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

Hello, everyone. Welcome back. Good afternoon. My name is Allison Poliniak. I am the senior analyst here at Wells Fargo, following Industrial Technology and Transportation. Delighted to have RXO for the first time at the conference this year, Drew Wilkerson, the company's CEO; and Kevin Sterling in the Finance Department. Drew, since it's sort of the first time out and maybe people aren't familiar with RXO, maybe just talk a little bit about what you guys do.

Yes. So RXO spun off from XPO Logistics in November of last year. We're a leading asset-light transportation company. We're made up of 4 lines of business. Our crown jewel of the business is our brokerage business. And when you look at the brokerage business, it's a great business to be in. So from 2013 through 2021, you saw the brokerage industry grow at a 9% CAGR. During that same time period, our brokerage grew at a 27% CAGR. And we were able to do so because we've got the best technology in the industry. We've got very deep and strong relationships with our customers, and we got good continuity among the leaders from the brokers team. The 3 complementary lines of business that we have supporting brokerage, the one with the most synergies is our Managed Transportation business. So for Managed Transportation, think of a customer who would come in and outsource all of their transportation to us, and we would act as their transportation department. And the reason that the synergies are so strong between truck brokerage and managed transportation is because brokerage gets to be a carrier for managed transportation from a synergy perspective. The other 2 lines of business are freight forwarding and Last Mile. And freight forwarding is a good business. It's a smaller business for us. It's roughly 7%, 8% of our overall revenue, but it does help give us visibility into what's going to be hitting the domestic U.S. market from Asia as well as Europe. Over the last couple of years, we've worked to build our freight boarding team out with domestic services that are really complementary to brokers. So if you think of transloading at the port, if you think of customs brokerage for border crossing, if you think of cross stock warehousing, those are all things that are done in our freight boarding. This is not a typical freight forwarding, but it is something that we were able to build out as a niche. And that now represents about half of their profits overall in freight forwarding as domestic services that really help tie in to brokerage volume. And then the last one is Last Mile. And we're the leading provider of big and bulky goods that are going into a home, so think washer and dryer, refrigerator, stove, fitness equipment, furniture. When you look at that, we've been the leader over the last decade, and we've got facilities that put us within 125 miles of 90% of the U.S. population. So one thing that we knew is that end consumers wanted the product and they wanted it faster. And so for our large customers, and you're talking about some of the largest retail and e-commerce customers in the country, we're their last brand representation that they have with their end consumer. Because of that, we get a lot of access to the C-suite within that. And we're not only able to talk about Last Mile, we're able to talk about our other lines of business, specifically truck brokerage, which has helped us drive volume growth, profitable volume growth in brokerage.

No, that's great. And as the key theme, as you can -- you're well aware of what's going on in the cycle? Are we done? Are we bottomed? Are we inflecting? Are we going down more?

So I mean, obviously, you saw 2020 and 2021 was an up cycle. And throughout that, we didn't call the peak of the cycle. So we're not going to be the ones who are up here and going to call the bottom of the cycle. But when you look at what we've seen, we talked about, on our first quarter earnings call, that we have seen capacity start to exit the market externally that we're looking at, but also even within our own system. And so for you to start to have not just the bottom, but the market inflection standpoint, 2 things have to happen or 1 of 2 things has to happen. Either enough capacity has to exit the market where it's going to increase the supply and demand or demand has to increase. So we have started to see signs of capacity exiting the market. For us, looking at any type of market on inflection, we're monitoring what is load-to-truck ratio, what is tender rejections, the amount of carriers that are entering or exiting the market, and then we're listening to what our customers tell us. As we did the first earnings call, load-to-truck ratio was at roughly 2:1. I've been in the brokerage business for 17 years now. And while I've seen it go below 2:1, I haven't seen it do that for a sustained amount of time. So feel good with where we are. We've even seen it creep up a little bit to 3 to 1 now.

And Allison, if you think about where spot rates are today, they're down 30%, 40% on a year-over-year basis and carrier operating costs, I think some of the costs are dealing with some inflationary pressures, whether it's tires, maintenance, their costs now -- many of the smaller carriers, their costs are above where spot rates are. So that's a dynamic that's not sustainable. So it kind of helped lead to this capacity exodus at some point.

