year EBITDA. While our leverage is above our long term target of 1 to 2 times, our liquidity position remains robust With $604,000,000 of available liquidity at the end of the quarter, we will again cycle through a tough comparison in the 4th quarter And expect net leverage to move higher at year end.

Speaker 2

I'd also like to review our capital structure. In early November, we exercised the according feature Under our existing revolving credit agreement that increased total revolver commitments from $500,000,000 to $600,000,000 We simultaneously repaid all outstanding obligations under our term loan credit agreement. Pro form a, these actions will yield annual Interest savings of more than $1,000,000 Gross debt will decrease and our net debt and liquidity positions remain unchanged. We've maintained the same liquidity with more flexibility at a lower cost. As you'd expect, at the end of the Q4, you will initially see a lower cash balance as a result of the prepayment.

Speaker 2

Our customers want to work with strong partners that can perform and invest across all market cycles, And these actions highlight our financial and balance sheet strength. You can find our updated 20 23 modeling assumptions on Slide 15 Capital expenditures are expected to be between $60,000,000 $65,000,000 This includes $10,000,000 to $12,000,000 Strategic investments in real estate to position us for additional growth in our brokerage business. This is down slightly from our prior estimate of $15,000,000 Due to some changes in project timing, depreciation and amortization is expected to be approximately $70,000,000 At the low end of our prior range, stock based compensation expense is expected to be between $20,000,000 $22,000,000 Interest expense is expected to be between $32,000,000 $33,000,000 which is slightly lower than our prior estimate. This is pro form a for the capital structure optimization and includes the 4th quarter benefit associated with the net interest expense savings I mentioned earlier. We continue to expect a full year 2023 adjusted effective tax rate of approximately 25%.

Speaker 2

You should also model an average diluted share count of approximately 120,000,000 shares. This does not include any impact associated with Potential share repurchases. Overall, given the current state of the freight cycle, we're pleased with our execution. We have a strong balance sheet. We're operating well, investing strategically while remaining disciplined on cost and positioning RXO for the cycle inflection.

Speaker 2

Now, I'd like to turn it over to Chief Strategy Officer, Jared Weitzfeld, who will talk more about our outlook.

Speaker 3

Thanks, Jamie, and good morning, everyone. We continued to outperform the market in the Q3, growing brokerage volume by 18% year over year With continued substantial profitable market share gains enabled by our people and technology, loads per day grew every month throughout the quarter. More specifically, we grew our core truckload volumes by 13% year over year and grew LTL volume by 55% year over year. Our full truckload customers continue to award us LTL loads because of our strong service and relationships. LTL now represents approximately 17% of brokerage volumes.

Speaker 3

From a vertical perspective, we saw growth in every major category. Specifically, retail and e commerce volumes accelerated significantly with volumes growing by 21% year over year, first 3% in the second quarter. Several existing customers awarded us new business in the quarter, but we also saw growth across the whole category. The food and beverage vertical also grew strongly. While industrial and manufacturing grew by low single digits year over year, the vertical decelerated from last quarter's growth rate.

Speaker 3

From a profitability perspective, we again delivered strong brokerage gross margin of 15.1% in the quarter, Down just 30 basis points sequentially enabled by our technology. As Drew discussed earlier, July was a very difficult month for RXO. However, our performance improved as the quarter progressed. RXO brokerage key performance indicators improved every single month throughout the quarter, Positioning us well into the Q4. I'll discuss this in more detail shortly.

Speaker 3

In the Q3, 97% of our loads were created or covered digitally 1st 81% in the Q3 of 2022. 7 day carrier retention was a strong 77% in the quarter Compared to 75% in the Q3 of 2022. We launched several new features of Oraxol Connect in the quarter, including enhanced pricing algorithms. Additionally, we leveraged new natural language processing solutions for automated order creation. We also made specific generative AI investments in the quarter To improve employee productivity.

Speaker 3

In the Q3, contractual volume represented 80% of our business, Up 100 basis points sequentially and up 700 basis points when compared to the Q3 of 2022. Contract volume growth was up 30% year over year, accelerating from 19% in the prior quarter. We have not yet seen the spot market emerge, but because of our contractual business and our deep customer relationships, when the market turns, RXO will react quickly and be a prime beneficiary of spot volume. Before discussing market trends, I want to emphasize the strategic investments that Drew and Jamie referenced earlier. Oraxol continues to invest in the business Across our people, service offerings and our technology, we are building for the long term and are laying the foundation for the market inflection.

Speaker 3

Taken together, we estimate our 2023 strategic investments will total approximately $20,000,000 to $25,000,000 While these investments impact near term profitability, we've run this playbook before and we are investing counter cyclically for the long term. Last quarter, we communicated that we believed we were approaching the bottom of the cycle. We now have further conviction in that view. Specifically, we believe that July's brokerage gross profit per load marked the low point for the year. I'd like to expand on our current view of the freight cycle and I'll refer you to 11 through 13 of the presentation.

