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

Okay, welcome back to the 2024 Industrial Select Conference. We are pleased to have with us RXO Inc. [ We welcome, Drew Wilkerson, Chief Executive Officer and Jared Weisfeld ], Chief Strategy Officer. This is their second time here at the conference, so we're pleased that they were able to come back. We'll get to some intros and opening remarks from them here in a second, but if you could just open by going up to the first audience response question. I'm sure everybody has seen that there should be a little device in front of you.

You can answer the first question here, which is do you currently own RXO stock? I think everybody is an XPO shareholder [indiscernible].

One for one.

All right, so some potential converts here. Next question. What is your general bias towards the stock right now? Positive, negative or neutral? Remember last year, the results were pretty positive. And tumultuous here a little bit, a lot of going on in the market than we will cover here. So still pretty positive. So overall, not too bad? Last question for us. Number three, your opinion, [ through-cycle ] EPS growth for RXO will be above peers, in line with peers or below peers? Okay. All right. So again, we have some potential converts for you. So Drew again, like I said, a lot has gone on in the market in the last year when you guys went out. There was definitely a real story to be told in terms of volume growth and a lot of earnings that you've been able to show. Has anything changed to change your outlook with what's going on in the market over the past year?

Yes. So I think when you look at what's going on in the market, the market has been down for longer than what, I think, most have expected. And when you look at that in the balance sheet that carriers built up through the strong rates of 2020, strong rates of 2021 and the beginning parts of 2022, you combine that with low interest rates on trucks and trailers, you add into COVID relief funds, it's easy to see how the market has been able to sustain longer with less capacity, and I think what everybody anticipated. When you look at what our outlook is right now, throughout all of 2023, you saw capacity rates accelerate. As you got into June, capacity rates were 30% above 2023's average. So for us, right now, when you look at capacity coming out of the market and where the overall macro economy is, if it remains stable, our base case right now is for a market recovery to start in the second half of the year.

I'm going to just follow that up real quickly. During this presentation, we may make certain forward-looking statements within the meaning of federal securities laws, which by their nature, involve 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 contained in the company's SEC filings as well as the earnings release, you should refer to a copy of the company's earnings release in the Investor Relations section of the 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. Ground breaking news there. Sorry about that, but thank you.

Like [ David ] said, though, it has been a lot of up and downs for brokerage. What have worked? Because we've actually seen some of these businesses exit now, some of your competitors -- could be a completely digital solution. How does RXO fit into the future of the brokerage landscape?

I think, one, that's never been our take, right? Like when you look at how we built the business from the ground up, what we aim to do and what we've done over the last decade is we've combined great operators with some of the best technologies, not just in the transportation industry, but in any industry. And so for us, it's never been go completely a technology route or completely an operational route, it's combining the best of both worlds. And for us, it's keeping it simple with how we look at the business for our customers. It's focused on service. Every load matters, picking up and delivering, when we say we're going to, making sure that we're giving customers complete visibility through the life cycle of an order. If there is a problem being proactive in communication versus reactive. Creating solutions for customers, so not just looking at what are the rates from point A to point B, but how do we look at their overall transportation spend and talk about what days of the week they're shipping, what modes of transportation they're using, do they have the opportunities to consolidate. The next piece is on technology. When you look at innovation and being able to use those tools to give our customers data, and it's one thing to have the data, it's another thing to be able to use the data to help our customers create and deliver results for themselves. And then the last thing is relationships. Relationships are really important in this business. And when you look at our top customers, they've been with us for 17 years on average. And they're not just coming back to us and saying, "Hey, we want to renew the business that we've got with you." Because of our service, because of the technology and the integration that we've got with us, they're coming back to us and they're offering us more freight. They're giving us the opportunity to haul more of their freight. And when you look over the last 3 years, our volume growth with our top customers has actually outpaced our overall volume growth that we've been putting up with.

On that relationship piece, I think, our thesis for you guys has been spot volumes are pretty low right now. But as the volume and the general demand trend turns, right, the spot volumes are going to come back and that's going to be pretty profitable for you. So I guess, what gives you confidence in those relationships that you're developing, with incremental volume you've gotten over the last year that will actually come to you and not go to other potential brokers.