So it could be almost a capacity reset and then you have to see more stabilization there versus the demand. And then even with managed transportation, you're obviously close to your customers. I mean how are they feeling? Are they getting any confidence that maybe -- or bottoming here?

Well, it depends on the vertical, right? Like so every vertical and every customer has their own story. And for us, the technology vertical, the health care vertical, automotive, in the first quarter, all performed extremely well for us. In the automotive, you think about the plants that are coming up and down, even going back to when we had the chip crisis. And as you saw that, that actually created more expedited moves, which made it for a stronger trucking environment for us within those. Retail and e-commerce is one where we have seen volume is still down on a year-over-year basis. But if you think of where it was down in Q4, it was down high single digits, low double digits for us. And in Q4 -- in Q1, it was down low to mid-single digits. So it started to decelerate. What we've heard from our retail and e-commerce customers, the conversation really shifted 3 or 4 months ago, where it was less about destocking, and it was more about restocking. Now for these customers, it's going to come down to is the demand there so that they are able to fulfill the orders from the restocking.

Got it. Got it. And along -- I would say along with that, using volume growth, you touched on it. Unusual in this environment where things seem to be down pretty significantly. Could you walk through the competitive dynamics there? What's driving that growth for you?

Yes. So when you look at what we did in the first quarter, we grew volume by 6%, which we're really proud of, because as we talked about growing 3x faster than what the brokers industry was growing from 2013 through 2021 and 2022 in the beginning in sort of the first quarter of 2023, you've actually seen our market share gains accelerate. And we've been able to do that at the best margins in the industry. And it really comes down to the fact that we've got great relationships with our customers. Our top customers have been with us for 16 years on average. So this isn't something where we're going in and we're selling a new solution to them. They understand the solutions that we've created for them. We've got a good history for them. And they're not just coming back to us and awarding us the freight that we had in the prior year. They're actually coming back to us and awarding us new freight. In the first quarter, our top 20 customers, their volume was down as a whole, but we grew volume with them by 13% on a year-over-year basis. You saw customers consolidate the number of carriers that they were working with. And we were one of the large winners through that in the market. And you'll see that hopefully play out for the rest of the year. And as you look at that, you set yourself in a great position for when the market inflects. And when the market inflects we're still going to have a strong base of contractual business, but then we're also going to have the spot loads that will increase. So you think of tender rejection starting to rise when the markets inflect. So whether it's asset-based carriers, putting their asset on the most profitable load, whether it's smaller brokers who start to have tender rejection on their contract freight, all of that is a tailwind for us at market inflection.

Great. And obviously, a lot -- it was a great market, a lot of new entrants into it. I mean we've heard of Uber Freight and Convoy.

I don't think they're new entrants anymore. They've been around for a decade.

Yes, they've been around awhile. We heard about them. What is your view in terms of those competitive dynamics? What have you done that you think has done better than what they were capable of doing?

We've invested in technology from day 1, and this was at XPO. And when you look at how we built the technology, we build it for customers. We build it for carriers and we build it for employees. And for every piece of technology that we roll out, it's very simple what we focus on. Is this going to help us increase volume? Is this going to help us increase margin? And is this going to help us increase our loads per day per head? So for us, it was never about building the flashiest technology. It was about building technology that actually helps us make money. And to me, we've done that better than anybody else in the industry at this point.

Now it is interesting because some of them tend to use DAT, right, as the backbone of their pricing system. You guys built your own. Can you talk about the competitive dynamics around like what benefit does that give you? And why didn't you use DAT?

