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

Good morning, everybody logged into the webcast. My name is Amit Mehrotra, and I'm the transportation and shipping analyst at Deutsche Bank. It's my pleasure to welcome you to Deutsche Bank's 11th Annual Global Industrials & Basic Materials Summit being held virtually. The conference covers 2 days, includes leading companies across several verticals within industrials and basic materials. We have over 500 people participating in this conference, over 370 clients and investors, over 150 company representatives. We appreciate and Deutsche Bank appreciates all your time and hope the next 2 days prove both insightful as well as productive. I'm very, very happy to start the summit with Brad Jacobs, the Founder, Chairman and CEO of XPO Logistics; as well as Matt Fassler, the Chief Strategy Officer of XPO. I don't have to say this, but Brad has an incredible track record of building companies from the ground up and creating tremendous, tremendous equity value in the process, companies like United Waste, United Rentals and now, of course, XPO Logistics. XPO is a $15 billion global transportation and logistics company. It's the #3 for-hire transportation company just behind FedEx and UPS. It's the #4 LTL company. It's the #1 provider of home delivery of big and bulky goods. And of course, it's a leading global contract logistics company as well. In the context of all that, I really can't think of a better person or company to kick off our conference today. So Brad and Matt, thank you very much for joining us, and welcome to Deutsche Bank's industrials summit. Appreciate it.

Thank you.

I'm going to start with the questions. But if those on the webcast -- we have many, many people on the webcast. If they wish to submit a question, please do so, and I'll present those to Brad and Matt. But to get things started, Brad, given the -- I'll ask the obvious one first. Given the global reach of the business and the various end markets that you guys serve, I think it would be helpful to start off with you giving us a sense of the very current trends in the business given how fast things are moving. Europe appears to have inflected off the bottom nicely. That's obviously 40% -- or about 40% of your business. Have those trends continued? And what are you seeing in the U.S. with respect to freight flows as the economy slowly starts to open up? If you can -- if we can start there.

Okay. Your description is accurate. Europe has rebounded nicely, and the United States is rebounding but has not rebounded as much as Europe. And if you look at Europe -- let's look at it geographically. Let's look at it by business line. Geographically, France has come back very strong, it's almost back to previous levels; Spain after that. U.K. rebounded, I mean, better than U.S. is rebounding but not as strongly as France and Spain, but absolutely in the right direction. If you look at it in Europe from a business line point of view, contract logistics is doing much better than transportation. But that's not surprising because, number one, contract logistics, as the name implies, is contractual. Number two, we've got a lot of exposure to e-commerce and food and bev over in Europe in contract logistics, both of which have been holding up very well. And in transportation, our -- the majority of our business there is in 3 verticals, construction, industrial and auto, which have basically just opened up in the last couple of weeks. So that rebound is likely to come, but it's not surprising that it's a little bit later than e-comm. If you come over to the United States, the end of May has picked up a lot more than the beginning of May, and that trend continued in the first week of June. So it's encouraging, but it's not as encouraging as Europe, which had a much faster rebound from the trough. If you look at it by different businesses here in the united -- business lines, in the United States, brokerage, you're seeing margin -- you're not seeing volumes come back in a big way yet. You are seeing -- well, you saw margins expand in May because the spot market was down. I don't expect that same margin expansion in June because the spot market has firmed up a little bit. On the LTL front, there is a nice rebound happening in both tonnage and price. That's encouraging. Let's see how that develops over the next few weeks, but the trend is absolutely encouraging. And the same kind of trends that some of our competitors reported last week, we're seeing the same general trends. In last mile, we had an acceleration in May over April, and let's see how June turns out. And in supply -- in contract logistics in North America, that also is outperforming the rest of the company, but that's not surprising given the verticals and then it's contractual in nature.

