RXO, Inc. (RXO) Earnings Call Transcript & Summary

So for those that don't know me, my name is Felix Boeschen, Senior Machinery and Trucking Analyst here at Raymond James. Today, very happy to have RXO with us kicking us off here very early. We have the full crowd: CEO, CFO, Chief Strategy Officer. So before we get into it, Drew, I was hoping maybe you could start us off. Just a couple of minutes about RXO, who you are, what you do, kind of the end markets that you play in. And we'll kind of go into a fireside chat after that.

Absolutely. Jared, do you want to read the disclaimer before I get started?

Thanks, Drew. During this meeting, we will make forward-looking statements that by their nature involve risks, uncertainties and other factors that could cause actual results to differ materially. You can find a discussion of factors that could cause actual results to differ materially in our SEC filings and in our earnings release.

So RXO is a leading asset-light transportation group. We are led by our tech-enabled truck brokerage platform. And when you think about why we are able to outperform what is an industry that has performed really well, it starts with the technology that we have built in the business. We started from the ground up over 11 years ago investing in technology that focused on customers, carriers and employees to gain productivity gains and for us, that's been a winning strategy in brokerage. The brokerage industry from 2013 through 2021 grew at over a 9% CAGR. During that same time period, we grew at over a 27% CAGR. So over or nearly 3x what the market was growing at. We've got 3 complementary lines of business that complement our tech-enabled truck brokerage platform. The first where there's the most synergies is our Managed Transportation business. That's where we act as a transportation department for our customer and so that it provides a lot of synergy spend to brokerage and our other lines of business off of the freight that you're able to spin off of that. The other 2 lines of business are our freight forwarding and that is something that is good because it gives us good visibility into what's coming over from the Asian and the European markets that will hit the U.S. domestic markets. We've also built out some nice niche businesses that like transloading at the ports if you think about the port congestions as well as customs brokerage crossing the border into Mexico or into Canada. The last business is our Last Mile business and we're the leader in last mile transportation. So if you think big and bulky goods that are being delivered to someone's home, we've been the leader in that space forever. We've got facilities that put us within 125 miles of 90% of the U.S. population. So when you think about the biggest retailers and e-commerce customers that are doing home deliveries, they want to start their conversations with us. Another good thing within the Last Mile business is something that because of that brand representation and customer experience that you are part of, it puts you in front of the C-suite more than any of our other lines of business. And because of that, we get to talk about our other lines of business, mainly truck brokerage, and we've seen some great synergies off of that.

Awesome. Appreciate that. Drew, I was hoping we could maybe start big picture. So you've been I think a stand-alone publicly traded company now since very early November, maybe end of October. Can you maybe walk us through sort of what's changed at RXO versus when you were maybe inside XPO? You have some external new leadership in. Just trying to understand what's different.

The biggest thing that is different is how we focus our time. When we were part of XPO, 1 of the great things for leadership development is you got to see everything that was going on across the company. So if there was something that was going on in the supply chain group whenever we had that before the GXO spin-off, if there was something that was going on in LTL or European transportation; we were a part of all of those conversations. So it was great from a leadership development standpoint, but you do kind of hit that cap. So right now whenever you look at our management team, we are 100% focused on RXO and our asset-light transportation piece. The second thing is 1 of the things that we saw during the spin-off is we'd already spun-off our sales force so for our customers there was really no interruption. We were able to focus 100% of the time on continuing to build the relationships and grow out with our customers.

Got it. You have some long-term financial targets out there I think 2027 and if I think about it, for me the headline is around $500 million of EBITDA I think at the midpoint. Correct me if I'm wrong. But what I'm curious about is in that number, there's really not that much assumed from capital allocation. Maybe walk us through that: how you think about capital allocation, how you think about free cash flow generation through cycles of the company and sort of maybe where we're at in terms of maybe coming out there with some incremental targets on capital allocation?

