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

Good morning. My name is Jordan Alliger. And for those who don't know me, I cover freight transportation here at Goldman Sachs. I rejoined Goldman about a year ago after about 16 years away, so it's truly my pleasure be able to help kick off the 2020 Industrials conference. Before we start, I do have to read some disclaimers and disclosures. First, this conversation is not intended for the media and is off the record. This webcast is not for the purpose of sharing or receiving nonpublic or otherwise confidential information. Attendees are public-side market participants who may not receive and should not request nonpublic and otherwise confidential information about issuers or securities or about the markets for security. Secondly, we are required to make certain disclosures in public appearances about Goldman Sachs' relationship with companies that we discuss. The disclosures relate to investment banking relationships, compensation received or 1% or more ownership. We're prepared to read aloud disclosures for any issue or upon request. However, these disclosures are available in our most recent reports available to you as clients on our firm portals. Disclosures and updates for those disclosures are also available by ticker on the firm's public website at www.gs.com\research\hedge. Also the views stated by non-Goldman Sachs personnel do not necessarily reflect those of Goldman Sachs. Great. So with that out of the way, it is now my pleasure to introduce Matt Fassler, Chief Strategy Officer, XPO Logistics. But before I turn it over to Matt, who has, I believe, a few brief opening comments on XPO, which is one of the world's largest global logistics leaders, I'd just like to share a quick anecdote. Matt and I actually started together at GS many years ago. I'll leave it to him if he wants to disclose how long to go. So when I returned to Goldman, It sure was a nice surprise to be able to interact with Matt again these many years later, albeit, of course, in different roles. But with that, I'll turn it over to Matt.

Thanks a lot, Jordan. Good morning, everyone. Thank you for having me -- having us at your conference, a pleasure to represent XPO at this event. And yes, Jordan and I shared many subway rides together back in the day, and it was a while ago. Just a couple of introductory comments about XPO and how we are approaching this very unique period and how we see ourselves emerging from it. We have really 3 focuses as we contend with challenges related to COVID and manage the business through it. We're very focused on taking care of our employees. We're very focused on taking care of our customers and providing an essential service. And in doing so, we have been up and running globally across our lines of business, across our various regions. And we're very focused on cash flow. In our first quarter, which we reported last week, we over delivered on cash flow, $95 million of positive free cash flow, which really flipped the sign from free cash flow consumption last year. We entered the month of May with $2.5 billion of available liquidity based in part on some actions we took to fortify the balance sheet between year-end and the past couple of weeks. That's more than double the liquidity with which we ended 2019. We gave some comments on April on our call last week. I'm happy to comment on those further as we talk. April was a difficult month for the economy, and our revenue was down in the low to mid-20s. We indicated in the middle of April that we thought we were in the worst of it. Having moved through April, we believe that that's the case. And there are indications of recovery in a number of different areas of our business, most notably in Europe, which is where we first felt the impact of COVID-19. Now as challenging as the environment has been for all of us, we're very excited about the opportunities for our business as we emerge from COVID for several different reasons, I'll speak to them briefly and can amplify, elaborate on them further in Q&A. One is that as supply chain has established itself as exceptionally critical across the business arena, our customers are increasingly focused on supply chain and we think are going to be more inclined to outsource their supply chain needs to companies like XPO. Secondly, we are a leading provider of e-commerce services and solutions to many companies around the world in North America and in Europe. E-commerce, which has been in secular growth mode for well over a decade, is experiencing a step function higher in the consumer economy today. We expect that acceleration, we expect those gains to hold, and we believe this will present us with tons of opportunity going forward. We see a push towards more supply chain automation with the deployment of advanced robotic solutions across warehouses. We're a leader in this segment of the industry. And again, we see tons of opportunity here as well. Finally, we see more focus on digital data. Our XPO Connect digital freight marketplace has been gaining traction and is gaining more traction now through this crisis. We believe that those gains are likely to be sustained. And this is a transformative moment for freight brokerage, and we know that we're a leader on the technology front, driving more productivity, more market share and ultimately, more profitability. So why don't I pause there, and Jordan, turn it over to you and happy to engage in Q&A.

Great, Matt. [Operator Instructions] So Matt, just to sort of start, you touched a little bit on demand and what you're seeing in April. I'm just sort of curious, as you think about what you heard from customers as you went through the month, you guys are sort of in a position where you have both retail exposure, industrial exposure. Any ability to share your thoughts on the reopening of the U.S. economy?