Speaker 3

Let's start with revenue per load. To get a better view of our consolidated year over year price on a per load basis, it's important to consider the impacts of length of haul, mix and changes in fuel prices. When normalizing for those items, revenue per load was down approximately mid teens percentage on a year over year basis in line with market pricing. As you can see on the chart, we generate strong gross margin across all different parts of the freight cycle by leveraging our proprietary technology and pricing algorithms To procure capacity at better than market rates. Moving to Slide 12, let's continue to walk down the P and L and discuss recent brokerage gross margin trends.

Speaker 3

RXO's brokerage gross margin improved as the quarter progressed given improved freight market conditions and RXO specific levers. The national load to truck ratio moved higher as the quarter progressed, tender rejection rates increased and carrier exits continued, albeit at a slow pace. We expect carriers to exit the market at an accelerated pace over the next 3 to 6 months. We also took further buy side actions, leveraging our technology, Resulting in significant improvement in our gross profit per load every month of the quarter. Specifically, our gross profit per load in the month of September Improved by greater than 20% when compared to July's low.

Speaker 3

Let's go to Slide 13 and look at RXO's brokerage gross profit per load on a quarterly basis. RXO's Q3 2023 gross profit per load declined moderated with continued significant volume growth Position us well for the inflection. The underlying inter quarter improvement of the business that we just discussed isn't visible in this chart since July's gross profit per load brought down the quarterly average. To put in perspective, given the squeeze earlier in the quarter, July's gross profit per load was our lowest since Q2 of 2017. I'd now like to review the relationship between Q3 volume growth and adjusted EBITDA.

Speaker 3

Early in the Q3, we experienced a squeeze on gross margin. The headwinds from the freight cycle were severe in the month of July, the most difficult month of the year and that significantly impacted near term profitability despite improved volume growth. This is typical at this point in the cycle with gross margins compressing as cost of transportation increase without a corresponding increase in sell rates. When those headwinds reverse like they did as we exited July, our model delivers significant operating leverage. I now like to look forward and give you some more color on the puts and takes we're expecting in the Q4.

Speaker 3

We typically see a seasonal uptick in all our lines of business in the Q4, Which we expect this year. Based on what we're hearing from our customers, we're assuming a muted peak season. We are staffed for growth and can respond quickly if a stronger peak season develops. Our brokerage sales pipeline remains robust and is up 115% on a 2 year stack. This gives us confidence that we will again grow brokerage volume On a year over year basis in the Q4.

Speaker 3

While October brokerage volumes still increased on a year over year basis, we did see year over year volume growth moderate when compared to the 3rd quarter. We are assuming Q4 year over year brokerage volumes will grow, but at a slower pace than the Q3. It's also important to note that we're coming off a very strong September And Q4 had a tougher comp when compared to Q3. Brokerage revenue per load trends are encouraging and we expect another moderation in year over year revenue per load declines in the Q4. Moving to brokerage gross profit per load.

Speaker 3

While year over year volume growth moderated in October versus September, RXO's gross profit per load was resilient, roughly flat with September levels with strong gross margin of 16%. Putting it all together, we expect RXO company wide adjusted EBITDA to grow sequentially into the 4th quarter. Over the last 3 years, on average, RXO adjusted EBITDA has grown by approximately 20% from the Q3 to the Q4. We expect RXO company wide adjusted EBITDA to grow roughly in line with that growth rate with strong company wide contribution margins. As a reminder, historically our adjusted EBITDA typically declines from the seasonally strong Q4 into the seasonally weak Q1.

Speaker 3

We're continuing to gain market share profitably with another quarter of strong brokerage gross margin. We're optimizing our cost structure while strategically investing in the business And have a playbook to deliver rapid earnings growth when the market influx. Our gross profit per load bottomed in July for calendar year 2023 And we're entering the Q4 with improved momentum. We're still operating in a soft part of the freight cycle and the pace of the recovery will be subject to the broader macro environment, But we are making the right strategic moves to position us well for the long term. With that, I'll turn it over to the operator for Q and A.

Operator

Thank you. Ladies and gentlemen, we will now begin the question and answer Our first question comes from Ken Hoexter Sir, from Bank of America, please go ahead. Your line is open.

Speaker 4

Great. Good morning, Drew, Jared and Jamie. Maybe just talk about your outlook there, right? So you talked about slowing growth in October, some increased mini bids. Just what lends confidence that the Q3 is the EBITDA bottom?

Speaker 4

I guess you talked about confidence that inventory I'll stop there. What gives you the confidence that we're really seeing the bottom given that backdrop that October seems to be a bit more flattish?