So Felix, you're correct. We gave a target at the time of our spin of $500 million midpoint EBITDA target for 2027. We remain confident in that target. We took into account a lot of cycles, a lot of economic cycles that would occur between now and then. From a capital allocation standpoint, we assumed growth was organic, it did not include a lot of M&A. When you think about capital allocation, we started to spend with a very strong balance sheet. Our net leverage was approximately 1.1x. We reported it at 1.2x at quarter-end -- at year-end. We have a very strong free cash flow business. Last quarter, we reported in excess of 60% conversion; EBITDA, free cash flow. So there will be a lot of options that we can have for capital allocation. From an M&A standpoint when we look at M&A, it will be a strategic look. A niche add-on and a bolt-on type M&A strategy that would help us grow in an area that we want to accelerate our growth in. And there's shareholder distributions; a buyback program, a dividend program; is something that's also in our framework. But I think the key to our capital allocation is strong free cash flow off the basis of a strong balance sheet gives us a lot of options to be able to grow to meet that $500 million target that we've given.

And Felix, maybe it makes sense to just hit on some of the growth algorithms to take us from where we are today to the $500 million of EBITDA in 2027. So in calendar 2022, we made $306 million of adjusted EBITDA and our guidance calls for an approximate 60% increase to 2027, we took $500 million at the midpoint. So I think it's important to take a step back. We operate in a $400 billion for-hire truckload market. Brokerage as an industry has been gaining steady share for the last decade. If you think about 10 years ago, brokerage penetration of that for-hire truckload market was as low as low double digits. That is now in excess of 20%. So the for-hire truckload market has been penetrated to the point of about $88 billion, of which RXO continues to participate in. We expect that to go ahead and continue to kind of increase from a penetration rate perspective up to the high 20%s, low 30% through the projected period. So as Drew was talking about earlier, brokerage as a category for many reasons, which we'll get into I'm sure, continues to gain share from asset-based carriers and RXO has been growing at a rate at 3x faster than the market. I think it's also important to point out in times of economic uncertainty like this and when you look what happened in Q4, RXO is actually accelerating our market share gains during the downturn. So hopefully that gives a little bit of perspective in terms if you think about where we are today, where we're going. And I think it's also important to point out that it's all about profitable growth from an RXO perspective. We're not just about growing volume. We're about growing profitably. If you look at last quarter, our brokerage business posted 18% gross margins.

That's super helpful. It actually kind of goes into my next question. And I guess what I'm curious about is you all gained a tremendous amount of market share over the last really 2.5, 3 years throughout the pandemic. I guess what I'm curious about we're in a very different truckload market today. How sustainable are these type of share gains even versus the brokerage market, which is a growing pie for RXO, in maybe a looser truckload market or a more balanced truckload market?

We think it's very sustainable. When you look at what happened in Q4, we were the only publicly traded company to grow volumes and we grew volumes by 4%. You saw a lot of our competitors were negative, some of them negative as much as by 40%. So when you look at this, we're going to continue to outperform and take share within the brokerage industry. It starts with customer relationships. Our top customers have been with us for 17 years on average. These customers, they don't just come back to us year-after-year. They come back to us year-after-year and give us more freight because of the service, the solutions and the technology that's integrated into their business.

Well, maybe this is a good time to talk about your technology. Could we talk about RXO Connect? Could you maybe talk about what it is, what's different about in the market and how does it feed into your share gain story?

Yes. So RXO Connect, remember when I made my opening comments, I talked about what we built the technology for; it's for customers, it's for carriers and for employees. So for customers, RXO Connect has become a tool that they're using on a daily basis. It tells them things like what day of the week they should ship something, what mode of transportation that they should use, do they have the opportunity to consolidate freight. We've even gone as far as helping customers decide where they should place a warehouse so that they can most efficiently route their transportation. For the carrier side, you have to have scale. So it's the fourth largest truckload brokerage in the country, we've got scale which means you don't have to leave the system to find your next load. You can reduce your deadhead miles just by staying within RXO Connect. And for us when you look at why they can come back to us, it's because the platform is easy to use. They can pick up their cell phone, they can book a load, they can negotiate and do all of that with no human interaction. And then you've got access within RXO Connect as a carrier to our RXO Extra, which is a rewards program for carriers. We give them discounts on fuel, tires, roadside maintenance. We even announced a few weeks ago that we've got hotels and Sirius Radio. So if you think about the things that a trucker is using in their everyday life, we've set up discount programs and we base those discounts off of the service and the volume that they haul with us. So that pulls them back to the system. The last piece is on employees and this is important to me because I came from the desk level within brokerage and when you look at what you're measuring a broker on productivity by, it's typically by loads per day and margin. So when you look at how we've improved the productivity over the last 5 years that ended in 2021, we grew volume at nearly 3x the rate of what we grew headcount. So what we focused on was just creating less clicks on the mouse, less key strokes so that the brokers were able to go in and get less loads per day and they were able to do it with higher profits.

