XPO Inc (XPO) 2018 Q3 法說會逐字稿

Welcome to the XPO Logistics Q3 2018 Earnings Conference Call and Webcast. My name is Rob, and I'll be your operator for today's call. (Operator Instructions) 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 security laws, which by their nature, involve a number of risks and 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.

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 also may 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. 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 Brad Jacobs. Mr. Jacobs, you may begin.

Thank you, operator. And good morning, everybody. Thanks for joining our third quarter call. With me in Greenwich are Scott Malat, our Chief Strategy Officer; and Tavio Headley, our Senior Director of Investor Relations.

As you saw yesterday, we maintained strong momentum throughout the quarter. Our revenue, net income, EPS and adjusted EBITDA were all third quarter records. We generated robust organic revenue growth of 10.5%. And we signed up another $918 million of new business in the quarter, which was up a whopping 43% from a year ago.

We entered October with a new business pipeline of $3.7 billion. That's up $400 million year-over-year. We again grew our profitability faster than revenue. We generated adjusted EBITDA of $415 million despite a $16 million headwind from a customer bankruptcy in Europe.

Looking at our lines of business. Contract logistics was a standout once again. We grew our logistics revenue year-over-year by 13% with e-fulfillment ramping up globally. In North America, we grew our logistics business in the quarter by 18%. We implemented 26 contract logistics start-ups in the quarter, bringing the year-to-date count to a record 90 start-ups through September.

Freight brokerage was another highlight. We grew our North American brokerage revenue by 18% and notably, we increased brokerage net revenue by 46%. We launched the XPO Connect from scratch in April. 3 months later, 6,000 of our carriers had opted in and in the 3 months since then, we've expended to over 13,000 carriers. We expect the count to keep climbing fast. These are quality operators in our core network.

In North American LTL, we're continuing to create a more profitable customer mix, and the investments we're making in sales and operations are showing results. We've improved adjusted operating income by 220 basis points in the third quarter. And we expect our fourth quarter operating ratio to improve even more.

Companywide, we're continuing to make investments in secular drivers such as our proprietary technology and XPO Direct, our shared space distribution network. We have a collaborative sales force, sharing large customer relationships across geographies.

In last mile, we completed the expansion of our network to 85 hubs ahead of plan, and in contract logistics, our labor planning tools, powered by machine learning, are continuing to get results. We're seeing productivity gains of between 2% and 5%. These are some of the things that Fortune looked at, when they recently named us to their Fortune Future 50 list of companies, best positioned for breakout growth.

We've updated our full year 2018 target for adjusted EBITDA to approximately $1.585 billion. The revised target reflects the impact of the customer bankruptcy I mentioned earlier. And we've reaffirmed our target for approximately $1 billion of cumulative free cash flow over 2017 and '18.

Given our strategic positioning, we expect to continue to outpace the market in any macro environment, and we're looking at some exciting opportunities to accelerate that growth through acquisitions. Now, as you saw from yesterday's release, Scott will be leaving us in December. I'm grateful to Scott, for the major role he's played in growing the company. We've worked side-by-side since the beginning of XPO, and we'll sorely miss him, and we wish him the very best. And I'm very pleased that Matt Fassler will be joining us as our new Chief Strategy Officer. Matt's a well-known retail analyst and business unit leader at Goldman, and we're looking forward to introducing him to you.

With that, I'll ask Scott to review the third quarter numbers in more detail. Scott?

Thanks, Brad, and thanks for the kind words. I'm very proud to have been part of the growth of XPO these last 7 years. On a personal note, my family and I are moving to Europe. And we're looking forward to spending some quality time together. I have no doubt that XPO will continue to outperform for many years. I happen to know Matt Fassler well, having worked closely with him at Goldman. He's an incredible talent. He's going to add a lot of value to the team.

Now, looking at the quarter. We kept up the momentum across our operations. I'll walk you through the numbers in the operating environment by business unit. Starting with our transportation segment. We increased revenue by 11% to $2.9 billion. We grew operating income by 34% and adjusted EBITDA by 20% to $327 million. We generated our strongest transportation growth in freight brokerage. We increased revenue by 18% and improved our net revenue margin by 370 basis points to a record 18.7%. Within freight brokerage, the tight truckload market worked in our favor. We grew our truck brokerage revenue by 30%, and we did that with, roughly, the same headcount as last year. A large benefit came from our proprietary technology. We're able to manage more growth with lower costs by using automated load tracking, predictive analytics, automated load assignment and XPO Connect, our digital freight marketplace for shippers and carriers.

Market tightness has eased a little in October, with lower volumes being offset by higher net revenue margins. A strong holiday season could change that quickly. We'll know more over the next few weeks.

We also grew our intermodal business with double-digit revenue increase for the second straight quarter. The market dynamics for intermodal were favorable through the quarter and into October due to the delayed effect of what has been a tight truck market.