Speaker 1

Yes, Ken, this is Drew. Good morning. The first thing that I'd point out is the improvement that we've seen in gross profit per load. If you look From July, gross profit per load improved by more than 20% and it continued into October. So the biggest reason for optimism is what we've seen on the gross profit per load.

Speaker 1

The second thing is as you look at what was impacting the second Quarter outside of gross profit per load, we had 2 other factors. 1, last mile typically takes a step back seasonally From Q2 to Q3, but the cost to run the business doesn't change a ton there. And then the third is We're the largest manager of ground expedite shipments in the country and that was largely built off of automotive customers. So while that was a headwind for us as we came out of Q2, as the plants come back online, that will be more of a tailwind for us.

Speaker 4

Great. And just if I can do a follow-up. I guess you talked about customer inventories being you're confident that they're lower and kind of set To face that rebound, maybe talk about how you look at that given higher rates, the impact on consumer, just the economic backdrop. I don't know, maybe if loads are up, maybe because of the bankruptcy of Convoy, any thoughts there, if you're seeing the benefit there or if this is really Some sort of economic backdrop that you're seeing that's shifting?

Speaker 1

Yes. So 2 separate points there, 1 on disruption in the market, 1 on peak season. The first point on peak season is we expect a muted peak season, but we do have some customers that are telling us that they will have a peak season. So we're still staffed for growth and prepared to handle that if the inflection curves for those customers. The second point on the disruption in the market, The competitor that went out of business was less than 1% of the overall brokerage market.

Speaker 1

So it wasn't a huge play on capacity, But it did create some disruption and some noise in the market and that's a good thing for our business. Anytime that there is disruption or noise, Our customers are going to come to us to create solutions in times of chaos for their business and we've got a lot of experience doing that and delivering for them and we expect As the market influx, they're going to come to us on spot loads, projects and mini does as well.

Speaker 4

Great. Appreciate the time and thoughts.

Speaker 1

Thank you.

Operator

Thank you. Our next question comes from Christopher Kuo from Benchmark Company. Please go ahead. Your line is open.

Speaker 5

Yes. Hi. Thanks for taking my question and good morning, guys. One of the issues that comes up is that the Spot price kind of stays where it is. Can you continue to grow your gross margin from here if spot It's flat from here or slightly, it just goes up a little bit?

Speaker 1

We think that spot loads are at or near the bottom and have been floating around there for some time. And when you look at what we're seeing from spot rates, we do not believe that carriers can continue at Running below operating costs for much longer, we think that over the next 3 to 9 months, you'll see carrier rates actually accelerate, Where if you do not see a demand inflection and that would cause an increase in the overall spot market. But if things stay floating along the bottom, Our strategy has always been during this part of the cycle that we'll grow and we'll build our foundation. We'll continue to hone in our relationships With our customers, we'll make a fair margin, and we'll prepare ourselves for the inflection and to show the power of the model in the earnings When the market

Speaker 5

impacts. Okay. Thanks guys. Appreciate it.

Operator

Thank you. The next question comes from Stephanie Moore from Jefferies. Please go ahead. Your line is open. Hi, good morning.

Operator

Thank you.

Speaker 1

Good morning, Stephanie.

Speaker 6

Good morning. I appreciate the color you've given so far, particularly related to Tobar, but I'm realizing this is a tough question to answer. But just given maybe what you're hearing from your customers, How early bid cycle are trending so far? Maybe how this frames kind of your expectations for 2024 and just where we are in the cycle and The path to inflection at some point, maybe just your thoughts on when that might occur? Thanks.

Speaker 1

Yes. Thank you, Stephanie, we're just starting a lot of those conversations with customers, and we expect those to pick up as they typically do over the next 5 months. And we're hearing different things from different customers. Some of these customers we're actually going to and we're seeing slight increases on a year over year basis. Some of them are Slightly down.

Speaker 1

It depends on when they were bid and when they were put into place and what was going on with the market at that point in time. The biggest thing for our business though as we head into 2020 We're going to hold the model. We're going to continue to build the foundation, grow the base, have strong relationships with our customers. And as the market starts to inflect, when spot loads come on, when projects start, we're going to be the 1st place that customers go. We've got great service, We've created solutions for them and we've got the best technology in the industry.

Speaker 6

Great. Thank you so much.

Operator

Thank you. The next question comes from Scott Schneeberger from Oppenheimer. Please go ahead. Your line is open.

Speaker 7

Thanks very much. Good morning. Drew, the you gave Some color on load to truck ratio. Could you just talk, put it into historical perspective, where you see it right now, What you think it can be over the Q4 into next year? And what would be more importantly, what would be triggers?

Speaker 7

What would be levels That would make you change behavior of the versus the mode you're in right now? Thanks.