Helpful. And 1 of the things that I'm trying to better understand about RXO is even the modal exposure within RXO if that makes sense. You mentioned transloading, which I thought was very interesting, at the beginning. I guess my question to you is where do you see the most incremental opportunity to grab further market share if you think about it from a modal perspective and sort of why is that the case?

Well, it starts -- Jared talked about the for-hire truckload market as $450 billion and considering that our brokerage is just roughly $3 billion, we've got a long way to go in the truckload market. That's the biggest piece. What we built our business on was 53-foot dry van swing doors that are moving up and down, but we are continuing to build out into LTL. It was roughly 10% of our business last year on the less than truckload side, we'll continue to grow and take share there; as well as in refrigerated, intermodal drayage. We'll continue to focus on growing out all modes of transportation. But we've built the business off of 53-foot drive-ins and that's our biggest opportunity for growth in the short term.

Can I ask you about drop trailers?

Yes, absolutely.

So it feels like a lot of the more asset-based carriers are certainly penetrating the brokerage space for aiming to deal what they call power only. Could you maybe take a step back and explain to us what is power only? How do you play in that market? How big is it for you? And maybe where do you see the puck going on that?

Yes. So power only is where you are setting a trailer pool at either the shipper or the consignee or the receiver and potentially both and you're doing that for efficiency so that your driver is not sitting there waiting for the trailer to be loaded or unloaded, they can focus more on their drive time. And for us, we started doing drop trailer business over a decade ago and we built it on large retail customers. We're now doing it across all modes or all verticals within our industry. And drop trailer last year made up roughly 10% of our overall business and it's 1 of the reasons why you're seeing brokers go out and take share from asset-based carriers because you're seeing that you're able to create an asset-like solution. And what we've heard back from our customers is they don't care what the front of the truck looks like. They care that they've got access to the trailer and that they can load/unload based off of what fits their warehouse time frame.

And so how does that work for RXO? Do you have to lease trailers? Do you own them yourself? Sort of walk me through how that works and maybe how you think about the model over time?

So there's a few different ways that it works, it's not 1 way. One, we lease a good bit of trailers across the country and have placed those there. The second thing that we've done is we've worked where some of our customers actually have trailer pools and we've signed trailer pool agreements that allow other carriers to be able to haul those. And then the third is we're actually working with some carriers who are wanting to drop in trailers there. So there's 3 ways that you can look at the overall drop trailer business. And again for us in the brokerage industry, when I started in this 16 years ago, it was not something that brokers did and I think it's something that you'll see brokers continue to invest in as far as the trailer pool and will be a big reason for outperformance in the future.

Yes. I don't know if you'll entertain me on this, but I am curious just on the margin profile of that business. There is an incremental cost associated with it, right? You mentioned you have to lease the trailers or own the trailers. So how does that compare versus the rest of RXO? Is that a part of the book that's maybe growing quick or not as quick? I'm just trying to kind of understand sort of the evolution of the company over the next couple of years.

Is it growing as quick from a volume perspective? From a volume perspective, it is growing just as quick. And again once you go into these large customers; Fortune 100, Fortune 500 customers; we do business with 58 of the Fortune 100 and over 200 of the Fortune 500 and for these customers, the first thing you have to be able to do is go in there and prove yourself. Once you proved yourself, you can go in there and you can create solutions like drop trailer and it allows you to go in and take share and do it at scale with the capacity that you're able to offer. It's a little bit different than what asset-based carriers are able to offer because as a broker, I've got access to 100, 000 and 1.5 million trucks whereas if you're an asset-based carrier, you're limited to what you have in that area for that specific day that they're shipping. And so we've got more capacity to be able to bring from there.