Sure. We expect those segments of the U.S. economy that have been shut down to reopen gradually. We're most focused on 3 areas, 3 verticals that have experienced that pressure. One of them is brick-and-mortar retail. One of the -- another one is auto and the third is general manufacturing. Brick-and-mortar retail, we obviously are seeing the beginnings of reopening activity state by state as regulations are lifted. In areas where the closing was more self-driven, like automotive and manufacturing, we're seeing some reopenings this week. We expect to see more reopenings next week. It's very gradual and very tentative. And I want to stress, we're optimistic about what we have been seeing in Europe. And there is clearly a big bounce off the bottom in France. There's a bounce off the bottom in Spain and some glimmers of recovery in the U.K. Through the month of April, the U.S. was, as I said, bouncing along the bottom, still close to trough levels. So too early to say what the slope of that recovery is going to look like. I would add that there are a number of areas beyond the 3 that I spoke about that contended with shutdowns, where we saw lots of vitality throughout the crisis. As you might imagine, areas like various series of consumer staples, be it food and beverages, retail and production, obviously, e-commerce. And while there are elements of brick-and-mortar retail that were shut down, particularly those related to apparel, there's an awful lot of brick-and-mortar retail revenue associated with discount stores, associated with home improvement that remained open for business and did quite well.

Thanks, Matt. Just sort of curious because you do -- sort of thinking about your businesses, and you do have a warehouse component to it. I mean just curious, are you seeing -- is there any changes around what's in warehouses? Is it too early to tell? Inventories have moved much? Just sort of curious as I was listening to your response.

Sure. If you're talking about at this particular moment in the business cycle in this particular moment of the recovery, the one dynamic that's rather unique is that there's a little bit of imbalance in the supply chain today. In that, for example, apparel retail, and I think we all know this as consumers, has sort of missed its spring season. And by the way, some of that inventory made its way onshore and didn't have a way to get to consumers, certainly not in the fashion that it would have been conveyed to consumers previously through brick-and-mortar stores. So one of the things that we are doing is providing surge capacity for brands and some retailers who find themselves in possession of inventory that they can't solve for the moment. And they need storage, and we're able to parlay some of those into some intermediate or even longer-term warehousing and distribution opportunities.

Thanks. Just a question on sentiment. You mentioned that Europe, I think, specifically, France and Spain have been moving along here. I mean is there a real sentiment change as Europe -- folks in the field are talking to customers over in Europe? I mean is there more of an optimism from the actual -- your shipper base right now? I mean are they feeling better about things?

I'm more inclined to measure numbers than measure sentiment because I understand them better, and they're more tangible. Our European customers and our American customers have always been -- have always been eager to get back to business and reramp volumes. And what we're seeing right now is the result of, obviously, their desire and business conditions essentially allowing it. So it's always darkest before dawn, and the recovery certainly began when sentiment was probably at its worse. So I'm not sure that my measuring sentiment, I don't know if I have any edge in doing it. And I'm not sure how helpful it is. What we can tell you is that the declines in France began really just prior to mid-March, and they persisted and reached their trough levels in early April. And since then, there's been relatively continuous improvement in that market, which is still down, but it was down substantially less than it had been at the bottom. You can repeat the same pattern probably with a little less pronounced moves in Spain. And again, in the U.K., I think it's still early days, but some sign of it there. So clearly, we're talking about a business community, and this is true of our customers and presumably beyond, that is very eager to get back to where we were. That's one of the observations that gives us some cautious optimism about what the U.S. should look like going forward.

Got it. Let me ask you a question from an operational standpoint. Obviously, it's, as you noted, sort of an unprecedented situation, this abrupt stop in the economy. Can you maybe talk about your ability to rightsize your assets to demand? And I don't know if this is just an LTL question or it also touches on nonasset base. And I'm also curious, as the second part of that is how quickly do you as an organization decide to pull these levers because of the uncertainty around recovery, if it comes back in June versus August, let's say.

Now to make sure I understand the question, you said adjust assets to demand. So are you talking about hard assets or is there something else to the question?

Yes. No. I mean it could be hard assets. It could be people. I was just using it as a blanket term.