Speaker 1

Yes. So right now, when you look at where load Truck ratio is sitting roughly around 2:one overall and I've been doing this for 17 years Scott and Anytime that it's gone below 2 to 1, it hasn't stayed there for a sustained amount of time. You saw that whenever it went Below 2 to 1 earlier this year, it quickly went to 3, 3.5 to 1. So I do not expect that to hang down here for long because I do not think that carriers continue To operate below what it costs them to run their especially a small trucking company. So for us When you're talking about will we continue, we've always invested in the business.

Speaker 1

That's not something that we anticipate slowing down. We don't look at this business Quarter to quarter, we're looking at it over the long term. And we've laid out targets of in the EBITDA from $475,000,000 to 5.25 And the investments that we're making right now, we're confident are going to help us achieve that.

Speaker 7

Thanks, Chad. And you did mention acceleration carrier exits in Q4 and you are adding new team members. Maybe elaborate on where you're adding new Team members and sneaking another one in too, what are some areas of strength and weaknesses across your end market? I'm just curious Where you're winning and losing there? Thanks.

Speaker 1

I'll take the first part and then I'll let Jared take the second part. The first part on where we're adding people is to call the customers. Yes. We've got a lot of great relationships with existing customers, but we're also bringing on new customers. And to have those people come on and Being trained up and learn the freight industry, learn the differentiators for RXO take some time.

Speaker 1

So we continue to invest into people who are talking to customers And people who are building relationships with the carriers that we're partnering with.

Speaker 3

And Scott, hey, it's Jared. Good morning. From a vertical perspective, All of our major verticals grew on a year over year basis in the quarter. Retail and e comm specifically was up 21% year over year, which accelerated Pretty substantially from last quarter attributable to not only overall vertical health given the customer inventory levels that Drew talked about, but also RxO expanding business at existing customers. Additionally, food and beverage showed nice growth year on year.

Speaker 3

Industrial manufacturing did slow down year on year, but it did still grow Relative to prior year.

Speaker 5

Thanks guys. Appreciate it.

Operator

Thank you. The next Question comes from Jordan Allager from Goldman Sachs. Please go ahead. Your line is open.

Speaker 8

Yes. Hi, morning. I think you mentioned October, Some softening in volume trends year over year. I'm curious, would you assess that that's More of an underlying demand softening or could it be amped up competitive pressures as folks or other brokers are trying to stick around and go after the

Speaker 1

It was more of a demand softening that we saw, and it was broad based, and it was really across all verticals. Obviously, We did see an impact with the UAW strike, but it wasn't just limited to automotive, it was broad based across all verticals. But I do want to be clear, We are still growing volumes on a year over year basis in the Q4 and continue to take market share in this market.

Speaker 8

Okay. And then, thanks. And then, when I know it's still early on 2024. I think you mentioned the 4th Quarter though, expect sort of maybe usual seasonality on EBITDA growth. I mean all things equal, do you think we could have normal seasonal Sequential EBITDA patterns as we move through 2024 or will there be times where could it be less earlier, more later?

Speaker 8

I mean, is there a way to think about that?

Speaker 1

Jordan, I think there's still too many unknowns for 2024 to call that right now. As we sit here today, we're not sure where interest rates are going. We're not sure what the Fed's going to do. We're not sure what fuel prices are going to do. And those are 3 big factors To be able to call out normal seasonality.

Speaker 1

So we're not at a point where we can call what's going to happen in 2024 yet.

Speaker 8

Great. Thank you.

Operator

Thank you. Our next question comes from Brandon Oglenski from Barclays. Please go ahead. Your line is open.

Speaker 9

Hey, good morning everyone and thanks for taking my question. Jared or maybe Drew, you guys did talk about normal Seasonality, I think, coming off the 4th quarter being down from an EBITDA perspective. I know that's not necessarily guidance, but can you just help us what is the normal step down in 1Q EBITDA? And then I guess maybe a longer term follow-up to that. What's going to be really required here to demonstrate the operating leverage in the model, Especially given that you think the bottom was set in July.

Speaker 9

So what incrementally do we need to see from here?

Speaker 3

Sure. I can start and if others want to chime in as well. So it's Jared. Good morning, Brandon. So you're right from Q3 to Q4, we talked about 3 year historical average growth has been about 20% on adjusted EBITDA sequentially, which we expect to achieve roughly that growth rate from Q3 to Q4.

Speaker 3

Heading into Q1, there's been a lot of variance. I mean, if you look back over the last 3 to 5 years, that range has been anywhere from, call it, down mid single digits To down, call it low double digits, there's been a lot of variability over the last 3 to 5 years, but that's the appropriate range in terms of how to think about sort of the historical bridge from Q4 to Q1. In terms of incremental contribution margins, we touched about this a bit in the prepared remarks. We expect strong company wide contribution margins In Q4, with that sequential EBITDA growth from Q3 to Q4 and longer term, You think about what we're doing here in the business, not only are we continuing to strategically invest and we size that opportunity at roughly $20,000,000 to $25,000,000 of strategic investments In 2023, but we're also taking actions and year to date we've achieved cost savings of approximately $31,000,000 That's going to drive really, really strong contribution margins going forward.

