XPO Inc (XPO) 2017 Q3 法說會逐字稿

Welcome to the XPO Logistics Third Quarter 2017 Earnings Call Conference Call and Webcast. My name is Melissa, and I will be your operator for today's call. (Operator Instructions) Please note, 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 statement. A discussion of factors that could cause actual results to differ materially is contained in the company's SEC filings. 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 in the Investors section on the company's website at www.xpo.com. 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 on the company's website.

I will now turn the call over to Brad Jacobs. Mr. Jacobs, you may begin.

Thank you, operator, and good morning, everybody. Thanks for joining our earnings call. With me in Greenwich are John Hardig, our CFO; Scott Malat, our Chief Strategy Officer; and Tavio Headley, our Head of IR.

In the third quarter, we generated the highest revenue, the highest net income and the highest cash flow of any quarter in our history. In addition, we beat expectations for adjusted EBITDA at $370 million, cash from operations at $294 million and free cash flow at $183 million.

For the first 9 months, we closed business of $2.1 billion, a year-over-year growth rate of 49%. And we're growing sales at a record rate, while maintaining a global pipeline of over $3 billion. E-commerce deliveries propelled strong growth in last mile of 14% and revenue growth in our logistics segment of over 8%.

We grew our North American truck brokerage and intermodal revenues combined by more than 15% under favorable market trends. We also had some stars that didn't align in the quarter. There were the hurricanes and the typical puts and takes across sectors like a soft expedite market in automotive and a short-term drag from investments in growth. We have significant opportunities in hand to fuel new growth, particularly with sales and technology. We're implementing initiatives across the company with pricing, utilization, sales and workforce productivity, data analytics and warehouse automation. We're continuing to pursue M&A opportunities to augment our momentum, while staying focused on the substantial growth embedded within our current operation.

Finally, I want to take the opportunity to thank the thousands of XPO employees who contributed to our natural disaster relief fund. With the company match, we're sending over $690,000 directly to members of our XPO family affected by the hurricane, so thank you all.

On that note, I'll ask John to review the third quarter numbers in more detail. John?

Thank you, Brad. Revenue for the quarter increased 5% to $3.9 billion. Excluding the North American truckload unit we divested in Q4 last year and the impact of foreign exchange in fuel, organic revenue growth was 6.4%. Net income attributable to common shareholders for the quarter was $58 million compared to $14 million last year. Adjusted EBITDA, a non-GAAP measure, was $370 million, which was a third quarter record.

Revenue in our transportation segment increased 2.5% to $2.5 billion. Operating income increased 15.8% to $145 million and adjusted EBITDA increased by 4.6% to $265 million. Excluding the truckload operation we divested, we grew transportation adjusted EBITDA by approximately 15%.

In North American less-than-truckload, we grew volume and increased yield. Tonnage increased 5.6% and yield was up 1.8%. On an adjusted basis, excluding amortization of intangibles and integration costs, operating ratio increased by 20 basis points. We've made investments in our fleet and ramped up labor to handle the higher volume. Our average tractor age improved to 5.2 years from 5.8 years a year ago. We expect to improve OR in the fourth quarter from a year ago and achieve our OR improvement goal for the full year.

In last mile, we had another strong quarter despite the hurricane. We delivered strong top line and earnings growth led by our last mile e-commerce network and growth in our next to last mile service. Revenue growth was 13.9%, and we had strong cost control in the quarter.

In freight brokerage, we grew revenue by 16% year-over-year. The aftermath of the storms created tightened capacity. We were able to capitalize on the market disruptions and find solutions for our customers.

Truck brokerage was very strong in the quarter, given the tighter market and increased spot business. September was the strongest month in brokerage and that trend improved in October. We had strong performance in our European transport operations, partially offset by lower non-dedicated truckload revenue growth, and in particular, our growth was strongest in both dedicated transportation and LTL in the U.K. and in truck brokerage across Europe, and we had strong LTL volumes in France.

We're moving more freight through our brokerage network and utilizing our truck assets for dedicated contracts. We rationalized costs to increase margins meaningfully in the quarter.

Our logistics segment had a strong performance in the quarter. Total logistics revenue increased 8.3% to $1.5 billion. Operating income increased 2.8% to $77 million and adjusted EBITDA increased by 7.4% to $135 million.

In European logistics, we performed well, both from a revenue and profitability perspective, led by new e-commerce and cold-chain contracts in the U.K., Spain and the Netherlands. We grew revenue 14.9% to $801 million.