Well, we do. We use external stuff, but the core foundation of what we've built is our internal data. And so when you look at this, we've got access to a lot of data. Our truck brokerage is roughly $3 billion in revenue on an annual basis. Our Managed Transportation team has roughly $4 billion of freight under management. And then you look at the other parts of the business, there's another $1 billion. So there's around $8 billion that we've got that is running through our system on an annual basis. And then we've got all the stuff that we haven't won in the prior. So looking at what we've won at and what we've lost at is a key dynamic for us. And for us, we've been able to build a pricing algorithm that moves faster than anybody else in the market. And that's why when you look at our gross profit percentage on a quarterly basis, we typically have the best margins in the industry. And for that, it was never technology or operations for us. It was always both of those going hand in hand. We never claim to be solely a technology company. We claim to be great operators who had the best technology out there. And so I'll give you an example. On our pricing side as far as how that business is run, we've got a gentleman who's written books on pricing algorithms, he disrupted hotel pricing industry. But we didn't just stop with him. Like we partnered in with somebody who's been in the brokerage industry and has known and seen every market over the last 20 years. So it was the best of both worlds for us.

And with that, is technology -- and we're industrial, I'm industrial, right? We don't move that quickly. But others do. Like how do you protect that and continue to keep that edge over others?

So for every load that goes into our system, our competitive moat gets wider. To create what we create, there's only a handful of people who have the same amount or more data than what we've got. So one, it takes a lot of data to be able to build what we've got. The second thing that you have to have, which I think we are a long way ahead on this, is you have to know how to operate the data to be able to create solutions. And that's where you're seeing that in real time on the carrier side, our pricing moves extremely fast. So if you go back to 2022, you saw that was when the market started to fall was in 2022. And so what you saw was we had contractual pricing with our customers. But in Q2 of last year, the reasons our margins were the best in the industry because we pulled down purchase transportation faster than anybody else. And then as the market inflects, we typically hold on to the price longer at the purchase transportation before it's rising to catch up.

And we've had a lot of talk about managing the down cycle, a lot of focus on capturing that share as you move up. Your cash share gains are on the bottom. Is that share sustainable? Do you lose some of that? Or do those market share gains start to even accelerate from here?

I think that we're in the early innings of taking share. So I go back to -- I was at XPO for almost 11 years. And in my early days, I walked in and I was selling myself a lot, right? Like I didn't have the product behind me at that point. I didn't have the history with the customers of the relationships of what we have now. Now I can walk in the customers with real solutions that we've created for them, for one of their competitors. So for us, this is a huge marketplace. It's a $400 billion for hire trucking market. Our truck brokers is just $3 billion. So like whenever I look at it, I don't have a lot of excuses, no matter what the market is, to not grow volume.

No, that's fair. And can we talk about sort of the operations themselves, already great margins, right? Can you talk through maybe more decrementals first, just given the environment? Is that a concern or the incremental? How do we manage that business during this year?

Yes, listen, it's a good question. So as you think about the market, your contract rates have been falling, call it, roughly 10%, 15%. Spot rates have fallen much more. But at some point, there will be an inflection, right? Spot rates will tick back up. So we're not -- we're going to honor our contracts and there'll be a little bit of a squeeze on that contract. But what we're going to do is quickly lean into the spot market, pick up that spot market freight. So our contractual business, it's not going to change. In Q1, we're 77% contract, 23% spot. So we're going to honor those contracts, but we're going to lean heavily into the spot market with existing customers, new customers and that spot market freight will be very lucrative and help offset that compression. So while you may see some sequential degradation from Q1 to Q2 in the gross margin, but when the inflection happens, we're going heavily into the spot market. And that spot market freight will help offset some of that degradation in the margin.

The increment will be longer coming out...

That's correct. When the inflections happen, it typically happens pretty fast. And customers are going to go to -- on the spot loads for who they trust the most. And that's where you've seen on a quarter-over-quarter, we've actually shifted our spot-to-contract ratio by over 1,000 basis points quarter-over-quarter. And that's because we're the first place to go on the spot. It's not because we hold less contractual loads. It's just because as tender rejections go up, they're going to go to who they trust the most first.

And it's interesting when we went to tour your facility. Could you talk to maybe the productivity benefits that the technology is giving you versus the guy just answering the phone versus now sort of at the opportune...