Speaker 9

Okay. Appreciate that, Jared. And then, Jamie, talking about leverage, I'm looking at your chart in the presentation. I guess you have a net cash position now of $4,000,000 I mean is that a proper level to run the business or did you draw on the revolver since then?

Speaker 2

Yes. So, Brandon, we redid our capital structure, updated our capital structure, really what we did is we Our liquidity on our revolver, we had a somewhat inefficient use of cash. We took that cash, paid off the term debt, Ticked up, let's call it 130 basis points, 150 basis points of negative arbitrage on interest. We'll have an excess of $1,000,000 Of cash savings a year on interest on a pre tax basis. And so we feel like at the end of the day, we had a big pickup, Nice pickup in interest savings, kept the exact same liquidity, our net leverage was the same.

Speaker 2

We feel like from a standpoint of running the business with that level of cash, Yes. We'll dip into the revolver from time to time as the normal cyclicality of intra quarter cash flow occurs, But we continue to see a very strong cash flow business. We've talked about 40% to 60%. We still believe that's a good number to use. In fact, it's been about 43% year to date of conversion.

Speaker 2

So we think we feel very comfortable With the optimized capital structure that we put in place in early November.

Speaker 3

Appreciate that. Thank you.

Operator

Thank you. The next question comes from Scott Group from Wolfe Research. Please go ahead. Your line is open.

Speaker 5

Hey, thanks. Good morning. So just from the market overall, I'm curious where do you what kind of spread are you seeing between contract rate and Spot rate right now and how does that look versus normal? And then I guess what I'm trying to figure out is you guys are we're talking about hopefully July being the bottom. Typically with brokers when spot rates eventually spike, we get an incremental squeeze.

Speaker 5

Do you think that That is do you think we've already seen your squeeze or is there an incremental squeeze that comes whenever Spot eventually spikes.

Speaker 1

Yes. Good morning, Scott. You're still at a point where spot rates are below Contract rates at this point in the cycle. When you talk about the squeeze, we definitely saw a squeeze in July. I think that the squeeze can come at different points in the cycle and that's a good thing for the business.

Speaker 1

Whenever you get squeezed that can last anywhere from a week to 1 to 2 months is not something that is a bad thing as you start to see a shift in the market. I don't think that the squeeze that we experienced in July Was the broader turning of the market. I think that was more related to a produce season. But on the other side of the squeeze is when you start to see the spot loads come in And that's whenever you're going to see contract gross profit per load come down, but the spot gross profit per load will go up and more than offset and show the power of the earnings behind the

Speaker 5

And then I know a lot of talk about the gross margin, but I want to ask on the net operating margins Fell to 6% in the quarter. Any color on how brokerage net operating margin is doing versus the rest of the business? And And ultimately, when we get this upcycle at some point, how should we think about where net operating margins can go?

Speaker 3

Hey, Scott, it's Jared. A couple of things on that point. So in terms of the sequential decline in net operating margins, We look at the business on an adjusted EBITDA and adjusted free cash flow basis. But what you're calling out, I think I'd highlight a couple One, what Drew talked about earlier in terms of the seasonality in last mile from Q2 to Q3 is typically weaker with Generally a fixed cost base that doesn't move that much in for quarter when you think about the movement from Q2 to Q3. So those decremental margins impacted the sequential move.

Speaker 3

And then also remember that the low point in gross profit per load was in July. So the starting point for the quarter Really felt the full run rate impact of the squeeze coming out of produce season. So I called those two factors out As well as some of the impact that we talked about earlier with respect to managed transportation associated in the UAW strike. So boiling I think combining all those factors I think largely In terms of the incremental contribution margins from here, I'll hit on what I talked about earlier in terms of the cost optimizations that We're taking in the incremental margins that we're expecting. Last quarter, we talked about from the low point brokerage gross margin brokerage contribution margins Specifically, it can be pretty strong from the bottom of the cycle, certainly in excess of 50%.

Speaker 3

So that's how we're thinking about the business from a contribution margin standpoint.

Speaker 5

Thank you, guys.

Operator

Thank you. Our next question comes from Jason Seidl from TD Cowen. Please go ahead. Your line is open.

Speaker 10

Thank you, operator. Good morning, gentlemen.

Speaker 11

You called for capacity to come out

Speaker 10

of the marketplace at a more material level over

Speaker 4

the next 3 to 6 months.

Speaker 10

Most people would have probably called for the same thing in the last couple of quarters to be fair. So what's giving you the confidence that now finally capacity is going to start coming out of the TL market?