Got it. Can we talk a little bit about the current environment. So you just reported earnings, I don't think you guys gave a full guide, but you did talk about maybe 1Q expectations. Could you maybe level set that for everybody and sort of what you're seeing out in the truckload market today?

So we just reported Q4 earnings, a very strong quarter and you're correct in terms of we gave commentary with respect to Q1. So if you take a step back, similar to what Drew said, we grew volumes in Q4 by 4% year-on-year. The only publicly traded broker to grow volumes in Q4. Heading into Q1, we gave commentary that the volume growth in the month of January was at a greater rate than that of Q4 and we also expect volume growth for the entire March quarter. So I think this goes back to the point that we were talking about earlier. We continue to gain share. We were accelerating our share gains during the downturn and it really does speak to the deep customer relationships that we have. As Drew mentioned, some of our top customers have with us for 17 years, Think about some of the dynamics that are occurring in the current environment with respect to -- rewind 2 to 3 years ago with respect to thinking about the number of our -- when you look at our customers, the number of carriers and brokers that they added during the height of COVID were significant, right? They needed a lot of access to supply. And now you're in a more challenging macro and what's going on right now and we're seeing this in a lot of the bids that we're participating in. Those brokerages and carriers, they're getting consolidated at a very aggressive rate to the tune of 60%, 70% and above. And what does that mean? It means that from RXO's standpoint not only are we making that cut, but in many cases we're actually gaining share on the other side. So even though the overall pie is shrinking, RXO's percentage of that pie is increasing and what are we doing? We talk a lot about having a playbook for many different parts of the cycle. Right now we're positioning the company for when the cycle inflects. We doubled our EBITDA over the last few years from $150 million to over $300 million and we're going to do it again as we achieve our 2027 targets.

That's helpful. The other thing that I'm trying to better understand is how you guys maybe think about contractual and spot pricing through the year? And maybe if you could maybe talk about both of those expectations and how you think it will impact your gross margins just through the year directionally? I'm not necessarily asking for guidance. I'm just trying to understand what would happen if spot rates say bottom and reaccelerate?

Yes. So take a look at where we are in the cycle and just step back. If you go back into 2021, you saw what was an overall tight environment. At that point in time, we were in the low 60%s as a percentage of contract versus spot. As 2022 came, you saw the market loosen a lot so what we did there was we held on to our contractual pricing, we pulled down our purchase trend. So at that point, our contractual pricing gross profit per load was higher than what the spot gross profit per load was. And by the end of the year, you saw that 75% of our business was contract. It speaks to the strength that we've got with our relationship with our customers. They don't just view us as another broker. They view us as a strategic partner that they're doing business with. We said for Q1 you could see some moderation in gross profit per load and again in Q2 as you look to when it would inflect. So what you would see at that point was you would see contract gross profit per load would come down because customer pricing is coming down during this part of the cycle. And as you go into the back half of the year and you start to see that pick up for what you're talking about, you would start to see more spot and at that point, the spot gross profit volume percentage would increase because asset-based carriers and smaller brokers would start to reject tenders. And so we flipped our volume mix as much as 1,000 basis points in the quarter so you could see us head back down into the mid to low 60%s based off of what's going on in the market. And at that point, the spot gross profit per load would start to outweigh what the contract gross profit per load is.

Well, and so this is an interesting point. I guess I'm trying to understand your contractual and spot exposure can vary quite a bit quarter-to-quarter. Are there internal parameters that you all set for how you manage the contract spot? What's the most contract? What's the most spot you would ever go to in any given quarter or year?

It really varies off of what's going on in the market. It could get down into the low 60%s if the market is tight from a contractual standpoint. And then if the market is loose, you could see it getting to the mid upper 70%s.

Okay. And 1 of the things I'm asking all my companies here is there's this idea of capacity coming out of the truckload market just by virtue of where spot rates are, right? Spot rates arguably are sort of bouncing along maybe the cost to operate a truck. And I guess my question is twofold for you all. Number one, have you seen capacity come out of the market? And if so, what are kind of the indicators that you're looking at for that?