In North American logistics, revenue increased 1.2%. We generated solid growth in contract logistics, offset by a revenue decline in managed transportation. Net revenue excluding purchase transportation was up 6.4% in the quarter. The largest gains came from e-commerce and industrial customers.

Interest expense for the quarter decreased 22% to $73 million due to debt paydown and repricings of our debt. Net CapEx for the quarter was $111 million. We expect to end the year within the range of our full year CapEx guidance of $430 million to $455 million. Our cash flow from operations for the quarter was $294 million and free cash flow was $183 million. We remain confident in our target of at least $350 million of free cash flow for the full year.

And now I'll turn over to Scott.

Thanks, John. Starting with the macro: In North America, we're seeing broad strength from our industrial based customers with more modest growth on the consumer side. The standouts in retail continue to be e-commerce and omni-channel, both of which are booming. In Europe, our volumes and pricing have picked up since the French election in May. Euro Zone industrial production and consumer confidence are rising, and the PMI there is the highest it's been in over 6 years. In addition to e-commerce and industrial growth, another common theme in both North America and Europe is that transportation capacity is tight. Tight capacity increases the value of XPO to our customers because we have one of the largest owned and brokered capacity networks in the world. Our growing network in last mile puts us in an excellent position going into the holiday peak. We have strong capacity, and we opened eight new hubs ahead of Black Friday, bringing our e-commerce network to a total of 53 hubs in the U.S. We plan to add at least two more this year and an additional 30 hubs by the end of 2018.

We've also enhanced our technology in last mile to improve the operating efficiency of our larger footprint, manage routing with more real-time analytics and expand online capabilities for the end consumer. On the contract logistics side, we're realizing a strong benefit from e-fulfillment globally. Our logistics segment grew revenue with e-commerce and omnichannel retail customers in North America by 47%. And in Europe, where XPO is established as the largest e-fulfillment provider, we grew by 17%. Our global pipeline for logistics is near an all-time high at $1.7 billion. Our process automation team is constantly testing and implementing the latest technologies in robotics and other automation in our warehouses to increase productivity. In many cases, we have employees and robots working side-by-side to deliver the greatest efficiency and order accuracy for the customer.

The current tight labor market plays to our core strengths of scale in key markets and our recruiting expertise. We're hiring over 11,000 seasonal workers in North America and Europe to manage peak. That's up 25% from last year.

Turning to North American LTL, we've made huge progress, and we still have a significant opportunity to grow our revenue and margins. Our investments in salespeople, training and incentives are driving an increase in both volume and yield. We have a big focus on data analytics in LTL. Our data scientists are helping us price more intelligently, based on market factors. The team is also implementing new tools for pickup and delivery optimization and linehaul utilization.

Looking forward to 2018, we remain confident of achieving adjusted EBITDA growth of 17%. Our third quarter results keep us in line with that target with mid-single-digit organic growth and steady progress on margin improvement.

With that, let's open it up for Q&A. Operator?

(Operator Instructions) Our first question comes from the line of Chris Wetherbee with Citi.

Wanted to touch base on LTL first and sort of get a sense of how sort of the quarter played out. I guess maybe 2 parts to the question: the first is on the cost side. You mentioned, obviously, there was challenging weather in the quarter, and you mentioned investments in the fleet. I don't know if you can quantify sort of maybe what some of those cost impacts might have been on the OR. And then could you talk a little bit about sort of how tonnage progressed as the quarter went on? We saw some acceleration with some of your peers. Wanted to get a sense, relatively, of how you are approaching the market during the quarter?

Chris, it's Scott. So LTL it's right on track where tonnage is up by 5.6%, it was relatively consistent through the quarter. Yield has been improving. It was up 1.8%. If you look at the renewals, it improved to a 5.1% increase. We did make those significant investments in the fleet. You can see that in D&A. Depreciation was up about $12 million. It's the youngest fleet in over 5 years. We did train all of our 14,000 drivers on the new ELDs. We're fully compliant at this point. And if you look at the hurricanes, there was an impact in the quarter company-wide. We had a high-single digit to low-double digit millions impact across the company. LTL was the largest piece of that. But if you look at the fourth quarter, we expect a year-over-year improvement again in OR. And if you look at the year, we're right on track.

Okay. And then tonnage and maybe some comments on October. How are things kind of looking coming out of 3Q?