Speaker 1

Yes. Jason, I said over the next 3 to 9 months and the biggest thing is Sorry

Speaker 3

about that.

Speaker 1

No worries. The biggest thing on that is carriers right now, what it costs to run a small trucking company, spot rates are below that right now. So We do not think that the balance sheet that they build up during COVID can sustain much longer than where it's at right now.

Speaker 12

Okay. Fair enough. And

Speaker 5

you talked

Speaker 3

a little bit about some

Speaker 10

of your customers saying that sort of you're With the sort of inventory drawdown, what are they saying about the restock going forward?

Speaker 3

Hey, Jason, it's Jared. Good morning. From a refoc standpoint, we saw encouraging trends in Q3, specifically in the retail and e commerce vertical, which was Continuation of the acceleration that we saw in the prior quarter as well. Some of that was expanding share of wallet and market share gains at RXO, but Also indicative of the broader health of the vertical. So like Drew said earlier, we are hearing different things from different customers, some think that we're going to have a peak, some are more mixed on that view.

Speaker 3

I think what's important for us is to ensure that we are prepared for that. We are staffed for growth. We have the right investments. And we'll see as the rest of the quarter plays out whether or not we'll have a But we did see encouraging trends with respect to the retail and e comm vertical during the quarter.

Speaker 12

Appreciate the time, gentlemen.

Operator

Thank you. The next question comes from Tom Wadewitz from UBS. Please go ahead. Your line is open.

Speaker 13

Yes, good morning. Wanted to just I guess kind of a fine point first. You talked about the slowing in October, but didn't really quantify it. Can you give a little bit of a truckload load growth is up, I think you said 13% for 3Q, is it up like low single digits in October or Is it 10% plus or is there any more kind of fine tuning on that you can give us just to understand how much slowing there is?

Speaker 1

Yes. Truckload volume was up, let's call it, mid single digits and overall volume was up double digits.

Speaker 13

Okay, great. Yes, thank you for that. If I look at the I think you had some questions on this and Scott asked about it. And it seems to me like a significant kind of overhang on 2024 It's just that transition process of eventually spot rates are going to go up, right, which I understand is ultimately good for the business. You've got 80% on contract and so that's maybe that's a pretty heavy SKU to contract.

Speaker 13

I don't know if you do you think you'll be able to adjust the contract rates more quickly than prior cycles? Or would you say, hey, there is a fair bit of risk that if Spot rates go up that we will have a kind of a normal cycle period where we do get squeezed on the gross margin percent.

Speaker 1

Tom, the first thing is that I would remind you and everyone that this business can shift and shift quickly. So like I told Scott, The squeeze can be for a matter of weeks and you've seen this business shift its mix shift from contract to spot by more than 1,000 basis points Quarter over quarter. So while there would be a little bit of a squeeze, the other side of that is a good thing and the squeeze doesn't have to last that long Depending on the capacity that's exiting the market as well as depending on demand.

Speaker 13

Okay. And If I could just one more quick one. On the attrition, you were asked about convoy, I think that's high profile, but there have been a bunch of other kind of midsized brokers leaving. I Normally we focus on carrier attrition. How do you think about broker attrition and whether that's a significant enough factor to help Help the bigger brokers, help the stronger brokers like yourself as you go through the cycle or is that just noise?

Speaker 1

Tom, anytime there's disruption and the carrier is exiting a routing guide, that's a good thing for our business. It doesn't matter if it's an asset based carrier or if it's A broker that is doing that. So with the noise that has been there, I would not call that it is a ton of capacity this exiting the market, but it has created some noise, Which has created some many bids and obviously you followed us for a long time. You know that we've got great relationships with our customers. Our largest customers have been with us for Over 15 years on average and what they're going to do whenever they have disruption, they're going to come to us and that's going to be the same thing for the prior question that we were talking about As soon as there are spot loads, they're going to go to the people that have delivered for them time and time and time again and that's RXO.

Speaker 13

Right. Okay. Great. Thanks for the time.

Operator

Thank you. Our next question comes from Allison Polina from Wells Bobo, please go ahead. Your line is open.

Speaker 9

Good morning, guys. James on

Speaker 12

for Allison. Just kind of wanted to follow-up on this Point around exits and the expectations for it to accelerate. Just like essentially sort of like what's the mechanism around it? I mean It seems like there has been some level of improvement from a bottom in that market. Like is there sort of a way where we could see sort of The improvement moved to a place where the carriers might be encouraged to hang tough and we could see an elongation here?

Speaker 12

Or and if that's the or does there really need to be in sort of another leg of spot rate pressure to sort of accelerate those exits?

