XPO, Inc. (NYSE:XPO) Q4 2022 Earnings Call Transcript

XPO, Inc. (NYSE:XPO) Q4 2022 Earnings Call Transcript February 9, 2023

Operator: Welcome to the XPO Fourth Quarter 2022 Earnings Conference Call and Webcast. My name is Melissa and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. Before the call begins, let me read a brief statement on behalf of the company regarding forward-looking statements and the use of non-GAAP financial measures. During this call, the company will be making certain forward-looking statements within the meaning of applicable securities laws, which by their nature involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those projected in the forward-looking statements.

A discussion of factors that could cause actual results to differ materially is contained in the company’s SEC filings as well as in its earnings release. The forward-looking statements in the company’s earnings release or made on this call are made only as of today and the company has no obligation to update any of these forward-looking statements except to the extent required by law. During this call, the company may also refer to certain non-GAAP financial measures as defined under applicable SEC rules. Reconciliations of such non-GAAP financial measures to the most comparable GAAP measures are contained in the company’s earnings release and the related financial tables or on its website. You can find a copy of the company’s earnings release, which contains additional important information regarding forward-looking statements and non-GAAP financial measures in the Investors section of the company’s website.

I will now turn the call over to XPO’s Chief Executive Officer, Mario Harik. Mr. Harik, you may begin.

Mario Harik: Good morning everyone. Thanks for joining our call. We’re excited to talk about our simplified business model following the spin-off of RXO and how it focuses our resources on growing the value of our LTL network. I’m hear in Greenwich with Carl Anderson, our CFO, who will cover the fourth quarter and full year results, and we also have Ali Faghri with us for Q&A. Ali is our new Chief Strategy Officer and he’s a great addition to the executive team. Yesterday you saw us report a solid quarter of growth in a soft macro environment. That statement is true for the company as a whole and also for our two reportable segments of North American LTL and European Transportation. Company-wide, we generated revenue of $1.8 billion reflecting year-over-year growth of 3%, and we grew adjusted EBITDA year-over-year by 38%, which far outpace our revenue growth and beat consensus for the 11th straight quarter.

For the full year, we generated over $1 billion of adjusted EBITDA in our LTL business. This exceeded a major target we had set for 2022. Looking at the business by segment, I want to focus on LTL and some key results that tied directly to our growth plan. In the fourth quarter, the LTL industry in North America saw a year-over-year decline in shipment volumes due to macro pressure, but at XPO, we grew our shipment count and tonnage. Our positive tonnage growth ties back to the plan we call LTL 2.0, which is to invest in capacity ahead of demand and earn profitable market share by providing best-in-class service. We continue to have great success onboarding new business, including volumes from blue chip customers who are either signing up with us for the first time or giving us more of their business.

This drove a strategic change in our mix in the quarter, and our tonnage trended up more than typical seasonality. We also had a high margin local base, and these customers gave us more shipments per day, however, to wait for shipment declined in the softer macro. As a result, our yield came in at the lower end of our outlook. Our mix should become a tailwind for us to both volume and yield as the macro recovers. The second reason we’re outperforming is service, and I’ll give you an example. In the fourth quarter, we improved our damage frequency by 66% year-over-year to the lowest damage frequency and six years. There’s no doubt that our intense focus on service is helping us secured more tonnage, especially as we are hearing from you customers that we rank as one of their top LTL carriers for quality of service.

Customer feedback like this has a ripple effect on our entire organization. Employee satisfaction is up sharply, which is an indication of the pride our team is taking and our service standards. And our year-end survey, employee satisfaction, including drivers and dock workers was the highest and more than a decade. For the full year 2022, from an operating ratio perspective, there were a lot of puts and takes, including the software macro. We improved our adjusted operating ratio, excluding real estate gains by 40 basis points for the year, which was short of our target range. Strategically, we made good progress in setting up the network to capitalize when volumes rebound, and we like our positioning. With executing on the growth levers in our plan like the 369 net new doors we added with six new terminal openings.

In the next 90 days, we expect to open another 167 net new doors in Salt Lake City, Atlanta, and Dallas. We’re also pulling the unique levers we have within our company to help drive our extension. In 2022, we increased our line haul fleet by over 10% by manufacturing more than 4,700 trailers in house. We also trained over 1,700 truck drivers last year at our driver training schools. These are tangible advantages we have in the execution of our long-term plan for LTL 2.0, and they’re gaining ground. Turning to Europe. This business continues to perform ahead of expectations with solid organic growth, particularly in the U.K. and Spain. At constant currency fourth quarter revenue in Europe increased year-over-year by 9%. Our pricing in Europe was up year-over-year in Q4 and we’re continuing to win business with new and existing customers.