It's been steady. On tonnage, there is more availability of freight. So there's been a spillover from truckload into LTL. We remained disciplined on pricing. Our yield has even improved, and our tonnage levels have stayed relatively steady at these levels.

Okay, that's helpful. And then just a follow-up on the free cash flow side: I think, typically, seasonality would suggest maybe a bigger free cash flow number in 4Q. I think the guide implies that it could be a little bit lower. Maybe it's a little bit more because you do have $350 million plus. But just wanted to get a sense of some of the puts and takes in free cash flow from 3Q to 4Q?

Chris, it's John Hardig. So we are going to have a lower EBITDA quarter relative to the third quarter in the fourth. We expected initially to have more free cash flow in the fourth. We had a little bit lower CapEx in the third quarter than we expected. Some of that will roll into the fourth quarter. And then working capital, as you know, as the business starts to decelerate in the fourth quarter, working capital will be a source of cash and we expect about $50 million or $60 million of cash from that.

Our next question comes from the line of Ravi Shanker with Morgan Stanley.

Brad, can you just give us an update on where you are on the M&A process in terms of vetting potential candidates. And does tax reform being considered in Congress have any impact on your decision to move or your timing of moving?

We have nothing new to announce on M&A. Everything is still the same. We're looking at lots of interesting opportunities. We're still focused on the internal operations of the business and augmenting our above-average organic revenue growth with M&A. So we're looking at M&A as the cherry on the top. We're very focused on continuing to generate the great numbers that we've been generating quarter after quarter. With respect to vetting, sure, I mean, we're talking to dozens of different candidates and we've developed a lot of proprietary deal flow. We've also had a fair amount of inbounds. Oh, with the part on taxes? With taxes, Ravi, who knows what's going to come out of Washington on taxes. We're not counting on anything. And we don't see that really affecting the calculus very much in terms of the M&A discourse.

Got it. And just to follow up on what you said about the organic growth. You've put in your release that your pipeline continues to be over $3 billion. You had some very large wins into the second quarter. Any notable wins in the third quarter that impact it?

Nothing that we have to announce today. But we're always talking to customers, and we're always winning RFPs. We're always developing these bulk customized solutions for our supply chain customers. That's an ongoing process just every day of the year.

Got it. And then just lastly on managed transportation, I'm surprised to see the decline in that business, given that it is a growth area in this space. Is that temporary, and do you expect that to turnaround? How are you thinking about the MT business?

That is temporary, and we do expect to turn it around. Or the sales lead time in managed transportation can be 12 months, can be 1.5 year. So it's not going to turn around immediately. But it's an area, as we've discussed in previous calls, that we didn't pay enough senior executive management time to. We were focused on the larger contributors to profit and revenue in the company. And in recent months, we've started to focus more on it. And it's turning around. Takes a little while to turn it around.

Our next question comes from the line of Brian Ossenbeck with JP Morgan.

So, can you give us an update on the global procurement savings initiatives? I think, last quarter, the number was running around a $90 million run rate. So, just an update on outstanding RFPs, if any have come back in between the last time we spoke to you and what does the pace of those look like going into next year? Do you take a step up as you get to the global ones out the door and back? Just a sense of scope and timing.

This is John. In procurement, we've achieved over $105 million in annual savings so far. Our largest savings have come from areas like temp labor, tractors, trailers, insurance, tires, facilities management. We're now going through a process of global RFPs in other areas like material handling equipment, recruiting fees, trailers, many other categories that add up to about $1 billion of spend. So we've got a lot of things that we're working on right now. We're on track to get at least $160 million of procurement savings in aggregate, since we started this process a couple of years ago. Our total addressable spend is about $2.6 billion. So far, we've attacked about $1.6 billion of that, and we've achieved about 4% savings on that spend. So that's an update on what we see coming ahead.

Okay, great. And then would that step up in terms of pace next year? Or would it just be more kind of annualizing the work that you've done already?

Well, it's a little bit of both. So we do have some savings that we've initiated this year that will roll into next. And so we're looking at something in the 40 to 60 range for next year. It's really something that's a work-in progress because we're working through a lot of those RFP's right now. So it might be a slight step down sequentially over this year, but there is still a lot of opportunity to go.

Okay, got it. And then just a question on the team. You mentioned building out the sales force, especially in LTL with new local count execs. If you can give us an update on how that's gone? Also, tripling I think the strategic account execs, moving one into Europe. So, clearly focused on getting more people in front of customers, so an update on that. And then also, from a higher level, promoting Malcolm Wilson to run Europe. What does that give Troy Cooper more bandwidth to do since he's been running that business since 2015?