Speaker 1

I think the hang in tough is what you've seen over the last 6 to 9 months when carriers have already been running below the operating cost Of what it takes them. So for us, we believe that you have seen the hang tough and now it gets to the tougher time that they can actually go out and do something else and Earn potential income for themselves.

Speaker 3

Got it. And then you mentioned

Speaker 12

The LTL side of it, any sense of like the percentage of revenue and sort of what you could possibly see that growing to over sort of the next 12 months?

Speaker 3

Hey, it's Jared. So we mentioned on the prepared remarks that it's about 17% of our total volume and it continues to grow. It grew 55% year over year In the current quarter, when that business is at scale, it's going to provide a nice stable learning stream for the business and really provide a nice opportunity For us to grow, we continue to get rewarded LTL freight from our largest TL customers based on the exceptional service and the customer relationships that we have And we don't see that stopping.

Speaker 12

I think any sense of percent of revenue or percent of profit?

Speaker 3

Thank you. Yes. We're not talking about that as a percentage of revenue, but from a percentage of volume standpoint, it was 17% in the quarter and we continue to expect that to increase. Thanks.

Operator

Thank you. Our next question comes from Bruce Chung from Stifel. Please go ahead. Your line is open.

Speaker 4

Hey, thanks operator and good morning everybody. Drew, you talked about a very nice move up in loads So digitally versus last year, when you think about cycle recovery, can we maintain those levels of digital fulfillment or is there more Manual touch that's required to onboard the spot business. And then maybe just a related question there, when you think about the headcount, you've been adding here And investing aggressively as you put it, do headcount additions need to accelerate even more as the cycle comes back?

Speaker 1

Yes. Thank you. So when you look at the digital, we're at 97% created or covered. We have made significant progress With our customers and we do not expect that to slow down. On the carrier side, we still got a lot of white space to go and we do expect that to accelerate Over the next 6 to 12 months.

Speaker 1

Your second question on headcount, we're investing appropriately in the business in terms of headcount. We've said before that we like to stay staffed for growth of 15% overnight if we need it and that's the position we're in right now. When the market turns, As you've seen us do before, we'll be able to handle the volume. We did that during the early parts of COVID when we were growing volume 20% 30% on a year over year basis. We've got the team that's prepared to handle it and the customer relationships, so we know that the volume will come our way when that time comes.

Speaker 4

Okay. I appreciate that. And then just going back to the first question, when you think about the differences in the spot business versus the contract business, is it You know, materially easier to create those loads digitally for contract versus spot or is there not an appreciable difference?

Speaker 1

Well, on the customer side, it is easier for them to be created on a contract load than on a spot. You're right on that.

Speaker 4

Okay, got it. Thank you.

Operator

Thank you. Our next question comes from Brian Ossenbeck from JPMorgan. Please go ahead. Your line is open.

Speaker 11

Hey, good morning. Thanks for taking the questions. Maybe for Drew, just to come back to the whole contract spot mix. I I guess what gives you some of the confidence, maybe give us some conversations around this in terms of the confidence level in getting the big shippers to really provide The spillover freight, the spot loads rather when the market does turn. I imagine part of that depends on the strength and timing of the market turn.

Speaker 11

But Just wondering how you can get some visibility or confidence if that happens because I think in the past we've seen some of your peers expect something similar, but ended up Not quite living up to the turn they thought and ended up running lower for longer.

Speaker 1

Yes. Brian, this isn't our first rodeo. We've seen this before. When you look at what has happened as the market is in black, you're right. We don't know the shape and the timing of the recovery.

Speaker 1

But what we do know is We're talking to our customers every single day. We know that whenever there's opportunities right now in the markets that we're in, when there's disruption, they're coming to us to create solutions. We know that we do business with 58 of the Fortune 100 and over 200 of the Fortune 500. We've got a lot of white space with customers that we don't do business with. Our pipeline is in very good position.

Speaker 1

So we're confident that not only will we get the contract piece of the business, but we'll be rewarded on the spot piece of the business. We've got great service and our customers come back to us because we understand the blocking and tackling of picking up and delivering on time and showing them complete visibility of the loads.

Speaker 11

Okay. So I guess when you think about cadence of renewals for next year, With the many bids and things have changed and obviously the market is still quite dynamic, is that sort of normal, most of them done in the Q4 and Q1, Do you expect that to stretch out into next year? And just I know you mentioned earlier, but just what are the initial Indications in terms of where people expect rates to go. Do you feel like people are going to take some shippers might take one more crack at this to get a lower rate and Worried about what happens on the other side.

Speaker 1

Yes. So, the bid season is typically in the latter part of Q4 and then through The Q1 of next year. And what we're seeing right now, we're starting those conversations with customers. And as I said earlier, Some of the rates are coming in right in line. Some of them are slightly above.