Okay. That's very helpful, Brad. And given that I have you here, I want to focus more on kind of the structural outlook for the company, whether it's the LTL business or it's the contract logistics business. But I think given you just mentioned LTL, let's start there. XPO acquired Con-way Freight or Con-way -- really Con-way Freight, back in 2015. The company was operating at a, call it, 5% operating margin. Today, it's 1,500% operating margin. It's been a pretty remarkable transformation in terms of what the company has been able to do to restructure the margins. Can you talk about some of the drivers behind that? Obviously, Old Dominion is the bellwether benchmark in the industry. Con-way Freight actually have higher margins than OD prior to the Great Recession. So there doesn't seem to be anything structural holding XPO LTL back. But if you can just talk about the structural outlook for LTL. How quickly do you think we can see the old Con-way Freight business reach parity once again or even better than OD's margins?

Okay. Well a few things there. When we bought Con-way, it was really 4 things. While LTL was the main part of the business, it had a nice truck brokerage business, which we completely integrated into our truck brokerage business. It had a nice managed transportation business, which we also merged completely into our managed transportation business. And it had a Menlo subsidiary -- a subsidiary called Menlo, which was contract logistics, which we merged into our contract logistics business. On the LTL front, yes, it's gone very, very well as the other 3 did, too, but it's hard to track the other 3 because they're so completely integrated in. We can look at customers, but it's hard to give a full P&L -- actually, impossible. As you have to allocate a bunch of costs, it'd be tricky. On LTL, it's very clear and black and white. We've more than doubled the profit of that business. And to answer your question of how we did it, we did it in a good old-fashioned way, is we paid attention to detail and execution and operational excellence and got the compensation program throughout the whole organization tied to profitability improvement and we made the culture focused on performance on all levels, operational performance, financial performance, and it worked. So we had good focus on cost control, and then we had a lot of transformational-type initiatives that you don't really see outwardly. But inwardly, we've got rid of a bunch of freight that we shouldn't have had in the first place, and we onboarded a bunch of freight to replace that, that matched our network better. That's a big, big deal. So you don't see that externally because a dollar is a dollar. So if $1 is going, another dollar comes in. So you don't see it in the revenue line, but you see it on the bottom line because the freight matches our network and it's more desirable freight than what it replaced. And then we've been on a multiyear journey that's extremely exciting there. Maybe it's the most exciting thing going on in the entire company where we have technology applications to improve the way we pick up people's freight, the way we handle the freight, we consolidate it and deconsolidate the freight, the way we haul it on a line haul, the way we price it to begin with. So all aspects of cradle to grave, from a pallet -- we've applied technology to make it more efficient. And while we've made great progress, and that's been a big contributor to our profit improvement, I would say we're in the second and third inning of that technology development in LTL, and we got a lot of effort going into that. So what we've done in LTL is really great. What we can do over the next several years is even greater.

What I'm really intrigued by on LTL, and we're seeing this at some other companies that are nonunionized that are still kind of making their way up the margin curve, if you will, is this totally transformational way to think about labor management. And obviously, labor is the biggest piece of the cost structure of most, if not all, transportation and logistics companies. And you have obviously this XPO Smart tool that is a tool that you can overlay over every service center that can dramatically change how you think about productivity and overtime pay, and I don't think it's as well appreciated. I mean I was in Boston at your tech day, and I actually saw this tool in action. And I think it would be helpful if you can talk about how much you spend on labor, what this XPO Smart tool is all about and what the potential savings could be and the payback kind of time line for that.

Yes. So you're absolutely correct that the management of the labor cost is critically important and -- because it's our biggest cost. And the way we do that is to apply technology to give visibility to that throughout the company, at the service center level, at the district and regional level and at the corporate level and to be benchmarking and monitoring the different ratios that are relevant there, and it's amazing, the results. And that smart -- that proprietary smart labor tool started in our contract logistics business. It's one of the skunkwork projects, one of the innovation projects that the contract logistics people are working on. And once they put it in, in the warehouse, we saw over 5% labor productivity literally within a month when we put the tool into a warehouse. So we made some adaptations that made it more applicable to the cross-stock facilities in LTL, and we've been rolling it out. And we've been seeing the same amount of labor productivity. So what do you do with the information? So the information comes in and then you're using predictive analytics to say, "Okay, here's how much labor we had today. Here's how many pallets we had today. What kind of labor do we need tomorrow, for the rest of the week, for next week?" And then we plan accordingly so we're not overstaffed, we're not understaffed. The upshot of that is that our overtime becomes appropriate, that our ratio between temporary workers and permanent workers becomes more optimal. The ratio becomes more optimal between drivers and dock workers. And very importantly, it tells us what should be the length of the shift. Historically, the industry has had 3 8-hour shifts. But the freight doesn't come in, in 3 8-hour shifts. It comes in, in big spurts in certain parts of the day and it's kind of quiet in other parts of the day. So the smart labor tool shows us very graphically when the shift should start, when it should end and how many people should be on those shifts. And all that information is reduced to a dashboard that's very simple and easy to see and idiot-proof, frankly. And it's just -- it's been an amazing productivity enhancer.