Well, for one, again, these relationships aren't new relationships. They are relationships that we've had, top customers for 17 years. And so when you look at what we've done over our history from 2015 through 2021, brokerage industry grew at a 9% CAGR. Then there was a lot of up cycles and down cycles. We grew at over 27% CAGR during that same time period. So we've got a history of being able to do this. And what we'll do is it starts with the service. When the market turns, we're going to honor our contractual rates to our customers. And that gross profit per load per contractual rates will come down. But as you're starting to see load-to-truck ratio increase, and it gets around to [ 6, 7 to 1, ] tender rejections getting to high single digits, low double digits. For us, at that point, you start to see the spot gross profit per load more than offset the squeeze that you see on the contractual gross profit per load. It's really important because as you look right now, what's happened in the industry, customers are consolidating the number of carriers that we're working on. So whenever the market does inflect, where are they going to turn first? They're going to turn first to the companies that they trust, that have delivered for them. And whatever we've got, over a decade of experience of delivering results for them, we're confident that not for the first time, but for again, we're going to be where they turn when the market inflects.

[indiscernible] you said a number of times this afternoon, you want to keep this focused on the long term. You did bring up a kind of short-term point there and that you are expecting maybe some spot price inflection that can potentially lower your gross margin load there before you start to see contract loads to be set up or at least to further [ out contract ]. So is that part of what you were -- why the 1Q guide was as it was, the potential that squeeze could even happen after 1Q, depending on how the rates [indiscernible]?

Yes. So the 1Q was really about what we saw in January. If you go to what you typically see, the last 2 weeks of December and the first 2 weeks of January are typically fairly soft in the industry. You combine that with the weather impact that we had that lasted the entire month of January, it had an impact on the overall profitability, and the impact was in gross profit per load. And if you look at the areas of the country that were impacted by weather, particularly the Midwest and the Southeast, those areas, our gross profit percentage was impacted 2x to 3x more than the rest of the company -- than the rest of the country. So I think it shows the power of what happens on gross profit per load that is coming down. And if it comes down $5, $10, it's meaningful to the bottom line. And the same is true as the market inflects, it should go up $5, $10, $15, $20, that's very impactful to the bottom line.

On the recent earnings call, you talked about the goal of profitable growth. And we certainly get some pushback from investors on what the definition means there. Could you just unpack what you mean, how you're defining profitable growth and why you're confident that you're able to get [indiscernible]?

So well, I think first, if you go back and you look over the last decade, we've put our results up there whenever it comes to volume growth and the margin percentage that the business operates up against, most others in the industry and we are very proud of the results that we've created there. With that said, I understand that $12 million to $18 million is not the same, that we were talking about when you come off of Q4 coming in and spend $64 million. So I understand the framework of the question. For us, when you look at how we're performing in a gross margin percentage, it's near the top of the industry. And so for us, that's what we mean when we mean profitable growth. And also the second thing that I would add is out leading with price. If you look at how we price business from point A to point B, it is never our intent to go in below the market. We want to find out exactly where the market is, then hit that little window. And for us, what we do there is we're working with smaller carriers who are looking for a back haul, back to another customer, smaller carriers who are looking for a route back home, something that works very well for them, and these have become strong power links [indiscernible].

Jared, I think you said on the last call that you're expecting the rate of capacity exiting the market [indiscernible] on results this year. I think you've said something, you a bit like the double digits last year, capacity on the brokerage side exiting the market. What are you [ modeling ] this year for capacity exiting on the brokerage side and on the carrier side?

Right. So let's break that out in terms of capacity exits both from a brokerage standpoint and from a truckload capacity standpoint. On the former, with respect to brokerage exits, in 2023, roughly 10% of the industry was -- roughly 10% of brokers exit the industry. We expect that to continue into 2024. If you think about the brokerages that came into the industry during COVID, where cost of capital was effectively free, and now you're at a point where, if you're not large, if you don't -- if you're not at scale, if you don't have the customers, the carrier relationships, the technology and the investments, you can't compete in this market. So what's happening is you're seeing that -- you're seeing the rate of capacity from a brokerage standpoint, from an exit rate standpoint accelerate in 2023. Expect that to continue into 2024. From a truckload carrier -- from carrier standpoint, that we think is going to be the predominant factor as it relates to the rate and the pace of the recovery. So when we talk about our base case the second half recovery that helps in the freight market, we think the largest variable there is going to be the rate of capacity attrition from a truckload capacity perspective. So what we've seen throughout 2023 is the rate of capacity exit accelerate all throughout the year. And as Drew was mentioning earlier, in the month of January of this year, we saw that exit rate at about 30% higher relative to 2023 levels. So as that continues into the back half of the year, we think we're going to be in a much better supply-demand equilibrium entering the back half of the year, which leads to our base case recovery with respect to the freight market.

Long term, do you see this industry as consolidating more? Do you see more of the freight going to the larger brokers [indiscernible] or smaller brokers?