Despite the macro uncertainty there, our sales pipeline continues to be very robust. I want to wrap up my remarks by summarizing the exciting trajectory with created going into 2023. We successfully completed the spin-off of RXO in November, which simplified our business model. We now have two highly focused business segments with strong value propositions in the customer markets they know best. In North America, we drove above industry tonnage growth in LTL in Q4, and we ended the year with over $1 billion of adjusted EBITDA, making good on the target we set five years earlier. We’re winning LTL market share with our service quality and also through our investment and network capacity. We’re on track to open the remainder of the 900 net new doors we projected in our growth plan.

And in Europe, our business is performing above expectations. This is the momentum we’re carrying into 2023, and we intend to continue to invest in growth. We’re confident that we’ll deliver on the three targets we set for our LTL business, revenue CAGR of 6% to 8%, an adjusted EBITDA CAGR of 11% to 13%, and an adjusted operating ratio improvement of at least 600 basis points. These targets cover the periods from 2021 through 2027, and as we move toward them, we’re focused on being world class in every aspect of our business. We know that this combination of financial and operational excellence is the most sustainable way to deliver outsize shareholder value. Now, I’m going to hand it over to Carl to discuss our results and our balance sheet.

Carl, over to you.

Carl Anderson: Thank you, Mario and good morning everyone. Today, I’ll discuss our fourth quarter and full year results, balance sheet and liquidity. I’ll start with the fourth quarter where we delivered strong year-over-year growth and adjusted EBITDA and adjusted diluted earnings per share. Revenue in the quarter was $1.8 billion, up 3% year-over-year. Organic revenue growth for the quarter was 2%, and the net impact of fuel prices and FX contributed an additional point of growth. We grew adjusted EBITDA by 38% year-over-year to $262 million. This was primarily driven by our North American LTL business, which increased adjusted EBITDA by $42 million or 20% year-over-year. This includes a real estate gain of $55 million, which was up $20 million from a year ago.

Additionally, we had a $30 million reduction in corporate expense, as we continue to rationalize our overhead after the spin-off. Our adjusted EBITDA margin was 14.3%, representing a year-over-year improvement of 350 basis points. In the LTL segment, our fourth quarter operating ratio was 84.2%. Our adjusted operating ratio, excluding gains and real estate sales, was 87.1%, which is a 60 basis point improvement from a year ago. Our European business also continued its solid performance with revenue up year-over-year 9% on a constant currency basis. Please note that we won’t be addressing a potential sale of our European business on this call. We reported a net loss from continuing operations of $36 million in the fourth quarter, representing a diluted loss per share of $0.31.

This compares to income of $47 million and earnings of $0.40 per share a year ago. The fourth quarter, 2022 net loss includes three impacts, primarily incurred in connection with the RXO spin-off completed in November. First, we had a $64 million non-cash goodwill impairment charge related to a change in our segment structure following the spin-off. Prior to that, the European transportation business was a single reporting unit, and goodwill was evaluated for impairment at that level. Following the spin, the European transportation business is comprised of four reporting units, and impairment testing is required to be performed on a disaggregated basis for each of the new units, resulting in the charge this quarter. The second impact related to the spin was the $42 million of transaction and integration costs.

And finally, we had $35 million of restructuring charges, mostly due to the plan step down in corporate costs. On an adjusted basis, our adjusted earnings per diluted share for the quarter was $0.98, which was up 3% from a year ago. This increase was primarily driven by higher adjusted EBITDA and a lower effective tax rate. We generated $196 million of cash flow from continuing operations, spent $167 million on gross CapEx and received $78 million of proceeds from asset sales. Gross CapEx was up $77 million year-over-year, driven by our planned investments and expanding our LTL network. This resulted in strong free cash flow of $107 million. Turning to the full year 2022. We delivered revenue of $7.7 billion, reflecting a year-over-year increase of 7%.

Adjusted EBITDA was $997 million in 2022, up from $812 million a year ago. This was primarily driven by a 12% increase in adjusted EBITDA in our LTL business and a 75 million reduction in corporate expense. Adjusted diluted earnings per share from continuing operations increased by 82%, coming in at $3.53 per share this year. We generated cash flow from operating activities of $824 million for 2022. And free cash flow of $391 million, which was up 11% from the prior year. Our CapEx investments of $521 million almost doubled from a year ago, as we accelerated our investments in the business to support our long-term growth targets. Our LTL adjusted operating ratio, excluding real estate, improved by 40 basis points from the prior year to 83.9%.