Sure. I understand. So a couple of points on that. First of all, in a number of our businesses, particularly the network-based businesses, we're very accustomed to managing the allocation of expense dollars, the allocation of labor relative to the level of activity. And it's something that we do very carefully. It's something that we do with much consideration. It's also something that we've been doing over the past 12 to 18 months with a lot more technology. Some of you may have heard us talk about our smart workforce planning tools. This is a technology platform developed in our North American supply chain business that helps us plan headcount based on anticipated activity using historical productivity as a basis for algorithms and helps us monitor it in real time and make adjustments in real time, rather than conducting a post mortem after the fact and seeing what we might have done better a day or a week ago. This was, as I said, introduced in North American LTL -- I'm sorry, in North American supply chain and has been rolled out across North American LTL. It's been invaluable in helping us manage productivity -- labor and productivity in these arenas. And LTL, particularly on the dock and in North American supply chain, in our warehouses and distribution centers. We have taken the steps that we needed to take to try to rightsize the workforce to the levels of activity that we see. This has been achieved through furlough activities, which have been enabled in part by European governments who are providing some subsidies to help fund that. In the U.S., we've furloughed some people. They're also -- we've had to lay some people off, as I think has been common across the transportation space. From an asset perspective, a hard asset perspective, that's a little bit tougher to do, though we're reducing our gross CapEx for 2020 by at least 1/3 and certainly deferring some investment in hard assets and sweating some of our assets to a greater degree. And of course, when there's less activity, the lives of those assets tend to extend a bit. In terms of bringing people back, we've done this in such a way that we expect to be able to reramp employment as activity demands it. And that's one of the purposes of furloughs. And again, we have some experience doing this, particularly in our network-based businesses, so we're confident that we'll be able to staff the business appropriately as demand resumes.

Thanks, Matt. Yes, I was going to add sort of a CapEx question a little bit later, but you were mentioning the technology and the success you've had with technology, and you mentioned the CapEx reductions that you talked about. I'm curious on the IT front, does spending continue? Is that one area that is not necessarily touched, the IT perspective?

When you enter an environment like the one we're in, and you're as focused on free cash flow as we are, everything gets touched, but not indiscriminately. So our IT spending, both on the capital front and on the operating front, will come down in 2020 versus 2019. We're protecting a number of vital projects for the company. One of them is our warehouse of the future partnership with Nestlé. This is a significant warehouse and distribution center that we're opening up in the U.K. It has an unusual combination of massive scale and relatively low headcount. It really deploys some of the automation that I spoke about earlier. And it's going to be a real revolutionary approach to food distribution and one of the capstones of our network. We're also maintaining our investment in some of our most critical LTL -- areas of LTL innovation. Specifically, we're working on enhancing line-haul and pickup and delivery routing and routing compliance. There's much, much money accessible to the company from optimizing these. It does take some IT investment. That investment has stayed on the books, and we're very excited about the payout that we're likely to see from it over the next over the next several years. So those are examples of tech-related efforts where we continue to spend. But again, it's a moment of austerity. So we've been very disciplined, including in IT.

Great. So one actually high-level question. When the recovery takes hold, and I don't know if it's going to be gradual, rapid, who knows? Can you talk to what your thoughts are on supply chain fluidity as the economy reopens? Do you anticipate there being any pinch points in supply chains that could be problematic? And where, frankly, you may be able to step in and help with your capabilities?

I know that we'll be able to step in and help. We're not anticipating pinch points. If there are any, we'll certainly be there. Obviously, throughput has been diminished. So there's some excess capacity in the market, and that's true for us as well. And we really look forward to that throughput reaccelerating and getting better utilization of that capacity. That's obviously a very good thing for margins. We stand ready with our capacity in supply chain, our capacity in LTL, and our ability to help customers navigate markets in our brokerage business to help customers where there are imbalances. We saw that obviously in the second half of March in truck brokerage. When there is a surge, as you know, in food and beverage and dry goods consumption or at least accumulation by consumers that did stress the truckload market. We saw a big pop in our business, as you know, and I think that was true for the brokerage market broadly. And we were absolutely there for customers. There's been a different kind of pinch over the past number of weeks, which is, are you able to provide service in your transportation businesses and in your logistics businesses to your customers in the way that gets critical goods to consumers and achieve safety for everyone in the supply chain, yet our employees or the customers. And that presented a different kind of challenge, and our people really rose up. And frankly, we spent what it took and made it clear that their safety and their health were critical to us. That was a pinch point, if you will, and one that I think we've managed really, really well for the business and for the team.