So we think that longer term, it's going to be more of a winners take most market structure. If you look back at Investor Day, when we spun, we talked about the top 10 brokers comprising about 50% of the market from a revenue perspective. We think that number is likely higher now, given some of the exits that you just referenced. And we expect that number to continue to grow precisely for the reasons that I just talked about, right? Where you need the scale, the ability to invest, you think about our investments in technology, right? We spent hundreds of millions of dollars over the years investing in our technology platform our pricing algorithms, now leveraging generated AI in terms of some of our internal use cases. So to be able to compete at scale requires a significant amount of capital. So we certainly expect that the larger brokers will continue to provide a larger percentage of that market longer term. And I think you get some of that sort of -- maybe a little bit of a cyclical kicker in terms of 2023 and 2024 with the smaller brokers that aren't able to compete and effectively play in the market.

Drew, there was a period that you made a comment on earnings call that you felt that having the ability to combine the asset and asset-light leads to more power only type offerings is giving them a significant advantage. Do you feel like it puts you at a disadvantage with you having less of a capacity to do that kind of work?

Yes. So what I would say is drop trailer for large brokers is nothing new. We've been doing drop trailer business for over a decade. It comprises roughly 10% of our overall volume. And I think the difference for us is, as a non-asset-based carrier, we can flex that capacity up or down based off of what's going on in the market. So what we hear about from our customers is that the flexible capacity is actually a huge advantage. We're in Miami part today. You call an asset-based carrier, and you say, "Hey, I've got 20 loads." It's going to depend on how many assets that they have in the area. But whenever you've got access to over 100,000 carriers in your RXO Connect, it gives you the opportunity to be able to flex up, to meet the capacity demands in real time.

You guys were nice enough to have us down 2 times over the last 2 years. You gave us a great demonstration of the technology platform that you have there. There were notable improvements, I would say, in between the first time we got the demo and the second half we got the demo. What, I guess, have you been doing to improve the technology offering? What is the impediment to getting from that -- deliver 87% to 97% created or covered digitally to looking at fully covered digitally and more adoption on the technology side of the carriers.

So I'll start, and then Jared can come in and talk about some of the stuff that we're doing on AI and the generative AI piece. But if you look at the created or covered going to 97%, we're much further along our journey that the customers had. So that's the created side. So if you look at who we do business with, we do business with over 200 companies in the Fortune 500. So integrating with the technology with large companies is not something that's overly hard for us. On the carrier side, while we've made great progress, we still have a lot of green space ahead of us that we can capitalize on. Those are typically smaller carriers. 1 to 10 trucks, and so getting them integrated within RXO Connect platform is much slower than what it is with large type customers. The second piece for that say is, just like any tool that we build, we're focused on how does it impact our customers? How does it pull our carriers closer to us? And how do they come back and repeat to do business with us? And how does it increase employee productivity overall? So to do that, any tool that we do focuses on volume, margin enhancement or employee productivity. That's our mindset with everything that we go into, from an ROIC standpoint with our technology build-out.

And building on what Drew said, I mean I think it speaks to the mindset of the organization in terms of just a continuous improvement type mindset, and that extends to technology, right? So we are making constant updates to the system in terms of we will, as a management team, get updates every 2 weeks in terms of the enhancements that have been made to the platform, right. And this continues. It is not -- we've built the platform and then we're going to stop and then we go ahead and redevelop, right? It is a continuous type improvement mindset where we are always making enhancements to the platform based on what we're hearing across our 3 cohorts that we develop technology for, right? What we're hearing from our customers. What we're hearing from our carriers. What we're hearing from our internal employees, right? We talked about last fall, we increased productivity in 2023 as measured by loads per head by day by 15%. So we're taking all of this feedback into account when we're making these tech platform changes. So last quarter also, we talked about some new features that Drew was just alluding to in terms of increased LTL automation, continue to increase the ability to invest on pricing algorithms, where we are -- we believe that they are -- they play hand-in-hand going back to your first few questions, our sustainable competitive advantage in gross margin lead versus competition goes right into the technology investments that we've been making to the platform.

And Drew, given your history, your former employer, compared to other peers, we won't mention that. How important is the customer rep now today in the business or the carrier? I feel maybe that's an understated portion of the story.