Right. Well, Troy is still COO globally, and that hasn't changed. He will be spending and is spending more time here in North America. So his time will be more focused on LTL, North American supply chain and the other parts of transportation we have in the United States, and still going back and forth as the rest of us to Europe to continue to oversee the business we have there. Malcolm was a great person to put in that position. He's been there forever. He's got great relationships with Luis Gomez, who runs our transport business over there and with Richard Cawston, who now runs our European supply chain business and they were all in here in Greenwich last week. It's a strong team and lot of prospects, good prospects. With respect to sales, it's one of the main growth drivers for the company so far. And it's going to be an even greatest growth driver going forward. We have a tremendous opportunity to grow our existing share of wallet with existing customers and even though, we've made a lot of progress on cross-selling, we're now 25% of sales and 90 of our top 100 customers use us for multiple service lines, which is up from about 80 a year ago. There's still so much more to go where we've got fantastic relationships with customers. We have big transportation logistics spends, and we're only doing one or two or three service lines with them, and we've got to get in front of them and crack the nut on getting more of their business. Sales in general, sales force effectiveness, optimizing pricing, these are things that lots of time we internally are going into.

When you think about it, for next year, we are going to do $1.365 billion EBITDA this year. We'll do $1.6 billion EBITDA next year. We only have to do 2 things. We have to do what we've been doing all along in terms of getting mid-single digit top line organic revenue growth. We've been doing that for quite a while now, including this quarter. And we have to do about 100 basis points margin improvement, which we did this year over last year, which we did last year over the previous year. So, that's something we just have to continue doing that same thing. So sales is half of the story. Margin expansion is the other half.

Our next question comes from the line of Todd Fowler with KeyBanc Capital Markets.

Brad, I think that as you've been putting the business together, I don't think we've really seen the model complete as we've entered into a tighter freight market, at least, domestically. Can you help us think about how you would expect the model to perform, as capacity tightens into 2018? I would think that there would be some puts and takes, some areas of the business that would perform better but also some parts of the business that may not benefit as much. So it's a bit of a theoretical question, but if you can give us some high-level thoughts, I think that would be helpful.

Generally, it's positive across the board. Truck brokerage, obviously, as you saw from the results this quarter, does very well when you have a dynamic spot market and capacities tighten, pricing is going up. Intermodal follows truck brokerage, as does expedite. And to some extent, LTL is very much positively affected from the spillover from truckload. On the supply chain part of the business and contract logistics, I wouldn't say tightness in capacity is the main influencer there, but economic activity helps. It's not the biggest thing in the world because that business gets outsourced more during downturn. So it works well there too. But generally, a buoyant economy can't be a bad thing there. And in European transport, the same positive effects that I just talked about in North America exists. So overall, tighter capacity is a good guy for us.

Okay, that helps. I was thinking on probably a little bit more on the logistics side, I guess, how do you think about the leverage in the models? As I look at the slide that you have on the path to the 10% adjusted EBITDA margins into next year, it seems like a lot of that is company-specific acquisition or cost opportunities. If we see a stronger top line, would that imply that there is upside to what you're thinking about from an EBITDA margin standpoint as you move into 2018?

Well, we don't want to raise guidance for guidance that we just confirmed yesterday afternoon. We feel very comfortable with the...

Like I said, theoretical question.

Theoretical, I appreciate that. So underscore that. We feel comfortable with the 10% EBITDA margin, the roughly $1.6 billion of revenue and, at least, $1.6 billion of EBITDA. We have a plan for that. And the plan, high level, is simply to continue to generate mid-single digits organic revenue growth and to continue to grow the margin by 100 basis points. There are a lot of things that are stub points of that. We talked about the sales force effectiveness, and I talked about optimizing pricing. Workforce planning is an activity that's a big lever in our LTL business here in Europe and in our global supply chain business as well. We do it very well, planning our headcount and our overtime and our temp labor, in some places, and frankly, we have room to improve and room to improve significantly in labor management, in workforce planning, in both those business lines, globally. We're going to continue to press our advantage in e-commerce. We have exposure in many different places, including the largest e-fulfillment platform in Europe, including the largest last mile provider of heavy goods here, omnichannel distribution, which was up 47% in the third quarter and being a leader in reverse logistics or returns management. So, e-commerce, and particularly, growing our last mile hub in North America, we are up to 53 hubs. We're going to add another couple before the end of the year. We'll add another 30 next year. So we're really creating a unique last mile network. We're also going to keep pressing on automation everywhere in the business, and that's a big chunk of what we're investing our $425 million here in technology on. And trailer utilization, capacity utilization. Our trailers in LTL are about 2/3 full and about 1/3 empty, and best-in-class is more like 85%, and 15% empty. That's a $100 million opportunity right there that we continue to chip away at. We talked about procurements. I could go on and on, but there's many, many, many levers and the management team globally is focused on each one of those levers.