Right. And I think you guys spend over $6 billion a year on labor. That's across the entire business. And the XPO Smart tool is obviously being overlaid across every site you have, not just, obviously, in LTL. As you mentioned, it started in contract logistics. So just 2% savings is over $100 million of EBITDA. Obviously, you're doing more from the line haul and pickup and delivery productivity side, but just for the sake of time, let's just bow tie it for the people -- for the benefit of institutional investors on this call. The $1 billion of EBITDA that you talked about in LTL, any time line around that? I think it was a 2021 number a while ago. Obviously, the world has changed a little bit. Has it pushed out by another year? So is it a 2022 number? And then is it possible -- and this would be my last kind of shorter-term question on the LTL business. Is it possible, given all this opportunity, to actually see margin expansion in the LTL business despite kind of the -- this year -- margin expansion this year in the LTL business despite the depths of the decline in the second quarter?

Well we're still not -- we're still in the middle of the year. You're certainly not going to see margin expansion in the second quarter so let's just get that right on the table, not when you had tonnage and revenue down so much in the quarter. That's just not possible. For the rest of the year, let's see. Maybe -- I don't know. I don't want to go out and say -- on a limb and say exactly what margin expansion, give guidance on that partly because I don't know the extent of the second wave of the coronavirus. I don't know whether it's going to be a modest wave and we'll deal with it, it will be kind of background noise, that would be great, or whether it's going to come back in a more major way. So we don't know that, so it's very hard to predict that. So we need to step back and be realistic to the fact that there's a little ambiguity to how the coronavirus is going to play out for the rest of the year. On the labor cost itself, yes, we have -- it's our biggest cost globally, $6.5 billion. And yes, we are applying smart labor tools step by step in a methodical way to the entire organization. And that's one application of technology towards labor. There's other ways that we're approaching labor as well in terms of automation. So in the warehouse, for example, we've been on a big kick for a long time now to automate everything we possibly can, which is why we were one of the biggest pioneers, if not the biggest pioneer, in terms of cobots and in terms of other technology that we can put into a warehouse to do what human beings were doing, what people were doing, but do it through machines. That is certainly the way for the future. There is no doubt in my mind that if you go into one of our warehouses 5 years from now and flash back to what it is now, probably no comparison. The biggest difference will be the amount of people in those warehouses will be dramatically lower. The upshot of that is they will be safer, they will be more profitable, they'll be more efficient. Data will be more transparent. Accuracy will be better. It's going to be better for the customer and better for our shareholders. And the distinction between the haves and have-nots is going to be dramatic. So the 15-year joint venture we have with Nestlé, for example, where we're designing the warehouse of the future, that's going to be a standard. We're not just designing 1 warehouse of the future with Nestlé. And then at the end of it, we're taking all that technology, we're taking all that know-how, we're taking all the expertise and we're applying it to the rest of the organization. And in contract logistics, we think in a very engineered, consistent, standardized way globally. So that is the future of the contract logistics, is more and more automation. One advantage of that is our labor costs will go down quite a bit. If you look at the company over the next 10 years on it and you say what was -- and our margins are much higher and our profit is much higher, probably the biggest driver of that will be the dramatic reduction in head count and labor costs for the same footprint.