It's extremely important. Relationships matter. And -- but for us, the relationship is never tied to 1 person. It's about building layers of relationship. So while we may have an account rep who's got the day-to-day contacts they're talking to who are tendering out the loads on a daily basis, you also typically have a strategic account manager who is talking to higher level contact about building out the overall strategy. We have executives who are tied in with our largest customers. So there's a lot of touch points and layers of relationships across the organization. Relationships matter. People do business with people that they trust. And I think that if you look over -- from our history, they've shown time and time again that they'll come back to us. Now, what I would also say is that as we build out the technology, we build it for the customers where it shows them and it gives them data to help them make the decisions of what day of the week they are going to ship. You have the opportunity to take something that's potentially 3 LTL loads that's going into the same area of the country and make it a multi-stop -- make it a multi-stop truckload movement. So for us, it's about building the relationships, but also having the history of creating results for our customers that matter most.

And Jared, maybe along those lines, how does the managed transport business [indiscernible] the touch point?

So from a managed transportation standpoint, we've doubled freight under management over the last 3 years. And when we talked about it at Investor Day, it was about $4 billion. It's come down a little bit due to overall [ requirement ] rates. But managed transportation is really a key strategic priority for the organization. If you think about the ability to go ahead and manage freight on behalf of our customers. Think about it as it is a speculative theme where our customers are coming to us with complex problems, how do we go ahead and create solutions that lower total cost of ownership to our customers, right? And so we'll have that key competitive advantage internally. And then we also have the ability to go ahead and think about the ability to cross-sell across the entire organization, right? Where brokerage can become a customer to our managed transportation business and our customers get access to the best-in-class service and the best-in-class products that we provide from a brokerage standpoint. So brokerage -- continuing to grow managed transportation not only will have the added benefit of continuing to manage our complex needs for our customers, but also help accelerate the organic growth of our brokerage business.

Within managed transport, I know, auto is a pretty big vertical for you. And that was at least mildly a disappointment in the fourth quarter. What are you hearing from auto customers for 2024. I know there's been a [indiscernible] new growth in internal combustion engines. Is that an opportunity for you to [indiscernible] supply chain?

So from an automotive perspective, you are right, in terms of Q4, we talked about within our complementary services, which is where managed transportation is housed, I think volumes were a little bit lighter relative to our expectations. I think that speaks to just how well our customers within managed transportation or automotive customers managed and navigated throughout the ongoing strikes, right? So I think that production volumes were lower relative to our expectations in the quarter when we talked about on the call that we onboarded some several key managed expedite customers, which further enhance our leadership position within the space. I think when we look to automotive in 2024, I think there are a number of signs of continued robust growth from a production standpoint. We'll see how that ultimately plays out. I do think that ultimately, to the extent that -- I do think that it will probably be highly correlated to interest rate movements as we think about whether or not the Fed will give us 7,500 basis points worth of cuts in the back half of the year. I think there'll be a tight correlation there between that and auto production volumes. But overall, I'd say that the disappointment that you highlighted was more a function of just how well our customers navigated the UAW strikes.

And just to add on to what Jared's saying, we understand the automotive sector really well. Even if you go back and you look at a couple of the major OEMs, for the last 5 years on one and the last 6 years on another, we've been named Supplier of the Year. So again, it speaks to service and relationships and how deep and how long these have lasted for us.

In terms of Last Mile, we've heard from a number of companies at the conference that there a little bit of shift from goods to services coming out of the pandemic that certainly had impacted you to some degree. Then we would expect to see that in Last Mile, you were able to grow profitability in Last Mile last quarter. What are you guys doing right in Last Mile? I know you're still susceptible to maybe some cyclical pressures in that business in [ 2024? ]

Well, I think we said on the earnings call that stops for us were down in the fourth quarter or 9% on a year-over-year basis. I think that, that outperformed where the overall industry was. So to your point, there are less goods that are being sent to the home. But for us, we've got a leadership position in Last Mile. We've been the leader in this space for a very long time. Brand protection to our customers is extremely important. So when they talk about who is their last representation that they've got to their end consumer, they want to make sure that they're well represented. And I think that, again, the long history that we've got with these customers, the service that we've got, we got rewarded this year. And we said that last year, in 2022, we held the line on price even though carrier costs went up. We were able to get rewarded on price in 2023. We think as you go into 2024, the one thing that we're having conversations with customers on is expanding. So right now, what they're talking to us about is we understand the service that you provide. But can we start to talk about other markets across the country where you can provide that? And we're in a good position to do that because when you look at our Last Mile hubs, they're within 120 miles of 90% of the U.S. population.