Okay. So you've got confidence of what's in your control, and we can make some assessments around the macro piece and what's outside of your control?

Yes. Unfortunately, we can't control hurricanes. But we can control all the things I just mentioned.

Our next question comes from the line of Ariel Rosa with Bank of America.

So I wanted to start on the contract logistics side. We saw a big step up in European logistics revenue. Just wanted to see if we could get a little bit of color what's driving that? Is that customer wins, or is it repricing of contract? And then, similarly, in North America, there was a bit of a slowdown. I think Scott spoke about the robust pipeline that exists there. Wanted to see if you could, maybe, address when we might see a reacceleration in growth there? And if it's just that, that slowdown that you experienced this quarter was kind of a temporary phenomenon?

I'll take Europe. I'll give Scott North America. In Europe, it was not too many new customers, but it was a lot of new wins with existing customers and growing business with our customers because our contract logistics business in Europe is a lot of e-commerce. There's a lot of e-fulfillment. And we're growing with our customers' growth. So that's really the main contributor of the growth in Europe. It's not the only part--we have a big food and beverage vertical. We have half-a-dozen other verticals in which we have significant business, but without any question, our e-commerce customers are growing the fastest and we're helping them grow.

In North America, in contract logistics, we grew very strong. The organic growth in contract logistics was over 8%, and that had been accelerating. We ramped up a lot of new projects. So we had a 13% increase in headcount and square footage, both, as we ramped up. What the offset to that was is managed transportation. A good way to look at that is the net revenue growth. Our net revenue growth in North American contract logistics was 6.5%, which shows you the dichotomy between managed transportation and contract logistics.

Okay, that's helpful. And then just in terms of what you're seeing in terms of customer outsourcing of supply chain: you touched on that a little bit earlier, just, could you talk about trends across North America and Europe there?

Increasing. We're seeing more and more outsourcing of contract logistics by our customer base to mostly us, because we're the incumbent in most of those customers, and you're seeing them -- give more of that to third parties like us.

Okay, terrific. That's really helpful. To switch gears a little bit on the LTL side. We've heard a lot of transportation companies sound more encouraged about the pricing opportunity in 2018. I was just hoping you guys could touch on that, what you think you might be able to achieve next year, obviously, targeting above inflation. But how aggressive can you get there? And just kind of what are some of the initiatives on the pricing side?

So, you look at the contract renewals, which is the biggest part of our business, you see a nice quarterly trend. So it was up 5.1% here in the third quarter. It was up 4.8% in the second quarter. I don't know the exact number. The first quarter was lower than that.

3.5%.

About 3.5%. You see it going up nicely. First quarter to second quarter to third quarter. You'll remember, we had negative yields towards the beginning part of the year. We increased yield 1.8% now, at the same time, growing tonnage 5.6%. So the yield environment is positive. And the reason it's positive is there's more tonnage out there. Industrial production is up, and people who had three or four pallets now have four or five pallets. And there's more business out there, so it's supply and demand.

Our next question comes from the line of Scott Schneeberger with Oppenheimer & Co.

I just want to delve into the hurricane impact a little bit more. Scott, I believe you mentioned high-single, low-double digit EBITDA dollar impact in the quarter. I assume that's predominantly LTL. Could you just elaborate on this segment? And then what you think will occur in the fourth quarter as far as the hurricanes' lasting impact, positive or negative?

So the overall company was high-single digits to low-double digits, like you said. The biggest part was LTL, but it was a little less than half of that. As you look out into the future, it's really hard to tell. It's hard to tell how much restocking you'll see. Likely, you'll see in the areas in Texas and in Florida, some restocking on some of the heavier goods in last mile, like appliances and furniture. That usually happens after weather disruptions like this. And you'll usually see an improvement in those businesses over the next 6, 9, 12 months.