One of the things that we look at is the number of carriers that are coming on to RXO Connect. And if you look in the second and the third quarter of last year, we added 10,000 carriers to RXO Connect in each of those quarters. We added again in the fourth quarter. So we haven't seen capacity come out of the market. If that does happen because I think where you're doing with this is people bought trucks at a high point in the market and so at that point, they could get underwater with what some of the payments are. If capacity comes out of the market, that's not a bad thing for us. That creates a shift in mix at that point because you'll see capacity tighten, which will create more opportunity for us on the spot board where people are turning down.

Well, so I want to be crystal clear, but you're saying your active carriers have actually not gone down. And so do you think that's a function of carriers coming to your platform because you have that book of freight? I guess what I'm trying to understand is what about the other guys in the market that maybe are not hauling for RXO today?

Yes. So it's absolutely because of the technology that we built for the carriers that make them easy to do business with, the amount of volume that we've got out there and then RXO Extra is a differentiator for us with how we do business on the carrier side. At this point when you look at the external, we have not seen capacity come out of the market but it's something that we're monitoring closely and could see later in this year.

In Q4 our registered carriers on RXO Connect were actually up 42% year-on-year and you think about the 7-day retention rate that we have with our carriers, it's in excess of 70% and that goes exactly to the reason that you were just highlighting why the carriers come back to RXO for many reasons. Certainly a top priority is going to be because they know they're going to have access to freight, right? RXO is the fastest growing brokerage. We have access to that freight. And not only do they come back to us because they know they're going to have access to the freight, but they're also then incentivized by the robust carrier rewards program that we have. Think about it almost equivalent to an airline's frequent flier program where the more you haul with us, the more you're going to get rewarded and then that in return facilitates the flywheel effect where similar to what Drew was talking about. We deal with the largest shippers in North America across the Fortune 100 and the Fortune 500 and when we are providing that excellent service with our carriers, they're going to be incentivized to then go ahead and give us more freight effectively facilitating the flywheel.

And just one other thing to add to that. The majority of our carriers own 1 to 5 trucks so they're small carriers. Our customer base and our technology platform, we give that carrier access to a customer that they otherwise could not get access to. So a carrier that's got 1 truck, 2 trucks having access to a Fortune 100 company, our technology allows that interchange to happen. And therefore, our carriers are very loyal to us because they know they're going to get freight that they otherwise couldn't get.

Yes. And maybe the last part of this line of questioning is Drew, Jared, you guys both mentioned the reward system and I think it's an important topic to hit on. Could you maybe take a step back and explain how it works internally? If I'm a carrier for RXO, how does the reward system work and why does it keep me in your network?

Yes. So I mean when we surveyed our carriers, we asked them what was the most important thing to them as they were moving up and down the road. Obviously fuel prices is one, roadside maintenance if they were to break down, even as far as headsets that they wearing, TVs that are going into the sleeper cab. All of these things that they're using, we wanted to look at it and say what can we do to make it to where they're spending less time focused on where they're going to buy fuel at. You can pick up our app and you can actually see where the cheapest fuel is going down the road. So for us, it was really just about creating something that made their life easier, but it does pull them back to us because they get the discounts based off of service. They have to give us great service. Our large customers expect phenomenal service and we give them that. And then the second piece is the volume. We want to continue to pull them back. If they're a good carrier, we want them to come back to the system. So we base the discounts off of volume and service.

Got it. I think we only have 5 minutes left, but I want to make sure I ask about Last Mile because frankly, that was probably the most surprising thing to me out of 4Q, was I think you grew at 10%. Can we maybe talk about what drove that? Can you talk about maybe price versus volume of that? And then I would have thought a lot of that end market exposure would be retail-centric. Maybe talk to us about that. Are you gaining share? Sort of what's going on within that 10% number?

Again we're the largest last mile provider so if you're doing something upscale, you want to start your conversation with us. What we saw in the fourth quarter was we saw a nice uptick from appliances that are going into people's homes so think washer dryer, refrigerator, dishwasher, things of that nature. We saw the fitness equipment. So if you think about the commercials that you saw throughout the fourth quarter, we were a big part of that being able to be delivered into somebody's home. And then electronics was the third one. So if you think of on the electronics side, whether it's big TVs that are going into people's houses or something like that. Were all 3 areas that we saw an uptick on in the fourth quarter.