Probably a good time to queue up the question #4. In your opinion, what should RXO Inc. to do with excess cash? Yes. I think investors have, yes, thus far considered asset acquisitions to be part of the M&A. But nothing for you, guys? Draw up question 5. Your opinion on what multiple of 2024 earnings should RXO Inc. [ trade ]? Even split and then finally, question 6. What do you see as the most significant share price headwind -- potential share price headwind facing RXO?

Maybe while you get the response to that question, Drew, it has been challenging because earnings have come down so much. But can you talk about the innate leverage potential in the business, especially [indiscernible] spot loads coming up. How do you really leverage these relationships and the low growth that you have been seeing in business?

I think if you go back and you look at what happened in 2020 and 2021, we're growing volumes, 20% and 30%. So while now what we're doing is grow volumes, best-in-class, we're building the foundation of preparing for the inflection. So that we know that as customers shift, and they start to see tender rejections come up, where do they go? They're going to go to the people that they trust for spot loads, they're going to go there for projects. Even if you think back to the parts of COVID where the West Coast ports were backed up, we were able to create solutions for our customers. We were doing transloads there and doing multiple modes of transportation to get it to end destination. If you look right now, one of the things we're hearing the most from of our customers is nearshoring. We've made investments at Laredo. We're doing custom brokers there. We're handling both sides of the border for shipments. And so for us, it's about going in there and creating solutions so that whenever the spot loads are there, the projects due there, that we're the first call, we're the place they trust more than anywhere else.

Okay. I guess get put in here and now I'll [indiscernible]. But Jared, any issues on the balance sheet? I know you guys just, I believe, refinanced or paid down some debt, sorry. But you're going to access a revolver for cash. Is that correct? Can you talk through that change? And maybe where you see leverage in the business going forward?

Sure. So to your point, we paid down [ $100 million ] of term loan last quarter. We had a negative arbitrage spread in terms of the cash that is sitting on the balance sheet versus what we're paying in terms of interest rates. So from a net present value standpoint, it certainly made a common sense to go ahead and take advantage of them, that can spread [indiscernible]. To your point, we have access to a large revolver facility, about $600 million. We also have access to $700 million of unencumbered receivables on the balance sheet. So call it about a $1.3 billion liquidity position, so quite strong. From a leverage ratio standpoint, at 2.5x exiting Q4 based on the ratio that -- based on the guide that we gave for Q1, from an EBITDA perspective, probably somewhere between [ 2.9x ] and [ 3.1x ]. So no issues in terms of excess liquidity. I think we're working truly closely with our lender group and our bank group, and we're feeling very good in terms of the ability to give significant free cash flow. And from time to time like any corporate company, we'll go ahead and access the revolver to the extent that we need it from a working capital perspective, we'll certainly likely access it here in Q1, just given the lower levels of profitability. That's sort of just an ordinary course of business.

And then you previously mentioned 1 to 2 times leverage target, if that's still the right leverage target. And more broadly, I guess, is this business more -- is there more volatility in the business through the cycle that you think would potentially have you thinking differently about the leverage moving forward?

I'd say longer term, the intent to get to 1x to 2x absolutely still holds, right? I mean you think about the capital requirements of this business as we scale, they're not going to be meaningfully different. So we'll go ahead and delever pretty quickly as the cycle does recover and our base case [indiscernible] for second half freight recovery. You think about just the cash flow generation of this business, it's quite powerful on our road to come off of $475 million and $525 million of [ EBITDA ].

You mentioned cash flow, [indiscernible] working capital is going to be a drag during the recovery. Is that something that investors should be thinking about, and kind of factoring in as they're looking to [indiscernible]?

Yes, absolutely. We framed it on the earnings call, and I think -- let's go back to 2020, when we bottomed from an industry standpoint, coming out of COVID, right? Free cash flow for 2020 was negative for the year and in [indiscernible] Q4, we were a precursor to the greatest cycle that we've had as a company and we've had it in the industry, right? So I think that, that speaks to, certainly over the last 12 to 18 months, the power of the model from a countercyclicality standpoint. We've generated significant free cash flow during the downturn in terms of 2023, about $49 million of adjusted free cash flow. As we look forward to the cycle, it does inflect. General rule of thumb is for every incremental dollar of revenue, be about a 7% to 9% usage of working capital, and that's a onetime usage of working capital, it's a great return on invested capital will be investing in the business, strong return on invested capital in our [ Uber ] business. And as we go ahead and expand from a -- as we go ahead and recover, potentially like from a freight market recovery standpoint, you'll see us use that working capital, but it's a great return.

[ Drew and Jared ], thanks for joining us, much appreciated, and look forward to having you again next year.

Thanks for having us.

Thank you.