Great. And then just a follow-up, I think we're all relatively familiar with the dynamics in North American transportation, LTL brokerage presently. Could you just kind of give us a compare contrast that you touched a bit on the European dynamic, but could you compare and contrast so we get perspective of how Europe's looking relative to how we understand the North America effect?

Sure. There are more similarities than differences. Capacity is a major theme in Europe right now. It's tighter now than it has been in a long period of time, which is more conducive to higher prices. The geography's difference of a length of haul on loads is much lower. And there are more competitors in general, because the landscape -- the population density is much closer. So you'll see more competitors. But now with tightening capacity, you're seeing price increases.

Our next question comes from the line of Amit Mehrotra with Deutsche Bank.

First one is on the free cash flow guidance. I guess when it was first provided earlier this year, embedded in that was the assumption of 4% to 6% revenue growth. You obviously had a decent pace above that for the last couple of quarters. So I just wanted to understand if that may translate to some opportunity for upside for the $550m that you laid out next year or if there are some offsets that we should be thinking about?

Well I think the numbers are right. I think we'll do $900 million over this year and next year in free cash flow. In shorter term, you're right that free cash flow gets dinged by higher organic growth, which is an investment we're very happy to make. When we have organic growth above our expectations, generally, put some more money into working capital.

Okay. So is the implied comment there or takeaway that, I mean, do you expect revenue growth to, kind of, decelerate to your 4% to 6% target next year? Or do you think what you guys are achieving kind of in the second and third quarter is sustainable as you look out into '18 versus '17?

We think there's opportunity. We plan our business around mid-single digit growth. But we're much happier with the high-single digit growth when we have the opportunity to do that. With all the things we're doing around sales force effectiveness, all the things we've invested in our sales force from a strategic account managers for the large accounts to adding 200 local account executives to incentive compensation, all those things, we think we can drive that upside into 2018.

Okay. And just one more follow-up, with respect to just the numbers. If you guys are growing or doubling the size of your footprint in heavy goods last mile, why would the overall growth rate kind of stay in this 10% to 15% or 14% to 15% level if that footprint is doubling, I guess over the next 12 to 18 months?

A good rate is that 10% to 15%. You have to understand the different pieces of last mile. One is dedicated, which is the more common type of last mile business, where we're delivering off the dock of a retailer. The larger growth aspect is in the e-commerce network, which is co-mingled freight which is using the hubs. What we see over time is a lot more of that volume shifting over from a dedicated business to co-mingled freight that flows through our hubs, and that's why you're seeing us double our hubs. So what that does is improve the amount of service we can provide to the large retailers that might be decreasing the size of their footprint. But more importantly, it allows us to provide a national presence for e-commerce customers and grow that business.

Okay, that makes sense. One maybe strategic one for Brad, just a follow-up with respect to the M&A. You made the comment that M&A deals are the cherry on the top. It was interesting comment, I thought at least, because you did raise a substantial amount of equity for a possible deal. And maybe I'm reading too much into that comment, but it just seems like, based on that comment, it seems like M&A may have taken a bit of a step back as you're realizing some of the organic growth opportunities, which are obviously substantial. So any color there in terms of your thinking or evolution in your thinking would be appreciated.

Yes, you may be reading more into that. I don't know if it's Freud or a critic of Freud, but sometimes a cigar is just a cigar. But I didn't mean to imply anything changed. In fact, I tried to imply that everything's the same. I just didn't want to spend 3/4 of this call talking about M&A like we did last quarter. But nothing's changed at all. And we're looking for a chip -- you said M&A has substantial opportunity to improve the business or something like that. Yes, it is. And we're looking for a substantial cherry. And we will find it.

Could I just ask one quick follow-up. I know I'm over my allotment, but just one more unrelated to that is, there is one large European logistics company that recently talked about being acquisitive. And so when you do look at the M&A field in that context and generally we've seen a lot of M&A activity across the entire market over the last few months. In that context, XPO shares do trade at a pretty substantial discount to most, if not all, I would say, asset-like players in the market. So I'm just trying to think about...

Yes, we agree with you on that sentence, by the way. We're very lucky...

But do you think it impacts your competitive ability, I guess, to effect a transaction, is really the question.

Sort of. There's some truth to that. We have to be disciplined in terms of what we pay, mindful of what our cost of capital is, both the cost of equity and the cost of debt. On the cost of debt, I don't think we're at a competitive disadvantage. Our cost of equity is higher than others, who have much, much higher multiples than we do. So we have to bear that in mind and we have to be disciplined on the price that we pay. Having said that, we have no shortage of people who we're in discussions with and who would love to do a deal with us and where there are synergies, and lots of opportunities and our appetite to do something very substantially improving of the business, make something very substantially accretive, something that can drive significant value for both customers and shareholders has not diminished at all.