So one other high-level question. And I know you've talked to this before, the whole variable cost versus fixed cost in terms of OpEx. But it might be helpful to sort of review the variable fixed cost mix as people try to think about margins in this environment. And is there any difference between LTL and the nonasset-based or asset-light side of the company?

There is. So we've approached -- we've shared with people over the past couple of years that our mix of variable to fixed cost was about 77% variable, 23% fixed. And that has been true, and that was certainly true entering this period. And it's been a pretty good guide for people trying to forecast our earnings, certainly on a go-forward basis, to pop in a revenue number, and we shared our April revenue numbers with people and take that fixed and variable cost mix. And what you get is not that different from where TheStreet has generally been taking Q2 numbers. And we think that there's good basis for that. Now it is different in different lines of business. You asked specifically about LTL. LTL does have a somewhat higher mix of fixed versus variable cost, given that it's a network-based business. In contract logistics, the structure of our contracts tends to create a more favorable outcome when you think about incremental or really, in this case, decremental margins. Because we have a number of contracts that are either cost-plus or have a fixed payment component in addition to the variable piece that protects us at moments of pressure on revenue, such that the margin performance in contract logistics relative to revenue is likely to be superior to the performance of the company overall, which is the way we built the business, and one of the reasons that we think contract logistics is an excellent business for us.

I wanted to ask a couple of questions on some of the other businesses, too. But there's a question on -- as you think forward and look longer term, do you expect meaningful supply chain near-shoring or on-shoring in the U.S.? And if so, what are sort of the implications to you and the industry?

It's a really interesting question. It's a question we heard a lot early in the crisis. When the U.S. had sort of sidestepped, or so it seemed, the impact of COVID and the primary impact of COVID was disruption of the China supply chain. I think that's been -- that's faded into being one of many issues that we faced from COVID. So the question has been coming up less recently. If that were to happen, it would probably be a modest positive for the company. Our freight forwarding business is a nice business, but it's a small business for us relative to almost everything else that we do. So we're not really dependent on air and ocean. In the first quarter, really throughout the first quarter, the only area where we saw pressure throughout the quarter in the U.S. was in intermodal. And that was tied to some degree into the lack of freight that was being imported to the West Coast from Asia. So perhaps some of that could end up being sustained if there is near-shoring. However, if you see supply chain flows being reoriented, and you see distribution centers being relocated, reconstructed, moved from region to region, it's a very good thing for us because we can help companies cure and model, design and ultimately implement new distribution centers and new supply chain solutions. I think if there is a rethinking of this, we have a consultative capability within our supply chain business that is not very well understood by TheStreet. What TheStreet sees is our own brick and mortar and automation that we implement. But there's a very high-quality, very bright team of people that work with the largest companies in the world, because many of them are our supply chain customers, in supply chain design at the scale that transcends what we ultimately go for to try to understand where our own facilities will fit into their network. So to the extent that, that happens, I think we can have a very prominent place in that process.

Great. Thank you for that complete answer. So on LTL, obviously, one question that comes up all the time is price. There's been a lot of consolidation in the business over the last decade or so. Most talk about pricing hanging in there. And I'm just curious if you could share your thoughts on core price sort of stripping out any mix effects or what have you?

I think hanging in there is a good description. We haven't seen a lot of movement. Anything can happen, but so far, the market has been stable from a pricing perspective.

And then just thinking about contract logistics, can you talk a little bit about the pipeline? I think I saw a release this morning that you actually did sign a contract in Europe. So any thoughts you could give on the pipeline and maybe this recent example? Is there any impact on implementations as we go through the pandemic?

I think right now, the companies are very focused on the consistency and stability of their supply chains. So we're seeing a very high renewal rate, and we're accustomed to a very high renewal rate. But it's -- they're tending to happen more fluidly, fewer questions asked. There is a nice pipeline in contract logistics. If you think about where the world stood on March 15 and kind of where we are now, companies are very focused, as I said, on making sure that they can function well. And I think the implementation processes have been pushed out a little bit. And the negotiations have been pushed out a little bit. I consider that a deferral rather than anything more permanent. And in fact, I think the opposite is true for all the reasons that I stated at the top of this presentation, specifically the growth of e-comm, the need for more supply chain automation. And supply chain automation, among other things, also enables a socially-distanced warehouse environment, which is not something that we viewed as desirable for its own sake previously. We didn't really think about it. But obviously, that consideration is going to be with us for a very long time. And then in terms of digital freight marketplace, similarly, we think XPO Connect is proving its metal. In this environment, we think the ability to deliver the combination of capacity, customers and superior technology is going to stand out. But as you think back to contract logistics, specifically, we're going to be writing a lot of new business over the next couple of years.