Right. And I want to get into this Nestlé facility because it's really kind of fascinating to me in terms of the size of it and the automation in it. But before I do that, I just want to make a service announcement. If people on this call do have a question, please use the tool on your webcast. And I can see them come through, and I will ask them on your behalf. But hopefully, people have questions. I'm asking as many as I can think of, but if anyone has anything else, please come through on the webcast. Now Brad, on this Nestlé facility, so my understanding is it's the size of 10, 11, 12 football fields and only has 30 employees in it. 1/3 of those employees are automation and engineering employees, which kind of baffles my mind. First, if you can just talk about when does that -- I mean I know that, that facility is being built in the U.K. for a while. When does that actually come online and start benefiting the contract logistics business, if it isn't already? And the story -- well why don't we start there first on that specific facility, and then I'll get into how we should think about the contract logistics business in terms of all the verticals you're exposed to versus this e-commerce growth story. But let's start off with the Nestlé facility.

The Nestlé facility is about a dozen football fields long. Yes, it does have just a few dozen employees in it, most of whom are tech. It has -- we have virtually every vendor of warehouse automation pitching to us, and it's an amazing learning experience. And everything is documented, and we're really picking the best stuff. And then we're providing all the integration on a software level and on a technical level to make it all one integrated harmonized system. There are 3 whales, Nestlé being one of them, that are driving our growth in contract logistics. One of them is Nestlé. The other one is a contract that we won in February with one of the largest U.K. grocers, Waitrose. It's a 3-year contract that starts in July. It's about $85 million a year in revenue. Nestlé also starts in July. And then we purchased 3 verticals from Kuehne + Nagel in the U.K.: e-comm, food and bev and technology. And that should close -- that'll probably close more like October-ish time frame. And that e-comm, food and beverage and tech is highly synergistic with the business we have in the U.K. There are massive synergies there, it's very accretive, and our ops people are really excited about it. So there's a fair amount of wind to our back on the contract logistics side from those 3 big whales. The Nestlé one, yes, it's revenue, and that's really important. It's profit, that's great. But the bigger value to us is the R&D and to be able to have a template that we can then replicate all throughout our nearly 800 warehouses around the globe.

And the acquisition in the U.K. of Kuehne + Nagel is an interesting one. Obviously, even we were, to be honest, a little bit confused by it because the sale process was ongoing at that time. But my understanding just getting a little bit more educated on it, it sounds like that business was losing money on a stand-alone basis. And you guys, because of your scale in the U.K., can kind of come in, take out an enormous amount of redundancy costs and kind of have that payback be quite significant? And is that the right way to think about how that Kuehne + Nagel business could impact profitability in the back half of the year?

Yes. Synergies are a beautiful thing. And when you have 2 sets of -- parts of organization that only required 1 set, obviously, that helps for a lot of accretion. The transaction is something we studied in depth for a long period of time. It's very well mapped out what we do with it after we buy it, after we close on it. And suffice to say, it will be highly accretive. At the same time, it was a win-win deal. It was a good deal strategically for Kuehne + Nagel who was trying to refocus on other places.

And so if we kind of wrap all this together and think about the logistics business, which is obviously the biggest individual piece of your business at least from a percentage of revenue perspective, of course, it's spread across North America and Europe, but in total, it's the biggest piece of your business. Can that now -- is that entering a phase of kind of new growth as some of these big projects come online? Obviously, the R&D that you now -- the intellectual property that you have can be leveraged in terms of using that to grow in other areas of logistics business. Should we assume that kind of starting in the back half of this year, the contract logistics business kind of enters this renewed phase of growth that can kind of be sustained over the next several years. Is that a fair way to think about it?