Well, I mean I think back when I started and I had 3 phones on my desk. It's a lot different in today's brokerage world. And it took me 10, 12 minutes just build a load. And I mean you saw it while you're on our brokerage floor. It takes less than 10 seconds for our brokers to be able to build a load. And so for us, we monitor the loads per day, per head. And when you look at what we were able to do is 2021 ended and you look back over the last 5 years, we grew volume 3x faster than what we grew head count. So that's our technology paying all for us to where the people on the floor who have the relationships with the customers, they're able to do more. And at that point, they can shift their focus from a mundane task of building loads to where they can focus on the relationship. They can focus on solutions. They can focus on what the overall procurement is buying it. They've got to accept some management. But it becomes less as whenever I started building a load for 10, 12 minutes, and I told somebody earlier today, I wasn't the dumbest person out, like I could build a load fairly fast for what was going on in the system at that point in time.

And Allison, we don't use technology to replace people. We use it to enhance our people, help our people get more productive. And 10 years ago, we had reps maybe doing 8 to 10 loads a day. 10 to 12 minutes to build a load, he was fast. But now some -- same rep may be doing 80 loads a day, just get more efficient with the technology. So it just enhances our people to just become so much more productive to do more.

One of the simple things that we look at is how many clicks on the mouse do they have and how many keystrokes. Because we wanted as few key strokes and as few clicks of mouse as possible.

So to your point, right, you're saying you're enhancing the employees with technology. I think when we think digital, we think that people are going away, right? So there's never that kind of scenario where there's no people in brokerage.

Yes. It's -- I think I think Wall Street wants to put you into a broker to bucket either digital or traditional. And I like to tell people we're the best of both worlds. We were doing digital before it's cool to do digital. That's how Brad built the business, how we built the business. And going back to your point about using DAT, early on in the early years, we did rely on public load board data. That wasn't the most perfect pricing information. Now as we've gotten bigger and better, more pricing, our pricing information is so much better. Now we started on brokerage business, we didn't rely on outside data sources. Drew would be eating lunch because his pricing, his internal pricing is just so much better than what we would have. That's a huge competitive advantage. But our people, we just try to arm them with the digital capabilities just to be better, but it's still a people business. We have customers tell us all the time, "You're the only ones that come see us." It's still kind of that old school way, but it's -- I think you've got to be the best of both worlds. I think that's what we've created here.

Relationships matter a lot still, and we've created layers of relationships. When you look at what we build our business on, we build it on the largest companies in the country. We do business with 58 of the Fortune 100 and over 200 of the Fortune 500. And it's creating to where it's not one to throw, it's the layers of relationship across the organization that extends to the executive level so that you're able to create partnership and solutions over time.

And you don't own the carriers, right? But you talk about the reliability being very important. What are you doing to sort of more attract but also retain and keep the incentives there for those carriers?

We definitely don't own the carriers. They are independent owner operators and 49% of our carriers have 1 truck. So when you look at who we do business with, we do business with these large customers and a lot of small carriers. So we become an aggregator of capacity to bring a lot of capacity to our customers. What we do to keep the carriers is, one, they don't have to leave the system to find their next load. They can pick up their cell phone, they can book a load and negotiate, do all of that with no human interaction, manage their own internal load board off of our RXO Connect platform. And then we've also created a rewards program for carriers, and it gives them discounts on things that matter the most in a trucker's life. So whether it is fuel, whether it's tires, roadside maintenance, hotels, Sirius radio, anything that a trucker is using on a day-to-day basis, we've created a discount program. And we based the discount off of the service that they provide to us. So how good are they on on-time pickup, on-time delivery? What's the status of being able to track them without having to do check calls? How often do they fall off of loads? And then the second thing that we base it off of is how much volume they do with us. So the more they're coming back to the platform the stronger their discount can be.

Got it. And one of the terms that's often used in here is load digital book, right? Can you maybe define, I guess, first off here, how you're defining it?

Yes. So the way that we've defined it is whether a load is created or covered digitally. So created means it's from the customer side and covered means it is from the carrier side. We have seen that number go through the roof. If you go back a couple of years ago, it was in the 70s percent was created or covered digitally. Last quarter, we were at 96% was created or covered digitally. We haven't broken it out yet from a public standpoint of what it is from the customer and the carrier. I can tell you on the customer, we have a lot of integration there, and there's not as much white space on the customer because of who we're doing business with. It's easy to integrate with large companies who have invested in technology. On the carrier side, we still have a lot of white space and a good opportunity to be able to increase that number over the next several years.