Right. Just a quick one. Is there -- are you able to pull out what proportion of your business is tied to e-commerce or how you would define it -- define as e-commerce?

I can give you some indication segment by segment. Within European contract logistics, it's one of the largest segments, well into double digits. Within North American contract logistics, it's probably a low double-digit number. Within last mile, it's a significant piece of the business. Last mile is almost all retail brands. You don't always have visibility to whether the order was a store-based order or an online order, but a great deal of it is online, and we're very flexible in that business. We're really agnostic as to whether it's e-comm or store derived. But as you see more direct-to-consumer businesses grow, and they don't have their own logistics infrastructure, whether it's in the mattress arena or in the exercise arena, we're a critical conduit of helping to bring those goods directly to consumers. Those are the 3 areas where the e-commerce exposure is highest for the company.

On the truck brokerage side, can you perhaps share some thoughts on industry dynamics? It has been a whole host of debate, I think, cyclical pressures, competitive pressures. It's been a difficult market for brokers even before coronavirus. So perhaps some thoughts on your views for the sector, not just in the near term, but longer term. Is this -- cyclical thing that will wind up self-correcting over time?

Cycles are cycles, right? Truck brokerage had some amazing moments only a few quarters ago for us and for the industry. From a cyclical perspective, we had been in a cycle -- at a moment in the cycle where spot had stabilized and contractual rates were continuing to come down, and that created a less advantageous margin environment in Q4 and Q1. Obviously, the cycle has been impacted, not all badly, by COVID. You saw a surge in volumes with lower gross margin per load in the second half of March. And then as the spot market softened substantially in April, you saw margin per load come back nicely. So I think that what would have been a fairly predictable progression of the cycle was upended a bit sometimes for the worse, sometimes for the better. But I think that cyclicality, which has always been there, will persist. And we think it's been responsible for the bulk of the movement in numbers in truck brokerage. In terms of competition, it's been a competitive market from day 1. It's a wonderful market because it is rapidly growing. Truck brokerage is gaining share of the overall trucking transaction market every year, and it's a very fragmented market. We're a top 5 player in North America but with modest share and much, much opportunity for share gains. We do think that truck brokerage will be much more of a scale business. And it will be much more of a scale business because it's going to be much more of a tech-driven business, as I alluded a moment ago. I think it's going to be imperative to have your own technology, which we do. And we think those players who can provide a smooth digital online experience with great price discovery, making a very efficient market with scale are going to be able to gain a tremendous amount of share. We can do this on a multimodal basis, given our presence in intermodal and our role as a 4PL with managed transportation. So we think we're very well positioned for this market. And we think it's one, again, where the larger companies are going to get larger still, and EBITDA margins have the opportunity to move up in that business as technology drives productivity.

I think we have time for probably one more question. So it's probably good to ask, obviously, a little while ago, you put aside the strategic review, and you actually also improved your liquidity in the past couple of weeks, too. I'm just sort of curious, and I know you talked about reducing CapEx in this tough time. I'm just sort of curious, the company's thoughts on capital allocation going forward, M&A, buybacks, debt reduction. Is there a prioritization at this point? Or is it still early to say how it's going to shake out?

When we consider capital allocation, we think about debt levels and prospective debt paydown. We think about buyback, to your point. We think capital investment in the business and we think about M&A. And we approach the opportunity set, evaluating risk-adjusted returns, and we do what's right for shareholders. That's really -- our core strategy is driving shareholder value, and we're much more focused on the outcomes than on which of the multiple paths you might pursue one would take to get there. As for liquidity, we're very happy to have substantial liquidity, a very well-fortified balance sheet in an environment that we think is recovering, but hey, it's been a strange few months. And having some cash on the balance sheet is, we think, a very good thing for us. And that's not burning a hole in our pocket. We're very happy to have this kind of liquidity. But as the world normalizes and it's time to allocate capital, we'll think about all 4 of those options and pursue the best risk -- the ones with the best risk-adjusted returns.

Great. Well, thank you very much, Matt. I think that's probably it for time. I don't know if you want to share any quick final thoughts. If not, we appreciate your time, but I'll give you a minute if you need to close.

No, Jordan, we're good. Thank you so much, and thanks to all of you for spending time with us this morning.

Thank you very much, all.