Amit, it's Matt. I'm happy to take that one. If you think high level about the macro factors driving contract logistics, there are 3 huge trends which were already in evidence as we approached this year but, I think, post pandemic are going to be even stronger tailwinds for us. The first is outsourcing more broadly, and this is very relevant to the contract logistics arena. Our customers and partners, having been through the pandemic and having seen the potential fragility of supply chains, understand that they need well-capitalized, technologically savvy partners to help them manage their supply chains. The second high-level theme is e-commerce. E-commerce has obviously been a growth theme in the economy for years and years. It accelerated dramatically, as you know, and I think as most of us have experienced firsthand through this pandemic, there's been a step-function change in the penetration of e-commerce. We don't expect that to revert to the norm. We think that, that is going to be sustained. Consumers' tastes have changed. Companies' realization of their own capabilities have evolved. And there's some brick-and-mortar capacity coming out of the market. And by the way, even where brick-and-mortar capacity is still with us, lots of vendors, having been through this period, having had their distribution disrupted, want to make sure that their own direct-to-consumer capabilities have improved. We are very, very well positioned to help our customers in this regard. We have the leading third-party fulfillment platform in Europe. We're a major player in reverse logistics. We have a huge presence in omnichannel in both North America and in Europe, and we can deploy advanced solutions at scale across the world. We're one of the very few go-to partners that our customers have. And we expect that as companies emerge from this very disruptive moment of the pandemic, and they look to future-proof their businesses and to address that need, it will drive a real nice backlog of business for us over the next number of years. Third and briefly, this really follows logically from the Nestlé conversation. We've talked a lot about supply chain automation. Again, we can deploy advanced solutions at scale quickly. It's good for our customers, good for our shareholders, and we expect that to be a great source of business going forward.

Great, Matt, and that's helpful. And I want to end on the logistics segment and get into some maybe strategic questions, but I want to end with XPO Direct. I think this is -- when it was announced maybe a couple of years ago, it was really interesting because it was almost like a supply chain as a subscription model because you were utilizing your footprint, which is enormous across logistics, 800 sites globally and then, obviously, LTL as a way to kind of serve -- as a marriage between e-commerce fulfillment capacity and those that need the capacity in kind of an asset-light way. And what we've seen over the last couple of quarters is that the margins in logistics have actually re-rated a little bit higher. I think mostly because a lot of those internal start-up costs associated with XPO Direct have now been realized or incurred. One, can you just talk about how XPO Direct -- if I've characterized it in the correct way, that should mean the contribution margins associated with the revenue in that business should be higher as you're basically leveraging already your fixed cost base. And is the margin profile in logistics prospectively now at a new normal once these costs are now kind of in the rearview mirror?

Sure. I'm happy to take that one as well. So a few points on XPO Direct. I think you described the business well, a shared distribution network across our contract logistics facilities and our last mile hubs. It was profitable in Q1, barely more than a year after a full national launch, and we expect it to be profitable for the entire year. The fact that the U.S. retail world went on pause led to dramatic surge in opportunities for XPO Direct for many companies, retailers and brands as well as lots of digitally-native brands that are direct to consumer and need help getting goods to those customers. The core customer here can be a customer that's looking to go DTC, direct to consumer, or to accelerate its way from brick-and-mortar. It's capital-light for our customers that can leverage our footprint. Lots of our customers don't have the technology that they need for volume visibility. We bring that to them. And our sites drive strategic availability within 1 to 2 days with 95% of the U.S. population. That's -- there are very few business partners for our customers who can offer that. And it is going to contribute, we think, to enhance profitability in contract logistics, but that's not the only factor. We've talked about improving profitability in European contract logistics. That's been a core business initiative at the company for more than the past year. Over time, automation, we expect to materially aid profitability. And as we take on these large, complex, long-run contracts, that also should be margin-accretive for the company.

Okay. That's helpful. And then, Brad, we've got about 5 minutes left, and I wanted to hit on a couple of things. One is -- I have to ask this even though I think I may know the answer, but maybe not. Obviously, your strategy over the last, call it, 10 years with XPO has really been about what do I need to do -- or what does the company need to do to maximize equity value in the company. And I think that's kind of been your -- in a way that's prudent, that's risk-adjusted, et cetera, et cetera. And so that's what caused you to maybe go look at acquisitions back in '16 and '17 and then divestitures more recently. Obviously, the world changed earlier this year. The world is slowly getting back to normal. Credit markets are now very, very normal. Equity markets, deals are getting done. And so you terminated the sale-or-spin process. You didn't suspend it. And I think that language was very deliberate on the company's part. Talk about why it doesn't make sense now to revisit that with the markets opening back up. I know you probably are going to say you don't spend any time on it, but that's not the question. The question is really, why doesn't it makes sense to revisit that if you think that that's -- if that's clearly the way to maximize equity value in the company?