Great. And another question we get often times is really around margin. Like what's the appropriate margin for this business in a normalized operating environment? That's number one.

Yes. Are we talking about EBITDA margin?

EBITDA margins, yes.

Yes, typically mid-single digits.

Okay. That's pretty sustainable. And a little bit higher?

We have, right? So as time goes on, you've seen our brokerage business operate in mid- to high single digits. And during good times, you've seen them touch double digits.

And let's maybe touch on a few of the other businesses. You mentioned Last Mile, right, heavily consumer-oriented. Why is this a good business, and highly fragmented, is this scenario for you guys to continue to expand into?

Yes. So I mentioned earlier, one of the reasons why it's such a good business is because it gets us access to people that we wouldn't have access to if we were just calling on them from a brokerage standpoint. From a brokerage standpoint, you'd be calling on a Transportation Manager, Transportation Director. But when you're calling on them in Last Mile and you're representing their brand, going into some house, you're talking to a CEO, a Chief Supply Chain Officer or Chief Financial Officer, and then you're able to talk about other things from there. And these are huge companies. So there's a lot of freight to be had there. So that would be the first thing that I would tell you. And then the second thing that I'd tell you is it's a good market, and we've been the leader in it. So if you look at, overall, Last Mile is around $13 billion, $14 billion market, and we've got over $1 billion in that and continuing to grow. If you go back to pre-COVID, we were doing 9 million home deliveries a year. In COVID, it got up into 10 million and even last year, it got up to 11 million. It will probably take a slight step back this year, but it will take a slight step back to continue to build. For that, that is one business that we have said publicly that we've got the opportunity to improve our margins. And I think that you'll start to see that this year in 2023, where we said we would actually grow Last Mile's EBITDA in 2023 versus 2022.

Can we expand a little bit more on Managed Transportation as well? I feel like it's not a well-understood business in terms of you talked about the benefit for you, but can you explain a little bit more what that business is?

Yes. So just think of a customer who uses us as their transportation department, they wouldn't have a transportation department at that point. They use us and they outsource their transportation to us or they outsource a piece of the transportation, maybe as their expedite, maybe as their outbound, maybe as their inbound. And so that's a good business because it is long, sticky relationships. Average customer relationship is 5 to 7 years, is low turnover. We hold on to 98%, 99% of our customers in Managed Transportation. So long, sticky relationships that you're going to have for a long time that you're able to provide synergy loads as a customer to your brokerage line of business. So it's a great business, one that we love and one that we see growing over the next 5 years. And if we were to ever look at M&A, Managed Trans will be one of the places that we would because as you bring on a Managed Transportation customer, you're essentially creating organic growth within your brokerage world. Because a new Managed Trans customer means it's a new customer for brokers at that point.

Interesting. And so what does that pipeline look like today in terms of those Managed Transportation opportunities? Have they slowed as things have slowed in general? Or are the companies still looking to outsource?

Managed Trans, you see customers really go out in the bid during 2 times. One, if the market is starting to go up, they're trying to protect themselves from cost rising and they want to look at who can procure transportation better than they can, or if the market is starting to fall, then they start to look there as well. And so obviously, right now, our pipeline is extremely large. I think we've said this publicly, but like we've brought on a new customer in this quarter, it's roughly $200 million of freight under management. That customer is going to touch all of our lines of business. It's got Last Mile. It has freight forwarding. It's got over-the-road transportation, which will impact our brokers. So we've got a strong pipeline. And if you look over the next several years, that is going to be one of the business that helps drive organic growth in brokerage and creates long, sticky relationships in Managed Transportation.

Is there a way to think -- I don't know, an algorithm or multiple, like you bring that, say, $200 million into Managed Transportation, what's the multiple of growth of that, that you typically think you would see like into the brokerage and something...

We haven't put that out there. And so I don't want to put that one out there yet.

That's fair. That's fair.

A good question. It is important. It's something we measure.

We're trying. So certainly, you built a strong foundation, a platform in brokerage. What other areas of technology do you think need to be invested in? Is there something in Managed Transportation that's not done well that can be simplified? How do you think about technology investment over time?