Moving to the balance sheet. We ended the quarter with $460 million of cash. This cash combined with available borrowing capacity under committed borrowing facilities gave us $930 million of liquidity at year-end. We had no borrowings outstanding under our ABL facility and our net debt leverage at year-end was 2.1 times adjusted EBITDA down from 2.7 times a year ago on a previously reported basis prior to the RXO spin-off. This week we extended our ABL maturity to 2026, and we recently received a credit upgrade from S&P from double B to double B plus. Turning into the first quarter 2023. We expect the company to generate year-over-year growth and adjusted EBITDA in the low double-digits. This anticipates $5 million to $10 million of unallocated corporate costs in the quarter.

We expect to wind down these costs over the course of the year. And finally, a reminder that, starting with the current quarter, our adjusted operating ratio will include the allocation of incremental corporate costs and exclude pension income. You’ll find a historical reconciliation for this in our investor presentation. In addition, we’re providing assumptions for the full year 2023 to help with your planning. These are gross CapEx of $500 million and $600 million; interest expense of $185 million to $195 million; pension income of approximately $20 million; and effective tax rate of 24% to 26%; and a diluted share account of 117 million shares. Overall, we’re pleased with our results in 2022 and are excited about our growth prospects as we move forward.

We’ll now take your questions. Operator, please open the line.

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Q&A Session

Operator: Thank you. Our first question comes from the line of Stephanie Moore with Jefferies. Please proceed with your question.

Stephanie Moore: Hi. Good morning. Thank you.

Mario Harik: Thanks Stephanie.

Stephanie Moore: To start out, I was hoping — thanks. Could you provide a little bit more color in terms of how you’re thinking about the first quarter for LTL, and in particular how you’re thinking about pricing, which does now — which now appears to be kind of in that low single digit range where a lot of your peers are more mid high. Any color there would be helpful. Thank you.

Mario Harik: Thanks Stephanie. Well, we expect company-wide adjusted EBITDA for the first quarter to be up low double-digits as Carl mentioned earlier. For LTL specifically, we expect adjusted EBITDA to either be slightly down or slightly up depending on what happens in the demand environment in the month of March, which as you know, is a big driver for the first quarter for us. From a OR perspective, we expect to be better than typical seasonality in the first quarter. Typically, seasonality for us is a 50 basis point deterioration from the fourth quarter going into the first quarter. Now, the set — we’re up to a great start here in the month of January. Our tonnage is up and better than typical seasonality. And our yield ex fuel is in line with the fourth quarter as well.

Now we are cautiously optimistic about the demand environment, so when we look at the back half of the quarter, based on what we’re seeing in our results today, we are seeing pickup and more strength from the volume perspective. But obviously, we’ll see what the rest of the quarter will do. But hopefully this gives you a color on all of — on the entire quarter.

Stephanie Moore: And maybe just on the pricing side of it as well, if you can.

Mario Harik: Yeah. Sure. On — the first quarter, we expect CAGR to be in line with the fourth quarter, here in the month of January, that that was the case. We did take a GRI for our local accounts in the month of January as opposed to what we did last here in the fourth quarter. But we will continue to be impacted by some of the next dynamics. We mentioned some of our prepared remarks in the first quarter, but we continue to see the pricing environment being rational.

Stephanie Moore: Understood. And then just kind of more on the modeling question. Could you provide a bit more color on corporate expenses in the fourth quarter, and what it should look like again, kind of in the first quarter and then moving forward throughout the year? Thank you.

Carl Anderson: Hey, Stephanie. It’s Carl Anderson. I can — I’ll take that. So, if you look at the fourth quarter, our corporate expense was $29 million. And as we begin 2023, $20 million of that will be allocated to LTL starting in the first quarter. So, it really leaves about $9 million left as far as a pure corporate expense. And as I said in the prepared remarks, we expect our corporate expense to — in the first quarter to range around $5 million to $10 million in line with what we saw — with you make adjustment. And importantly, we expect that to wind down throughout the course of the year.

Stephanie Moore: Great. Thank you so much.

Carl Anderson: Thank you.

Operator: Thank you. Our next question comes from line of Scott Schneeberger with Oppenheimer. Please proceed with your question.

Scott Schneeberger: Thanks very much. Good morning. Could you talk to tonnage trends in the quarter, just kind of puts and takes versus your internal expectations of what occurred and then I’ll follow up on that. Thanks.