It doesn't makes sense to revisit it right now. You want to be a buyer when the market is soft, and you don't want to be a seller when the market is soft. You want to react to what the market conditions are. And while markets are coming back, they're not back to where they were. And -- but long term, we don't take anything off the table. I don't see any reason why we should. We have -- we get paid to allocate capital in a way that's going to generate the best return for our shareholders. And if that means putting it into growth CapEx, then that's what we're going to do. If that means we'll take it and pay down net debt, that's what we'll do. If that means buy back stock, well, then that's what we're going to do. If that means M&A, whether it's buying or selling, well, that's what we're going to do. So that is an ongoing, and always will be ongoing forever, strategy that we have, to keep an open mind and be very flexible to do whatever is -- best serves our core mission, which is to create shareholder value in the transportation and logistics field.

Okay. I'm going to end with maybe a shorter-term question. And maybe, obviously, this is for Matt. Matt, you've talked really nicely in the past, more recently about the cost structure and how much is fixed, how much is variable, and I think that's helpful. And when you kind of put that on a schedule, it implies that anywhere in a 20% revenue decline quarter, you're looking at decrementals of between 25% and 30%. And then on top of that, there's some unique circumstances around COVID-related costs. I think you guys talked about $50 million in the second quarter. So when you kind of overlay all that, I think consensus for the second quarter is around $100 million -- $180 million of EBITDA. One, I think in the past you've sort of characterized -- you've been willing to characterize whether expectations are in the realm of reasonable. I was hoping you can do that now. And then talk about those $50 million in costs. I know those were some -- an estimate and fluid. Are they less than that? Are they more than that in terms of when you said it? I mean any kind of update or color there as far as the prospective trajectory of those costs?

Yes. So for the second quarter, when you do the math and you take the 77% variable cost and 23% fixed cost and the revenue is down, what we said was it actually would be lower than the number you said in terms of EBITDA for the second quarter. I'm not giving guidance. Let's be very clear about that. I'm just telling you the math, is that if revenue comes down, then EBITDA would come down even lower than the number you said, not a huge amount lower but it would come down a little bit lower. In terms of the rest of the year, the rest of the year and the next couple of years is very, very positive. The reason it's very, very positive in my estimation is that we're benefiting from a bunch of positive tailwinds. Number one, you got the outsourcing trend, which has driven the business for the last 10 years every year. Just from showing up Monday morning, you got more and more people wanting your services. That's a good thing. I believe, as a result of the pandemic, that outsourcing is going to increase, not decrease. And I've seen it already. We see so many of our customers, I wouldn't say panic but I would say just be much more willing to outsource and derisk rather than doing it themselves. And COVID cost itself, the $50 million or so for the second quarter is not far off. For the rest of the year, we'll still have COVID costs. It won't be as much as it was in the second quarter. It will taper down over the balance of the year. But some of the other long-term drivers of the business in addition to outsourcing is the outsized exposure we've got to e-comm, which has been growing even during the pandemic, and I believe it's not just a temporary growth spurt. I believe that that's going to continue afterwards; the warehouse automation, which is a nice cost reduction and margin improvement driver; the investments we've made in technology and things like the digital freight marketplace, for example, which are taking off. And then we've got our 10 levers of profit improvement which collectively represent an opportunity of up to $1 billion of EBITDA improvement. And we're making nice progress on those, and we're going to continue. Those were crowd-sourced from a large number of people inside our organization, and these were the 10 best ideas that people had to significantly improve the profitability of the company. And people's names and times are associated with that, and the compensation is tied to it. And I'm optimistic on the execution of it.

Okay. We're 1.5 minutes over, so I'm going to end it there. Brad and Matt, thanks so much for kicking off our conference today. Really appreciate your time. I know you have a full day of meetings over the next several hours, so thanks a lot for taking the time to spend with us. Next up, for everybody on the webcast, we have the Chairman and CEO of Sherwin-Williams Company. That webcast is starting in about 9 minutes at 9:00 a.m. Eastern. You can just go back to your webcast link and click on the Sherwin-Williams webcast. Thanks, everybody, for joining us, and hope you have some great meetings. Thanks, Brad. Thanks, Matt.

' Thank you.

Thank you.