Speaker 1

Some of them are slightly below. So I think that when you're talking about Shippers taking another crack at it. What shippers want is people who are dependable, who provide good service, who have had partnerships for a number of years Who are giving them a fair market price, which is what we've always done. For us, we'll go out there, we'll give them the fair market price. But when the market inflects And you start to see tender rejections creep up, that's when we're confident that we'll be the beneficiary of the spot loads that come out.

Speaker 11

And just the timing of the renewals, is that going to be similar to what it's been in the past? Do you think that could be a little bit slower or maybe even faster?

Speaker 1

I think it will be Q1 and the early parts of Q2.

Speaker 11

Okay. Thanks Drew. Appreciate

Speaker 1

it. Thank you.

Operator

Thank you. Our last question comes from Bascome Majors from Susquehanna. Please go ahead. Your line is open.

Speaker 14

Jamie, with the post quarter end debt pay down, it looks like you've Gotten yourself a bit of breathing room with the 3.5 times leverage ratio covenant. Can you speak to that a little bit? And whether or not you expect Just cyclical draws on the credit line to put you back kind of closer to that? Thank you.

Speaker 2

Yes. So The capital work we did, again, the big picture is we saved over $1,000,000 of cash interest, The same liquidity, derivative benefit, it did change the calculation of our covenant, but we had adequate headroom already. It gives us even more headroom. We will have some more a couple more cycles that we'll have to cycle through, but we feel very good about where we are on our Covenants, in terms of draws, we'll use that revolver from time to time, intra quarter cyclicality, no cash flow and cash outflow is not Always perfect. So we do expect to go into the revolver occasionally, but we feel really good about the Optimization work we did and again our liquidity is exactly the same as it would have been.

Speaker 14

Thank you for that. And On the transaction, integration, restructuring costs, you have seen that come down sequentially like you guys promised it would. Does that tail off close to 0 next year? What are the early thoughts on how much of a long tail we have on that?

Speaker 2

Yes, it will go down. As you said, it has gone down significantly already this year. If you separate The transaction and integration will continue to decelerate rapidly. There will be some P and L into 2024, but it will be down significantly. On the restructure side, we have, as Jared mentioned earlier, dollars 31,000,000 of annualized cost savings.

Speaker 2

We spent For that 31 approximately 11, so the return on investment of that is significant. And again, if you go back to long term, we're trying to position ourselves on a cost When marketing flex, we really can leverage a lot of flow through. So we do see the restructure go down significantly in 2024, But if we have an opportunity to have that type of annualized savings, we're going to go for it because it's a good return.

Speaker 14

Thank you for that. And lastly, I'll close big picture here. A few people have asked about this, but If I look at the second half of this year, if you come in, in the Q4 where you think you are, that's maybe $55,000,000 to $60,000,000 in EBITDA, call it run rate with no seasonal lift $110,000,000 $120,000,000 If I look at Sell side consensus for next year, it's roughly $200,000,000 but the range is really wide, dollars 140 something to $220 something. And I certainly wouldn't be eager to guide if I were in your seat 3 months earlier than I had to, but is there any sort of book in you can put around What a reasonable expectation could be for next year or what a too high expectation could be for next year and just hope of Having folks expect more of the same and be pleasantly surprised by the better rather than expect better and be disappointed by more of the same. Thank you.

Speaker 3

Hey, Bascome, it's Jared. Good morning. You've covered us for a while. We don't give annual guidance. We wanted to give you some color into Q4 in terms of Acting positive seasonality and roughly 20% sequential adjusted EBITDA growth despite being in a soft market and despite being an expectation for a muted peak season.

Speaker 3

Heading into 2024, I think Drew summed it up perfectly earlier. We are prepared in the near term in terms of staff for growth, into the extent that the peak season emerges. Heading into 2024, how we think about the business is over the long term, right? So we're making strategic investments now. We are focused on Delivering the commitments that we gave at Investor Day to $475,000,000 to $525,000,000 of adjusted EBITDA, no matter what the market throws at us over a 12 month We are confident on sustained volume growth outperformance with best in class margins.

Speaker 3

Thank you.

Operator

Thank you. We have reached the end of our question and answer session. I'll hand the floor back to Drew Wilkerson for closing remarks.

Speaker 1

Thank you, Cinthu. In the Q3, RXO performed well in a soft freight environment with 18% brokerage volume growth And strong gross margins. We've got experience with this stage of the freight cycle and we've got a winning strategy that positions RXO for future growth. We have a strong balance sheet and a disciplined focus on cost. At the same time, we continue to invest in our people, our service offerings and our technology.

Speaker 1

We're staying close with our customers and providing them with unique solutions that help solve their toughest freight challenges. Thank you all for your time today. I look forward to seeing many of you in the coming weeks and I hope you all have a great holiday season.

Operator

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask you please disconnect your lines.

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Earnings Conference Call
RXO Q3 2023
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