Mario Harik: Sure, Scott. So, in the fourth quarter, tonnage came in on the lower end of our outlook, but we obviously bucked industry trends in terms of our tonnage being up and our shipment counts also being higher than our tonnage. Our tonnage came in roughly at plus 1% for the quarter. Now, in terms of the trends within the quarter, December was the soft month of the quarter, which was impacted by weather in the back half of December. So that was more softer than what we saw for the remainder of the quarter. Now, as I mentioned earlier though, January is up, better than the fourth quarter numbers. And it’s better than difficult seasonality as well. And we’re seeing — we saw a strong demand from our customers, especially a lot of the new customers we onboarded through the course of 2022.

Scott Schneeberger: Thanks Mario. Appreciate that. And then with regard to the operating ratio in the fourth quarter, sounds like weather was an impact there. Could you kind of hit on the main items that were impactful in the fourth quarter versus your internal expectations? And thanks for the guidance just provided. Appreciate that. So, just kind of focusing on fourth quarter and what occurred. Thanks.

Mario Harik: Yeah. You got it. So, predominantly for the fourth quarter, all came in short of our expectation driven by the tonnage outcome in the month of December. So, if you take out the impact of weather in the back half of December, we would have exceeded our expectation on our improvement for the fourth to fourth quarter.

Scott Schneeberger: Thanks Mario. It was purely the weather. Were there any other headwind impacts in the quarter that were worth calling out? Thanks.

Mario Harik: Yeah. Not outside what we had discussed on the last call, which was more driven by elevated cost inflation when you think about labor expenses and maintenance costs, but higher than expected. But we already had factors for that when we got together on the last earnings call.

Scott Schneeberger: Got it. Thanks. So, it sounds fairly isolated to the fourth quarter what was impacting that those other factors has just cost inflation. Is that in solid shape as you enter the coming this — in 2023 with your pricing and other strategies? Thanks.

Mario Harik: Yeah. So, as we head into 2023, obviously, we’re seeing inflation starting to taper off in terms of overall cost. When you look at the fourth quarter for us, the two big categories of cost are labor and purchase transportation. And for our wages, these were up 10% on a year-on-year basis in the fourth quarter, and roughly two-thirds of that was based on wage inflation, additional wages we have given our folks in the field. And the other one-third was to support the 1.5% shipment growth that we had in the fourth quarter. On the purchase transportation cost, that was down 10% in the fourth quarter. That was — but also you had appreciate that fuel as part of that line for the third-party providers, so effectively the rates were actually down more than that in the fourth quarter.

Now, as we head into 2023, that stronger cost inflation we saw in 2022 is starting to subside, especially on the purchase transportation side, that will become at tailwind through the course of the year. And same thing on wages, we expect them obviously to be up, but not as up as they were in 2022.

Scott Schneeberger: Great. Thanks Mario. I turn it over.

Mario Harik: Thank you.

Operator: Thank you. Our next question comes from line of Chris Wetherbee with Citigroup. Please proceed with your question.

Chris Wetherbee: Hey. Thanks. Good morning, guys. Maybe starting on the strategy around your local customers versus some of the national accounts on the LTL side. So, I guess maybe I just wanted to maybe better understand that, and then do you — I guess, over the course of the last several years post Con-way integration, I think there was a strong effort to kind of go through the customer base and right sizes and make sure you’re dealing with the best, most profitable customers and obviously the operator ratio improve over the course of that period of time. So, I guess, I’m kind of curious how much work is left to do and what does the strategy sort of really entail, and maybe ultimately, what do you think the potential benefits to your operating ratio of profitability, broadly speaking can be?

Mario Harik: Thanks Chris. If you think a step back and you look at the channel mix dynamic in the fourth quarter, and so I’ll walk you through that and then we’ll talk about 2023 and beyond. But when you think about the fourth quarter, we did have a channel mix impact on our yield, but that was driven by onboarding larger strategic national accounts in the back half of 2022, which we had discussed on prior calls as well. And these were important to build density in lanes in our network. Now on the local channel side, these are typically smaller accounts that are higher yielding freight for that type of business. And we have also taken market share in that particular segment where our shipment count in the fourth quarter was up mid single digit, but tonnage was down and that’s driven predominantly through the softness in the macro where these customers were shipping.

Again, we gained more customers, however they were shipping lower weight on a per shipment basis. So, as the macro covers, those local accounts would have higher weight per shipment that would drive tonnage up commensurate with the volume of shipments we’re seeing in the network. And that becomes both a tailwind for tonnage and for yield for us moving forward. So that’s the dynamic between national and local.

Chris Wetherbee: And in terms of how you think that that might impact the — I mean impact the operating ratio and I guess making sure I understand what’s sort of different now versus what you’ve been doing. Because I thought you were trying to optimize, sort of the customer mix over the course of the last several years.