The base of our system is built. So like the bulk of the CapEx to build RXO Connect is behind us. As you look at what we're going to do forward is continuing to stay fresh and keep the system updated, whether it's pricing algorithms, whether it's customer integrations, whether it's things that make it easier for the carriers to use on the app. One of the things that we did last year was, for the carrier side, we asked them what their favorite restaurant was. And so you'd be surprised to hear their favorite restaurant is Subway. And you think about a lot of gas stations have a Subway in them. And so for that, what we did was we actually tagged where all the subways were and drive RXO so they could see where their next meal is going to come from, where the cheapest gas is going to come from. So we're always doing updates to the system, but we don't have to rebuild the system again.

Got it. And certainly, a couple of months out of XPO at this point, can you talk about the benefits being a stand-alone company for you guys?

Well, I mean, personally, for me, the benefit is I got a lot of benefit from being around a lot of great leaders at XPO. And when you look at how Brad Jacobs built his organization, the top leaders know everything that's going on throughout the company. So if there's something going on in LTL, I was involved, if there's a monthly operating review for LTL, I was in it. For European transportation, I was in their monthly operating reviews. And at times, I even led their monthly operating reviews, just so that we could try to capitalize on synergies and learn best practices from one another. Now for me and for my management team, that's a lot of that impacted as well. 100% of our time is focused on RXO and the growth of RXO. So I'd say that we're more focused and more fit for purpose. And while we have a great ROIC at 42%, when you look at what we've got for return on invested capital, there's less red tape to go through now as a stand-alone company than what we had as a 5 business-unit company.

And then cash flow, obviously, can be strong in this type of business. Maybe walk through the dynamics there. You did talk a little bit about M&A. How important is that to you today?

Well, so first, we put out a guide for 2027 that our EBITDA is going to be somewhere between $475 million and $525 million. To do that, we assume 0 M&A to be able to hit that target. So it's largely an organic growth story. When you look at what we've done over the last 6 years, 100% of our growth has been organic. Over the last decade, 90% of our growth has been organic. So as you start to look out towards 2027 and you look at free cash flow generation, if we hit the midpoint of that target and you hit $500 million, then you're talking about a company that has generated roughly half of its market cap at that point in free cash flow.

And Allison, the way to think about it from an EBITDA perspective, EBITDA free cash flow can range depending on where we are on the cycle from 40% to 60%, okay? So obviously, at this part of the cycle, it's closer to 60%. When the cycle inflects higher, it will be closer to 40%, but our EBITDA will be much greater. But that's -- it's a great asset-light story because the EBITDA free cash flow conversion of 40%, 60% is very healthy.

Yes. So generating all this cash, M&A is sort of there, but not necessary. What do you do with the cash?

Well, we've got an authorization for share buybacks for $125 million. And the way that I would say that we're going to look at the cash in general is we're going to be opportunistic with how we're going to spend it. So whether it's share buybacks, whether it's M&A that fits within our culture and there's going to -- something that fits within the platform as well, the technology investments, we look at that 42% of ROIC hurdle and what is going to be the best use of cash at that point. So we've got a lot of optionality where we can be opportunistic.

Got it. And when you're thinking about the technology, it's low investment today, the foundation is there. Is there a way to think about it? Like would there be a CapEx bubble ever if needed or not really?

I don't want to say ever, but it's not any time soon.

Not any time soon. Great. I think we're actually running out of time. So any sort of last comments or color you want to leave with us?

Yes. We've talked about what we've done over the last decade and how we built a business to become one of the leading non-asset-based providers. But I am more confident about the next decade than what I was on the past. So we think our best days are ahead of us. Excited. I've said on our fourth quarter earnings call that this is my favorite part of the cycle -- and I caught a little bit of fly -- part of the earnings cycle. And it's not necessarily because of what the numbers are today. It's because of the base that we're able to build that it puts us in the best position for when the market inflects, we're going to go on a really good run. And if you think of the last time the market inflected, it was in 2020, 2021, we're growing volumes by 20% and 30%, and with the best margins in the industry. So again, I think our best days are ahead of us.

Great. Well, thank you.

Thank you.

Thank you.