Our next question comes from the line of Brandon Oglenski with Barclays.

This is Van Kegel on for Brandon. As you look at the traction in cross-selling across the portfolio, are you seeing more overlap in certain areas than others in terms of the secondary offerings being demanded by customers? And how does that play into your capital allocation strategy, generally, in the M&A, specifically, not to focus too much on that topic.

This is Scott. We do see some areas. Generally, we can cross-sell into our brokerage and transportation business a lot quicker, a lot faster. The sales cycles are a lot shorter, and the relationships on the contract logistics side are very tight. That's one of the great things about contract logistics. This is high value-add stuff. We're solving hard problems. We have very tight relationships with our customers, and we're able to cross sell our services over to other parts of the organization. It doesn't change our capital allocation strategy as much, if you look at our capital allocation strategy, technology is our top priority. Growth projects and supply chain is number two in size of CapEx. As we grow new projects, we make investments as we ramp them up putting in technology and ramping up the facilities. And then assets are right after that in terms of capacity on the transportation side.

And then, I guess, just quickly on managed transportation: How big a piece of that is in terms of net revenue in logistics? How much of logistics is managed transportation? And then can you give us an idea of the size of that business within the $1.7 billion pipeline?

Yes, the managed trans business in the quarter was about $135 million of revenue.

And then the pipeline?

It's part of the pipeline that we have. Brad spoke to the pipeline earlier in the call. But we do have a number of things that we're chasing right there. We've done a lot of in terms of enhancing the management team, both from a sales perspective and a daily management perspective. So we do see a big turnaround coming in that business next year.

Our next question comes from the line of Allison Landry with Crédit Suisse.

I was hoping to follow up on the strategy for North American last mile. So I guess, first, what are you currently generating in terms of revenue in the next-to-last mile business? And as we think about the expansion of the footprint of the hub, how large is the opportunity to run these trucks at night for the postal injection of palletized e-commerce packages?

Next-to-last mile is really important to our business. One of the reasons it's so important is for the contract carriers. One of the major competitive advantages we have in this business is that we're able to do more stops per day per contract carriers. And doing next to last mile business is overnight, which then gives the truck ability to run from morning till night, delivering appliances, furniture, those pieces. And then overnight, continuing to run that truck by slip seating a new driver in, and that makes it a competitive advantage for the best contract carriers in the industry, the ones that have the highest level of customer satisfaction, to want to work with XPO. It's still a smaller minority of the sales and profit of that business. But it's important strategically, because it gives us that strong capacity.

Okay. So that makes sense from a utilization standpoint and attracting and retaining the contract carriers. But is there sort of e-commerce capability with USPS injection sort of a key driver strategically when thinking about the expansion of the hub network?

It is a part of that, absolutely. Because as we have the hub network, we'll have the ability to do more for our customers at direct injection, the postal service with smaller package sizes. Now we can do the next to last mile. We can do also smaller package sizes for our customers that already doing the larger format goods. So it is a big opportunity long term for us.

Okay. And then I just wanted to ask about the peak season. I think you mentioned, I think it was a domestic comment, being in a good position from a capacity standpoint. But could you give us some color on your outlook or expectations for this year's peak relative to last year?

We can share with you what our customers are telling us, particularly in last mile. They expect a big peak season, specifically for the kinds of things that we do for them. So handling, appliances, and home electronics and furniture and hard-to-handle heavy goods that they use our networks for. The vast majority, not all, but almost all of the big retailers and e-tailers are telling us to get prepared. And they're happy that we have a bigger footprint this year to help them into the busy season. And we've actually added temporary buildings in major metro markets that are significantly larger than last year's temporary docs. So it's coming, it's coming, and we are prepared for it.

Our next question comes from the line of Bascome Majors with Susquehanna International Group.

Heading to 2018, you talked earlier about sticking by the EBITDA guidance and the organic growth guidance that you plan to. But if we do see organic revenue or you're able to grow the business a little bit faster on the top line, could you help us think about how that should flow through to EBITDA and eventually free cash flow? What are the puts and takes there and the leverage you may be able to generate to the bottom line in cash flow?