Interesting. Could we talk about gross margins? What I'm trying to understand is there's obviously a cyclical component to gross margins. We talked about contract versus spot and that certainly matters. I guess what I'm trying to understand is your gross margins are quite a bit ahead of some of your publicly traded peers. How sustainable is that? How wide of a range should we think about gross margins through a cycle? If you could just maybe expand on that, I think that would be helpful.

Yes. So if you look at why we're outperforming on the gross profit percentage line, it's because of our investment into technology. And we focused on one, we've got a lot of data. You've got $3 billion coming in from our truck brokerage group. With our maintenance transportation group, we've got $4 billion of freight under management. So having access to all of that data helps us understand on the pricing side. When we built out the pricing piece, we focused on technology and pricing algorithms, but we also focused on having operational expertise in understanding and knowing how to operate in every part of the cycle. So when we built it out, we had somebody who is extremely bright, has written multiple books on pricing algorithms and we partnered them with a 20-year brokerage industry veteran that has known and seen every part of the cycle. So for us what you see is our pricing algorithm is something that's always moving. So specifically on the carrier side, you see that typically we're moving faster when the market is swinging; whether it's coming up or going down, we're moving faster than anybody else in the marketplace.

So you mentioned technology as a part of this answer and you guys have talked about digitization, number of digital loads. Can you explain to us first of all how do you define a digital load? And then if I were to look at a digital load on an EBIT level not gross margin level, how does that compare to a live load?

Yes. So I'll take the first part and then Jamie can come in on the second part. We define digitalization whether it is created or covered. So on the created side that's the customer side, it's that part fully automated. And the coverage side obviously would be the carrier side. 87% of our orders were created or covered digitally in the fourth quarter and we said that we expect that number to grow in Q1 as it's grown over the last several years. So for us, it's important to break it up because there are 2 sides to the order of the customer side and the carrier side so we look at it as created or covered. We've made a lot of progress of integration within our customers. And with our carriers, Jamie talk about us dealing mostly with smaller carriers. We still have a good runway ahead of us to gain adoption on the carrier side.

Yes. To add to that, in terms of the margin or what's more profitable, we do a digital load or not with every customer. And so to Drew's point, the carrier side, less adoption electronically just because of the nature of the clientele we're working with. That being said, it clearly will be more profitable on an individual transaction if it was completely digital. That being said, 1 of the tenets of RXO is our customer service. When you're shipping goods for those who follow shippers, there's a lot going on in the shipment of Point A to Point B. Is the dock -- is the trailer on time? Is the dock clear? Is there traffic jams? So it takes human interaction to continue to get that load processed and so we look at it on a blended basis. We don't look at it individual transactions, more of a portfolio solution. But the digital is a very efficient way to do it. But customer service will always be part of the solution and we believe we're the best at that.

I think we have a couple of seconds left. I'm going to squeeze 1 last one in here, Jamie, if you don't mind. But I wanted to ask you about your cost structure. You obviously have some incremental public cost on the company. Maybe walk us through how you feel about that today? How much do costs have to flex up as volumes continue to grow?

Yes. So we are a new public company. We put in our Form 10 that we would have incremental cost from being a stand-alone public company. We called out about $45 million annual basis of incremental cost. We're highly variable. We said 87% of our cost structure, including the cost of purchase transit is variable. If you were to take away the cost of purchase transit, the variability percentage goes down obviously. That being said, we focus very hard, as Drew said, for the technology spend to be to provide a shipper a better solution, the carrier a better solution; but as also part of the technology spend that's helping our employees be more efficient in the work they do for customer service to be able to book a shipment or to procure a carrier. We're doing a lot of work right now as a company to optimize our cost structure. We believe that that's a continuous improvement every day. We think there's a lot of opportunities to re-engineer constantly the back office or the enablement functions and we think we'll get some gains out of that over time.

I think we're out of time. People want to get in. So I appreciate it.