Bascome, we're generally getting 11% to 12% incremental margins on new business. But there are also additional investments we continue to make. So we'll continue to -- if organic growth is high, we generally add more to the sales force. We generally add growth investments to ramp up more growth across the organization. But we'll get about 11% to 12% incremental margins. That's not perfect across the business, and some of the parts of our business it's much, much higher. In LTL, it could be over 30%. In some of our brokerage businesses, it's high-single digit percentages. But it all averages out to that 11% to 12%.

And as we think about free cash flow, is it safe to assume that EBITDA upside will flow through one-to-one or do you think we should think a little more, I'm just kind of thinking about the leverage you have from EBITDA to cash?

You'll see obviously a tax raise associated to that will be a full cash tax payer in 2018. And then you see working capital investments. Depending on business, you can see 7% of incremental revenue go into working capital.

Okay. And just lastly here, as we set expectations for M&A and the deal set that you guys are looking at. How quickly would you need to see a large transaction be accretive to free cash flow on a per-share basis for your current equity holders?

In the ideal world, immediately.

Our next question comes from the line of David Campbell with Thompson, Davis & Company.

What about integration and rebranding costs next year? Do you expect there to be any more next year?

Yes, we expect the integration, rebranding costs to drop down significantly next year over this year. Right now, we've done year-to-date about $55 million. We'll do about $10 million more in the fourth quarter. And that number will drop way, way down in 2018.

$10 million for the whole year or something?

It'll be $65 million for the whole year.

Yes, but next year?

Well, next year, we haven't given guidance on that yet. We'll do that next call, but it will be significantly lower than it was this year.

Okay, good. And, in general, you're talking about costs and revenue savings in 2018, but not so much on the cost side. Have most of the cost benefits, especially from the acquisition of Con-way, and most of those cost benefits been realized in 2017? But you do talk about the OR going down next year. So is that cost savings or revenue synergies?

It's both. By the way, David, it's Brad. I haven't talked to you in a while. Good to hear your voice. As someone who has been covering us since 2011, you're very welcome to be on this call. We enjoy your questions. So it's both. We're always looking at sales growth, organic revenue growth, getting more share of wallet of our customers, getting the right pricing for the services that we're providing. And, at the same time, and with an equal passion, we're committed to being the cost leader in each of the geographies and in each of the service lines where we operate. So cost is an ongoing continuously improving project. Now with respect to the Con-way acquisition that we did in 2015, specifically, yes, we've taken out a lot of unnecessary costs there, particularly on the corporate side, and streamlining the organizational chart to more traditional business structure. But there's always ways to get more productivity. There are always ways to get more productivity on the dock. There are always ways to get more productivity on linehaul. There's always productivity. There are cost opportunities all the time and in any company, particularly a large company. If you don't stay laser focused on your cost structure, there must be a law of physics or nature that makes it just get bigger. You've got to fight that, and you have to justify all headcount additions, all increases in anything on the cost line. And we have a culture that is thoughtfully frugal, and results matter. And that's our slogan, and it's the reality of how we look at the business.

So the operating ratio of 87% can it go lower, you're not forecasting that necessarily, but it could go lower next year?

It will improve in the fourth quarter, and it will improve full year next year. And it will improve for the full year this year. We're not at industry best. Industry best is our competitor report in the low 80s, but significantly better than our OR. But hey, we were like number 8 or 9 couple of years ago. We're number 2 now, so it's not bad, it's not bad at all. So we're making progress and we love it when competitors do a better job than us at something, because that sets a new goal for us.

And, let's see, wonder if you could give me your estimate of interest expense this fourth quarter and next year compared to the $86 million reported in the third quarter?

The interest expense for the quarter will be about the same as it was in the third quarter. So, about flat sequentially.

And what about next year?

Next year, it'll be lower because we did a number of things this year to reduce interest. We didn't get the full year benefit of those this year, but we will next year. So again, we haven't given guidance for next year yet on all of these metrics, but it will be lower year-over-year in 2018.

I would think so, because you'll be reducing debt again with your cash flow estimates.

Correct. That's correct, we'll be generating cash that will be reducing our debt balance. We also refinanced our term loan a number of times over the last 12 months. And we've got some other debt coming due that we might have an opportunity to refinance at lower rates.

It just seems to me like in a lot of ways that you can make more money next year, and lowering your interest costs is one of them.

That's right.

Mr. Jacobs, there are no further questions. At this time, I'll turn the floor back to you for any final comments.

Thank you, operator, and thanks to everyone for participating in this call. Talk to you in 90 days. Have a good one.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.