In North American less-than-truckload, we grew adjusted operating income by 24% and improved the operating ratio to 85.4% from 87.6% a year ago. We increased the amount of business with higher-margin local customers in our LTL mix, and the salespeople and dockworkers we hired are becoming more productive. We expect our fourth quarter operating ratio to improve at an even faster rate than the third quarter. Pricing on contract renewals in LTL was up a strong 5.3%. Revenue per hundredweight excluding fuel was up 1.9%, reflecting higher weight per shipment and shorter length of haul.

Our LTL tonnage declined 1.5% due to our decision to selectively target more profitable freight, partially offset by a 3% volume increase in higher-margin local freight. We were able to further reduce our purchased transportation costs by increasing utilization of our owned trucks to offset inflation. Purchased transportation made up 26% of our linehaul miles in the quarter versus 33% from a year ago.

We still have plenty of runway to optimize our LTL network. We're working on a number of technology projects that have the potential to add approximately $100 million to operating profit over the next 2 years. For example, we just launched Phase 1 of our new linehaul bypass model. This creates truckloads dedicated to direct freight shipments, instead of having the trucks stop at multiple service centers. So far, this change has shown an approximate 2.4% increase in direct loads.

In last mile, we grew revenue 12% to $271 million. Our net revenue margin was 28.2% in the quarter, below last year's margin of 29.5%. This was due to an increase in direct postal injection, which has a lower net revenue margin as well as to the higher cost of capacity. In September, we completed the planned expansion of our last mile hubs in North America. We're now at our goal of 85 hubs. This puts our last mile footprint within 125 miles of 90% of the U.S. population. We'll report almost $1.1 billion in last mile revenue this year. Our coverage and scale give customers a cost-effective national solution for heavy goods home delivery. Customers tell us, our services produce significantly higher customer satisfaction scores than our competition. We're working with a number of large retailers and e-commerce companies to ramp up their volumes on our expanded network going into the holidays and 2019.

In Europe, we had a solid performance from our transport operations. Revenue was $703 million, up 12%. Organic revenue growth, which excludes fuel and FX, was up 7.3%. This was the fastest organic growth in our European transport business on record. The U.K. was the leading driver with significant revenue increases in both dedicated truckload and LTL.

Other highlights for the quarter include our brokerage operations in France and Spain, where we grew both revenue and profitability. The truck market is tight across Europe, and our freight optimizer technology is helping us gain share by improving our access to capacity while lowering SG&A.

Turning to the logistics segment. The underlying momentum continues to be very strong. We increased our global logistics revenue to $1.5 billion in the quarter, up 13%. In North America, we capitalized on broad demand across verticals and grew our logistics revenue by a record 18%. The tailwinds came from double-digit growth in many of our verticals including e-fulfillment, consumer packaged goods, technology, agriculture, industrial and health care.

In Europe, we grew logistics revenue by 10%. If you exclude the impact of foreign exchange, our organic revenue growth in European logistics was 11.5%. The most rapid growth was in the Netherlands, the U.K. and Italy.

Our operating income for logistics globally was $60 million compared with $67 million a year ago, and our adjusted EBITDA was flat. These results reflect the bankruptcy charge from the one large customer Brad referenced earlier.

We're excited about the growth path we've created for contract logistics. Customers are continuing to outsource to us at a rapid pace. They like our advanced automation, our deep vertical expertise and our ability to secure talent. XPO is known in the industry as being a strong operator and the partner of choice for complex logistics. Last month, we announced plans to deploy 5,000 more intelligent robots in our logistics sites through a strategic partnership with robotics manufacturer Gray Orange. These robots have helped our employees to be about 4x more efficient while improving order accuracy. We've also been able to increase the density of product storage and enhance workplace safety.

Our XPO Direct shared space distribution network is ramping up fast. We now have 94 facilities in the network, up from 75 last quarter, with 2 more locations opening this month. Last week, the total value that ramped through XPO Direct was approximately 20x greater than what we shipped weekly during the summer. Most of this is coming from e-commerce and omni-channel customers. We also have some manufacturers looking for flexible distribution capabilities. We expect volume to step up again this quarter followed by an even more significant increase in the beginning of 2019. We expect XPO Direct to be a $1 billion business over the next 3 years.

That gives you an idea of some of the business drivers behind our momentum in the quarter. Next, I'll comment on a few financial items. Interest expense for the quarter decreased by 30% versus last year, due primarily to debt paydown and repricings. Given our recent ratings upgrades from both Moody's and S&P, our term loan is now investment grade. We'll continue to explore opportunities to optimize the terms and cost of our debt.

Cash flow from operations was $288 million, and free cash flow was $173 million in the quarter, despite higher levels of working capital and CapEx to support our growth as well as the customer bankruptcy. We expect our free cash flow to increase in the fourth quarter, partly due to an expected seasonal inflow of working capital and initiatives to optimize our AR and AP. We remain on track to generate approximately $625 million of free cash flow this year, meeting our cumulative 2-year target of $1 billion.

So in summary, we're on a strong trajectory heading into 2019. We'll continue to build on our leading positions in high-growth sectors and gain increasing share in the trillion-dollar market where we operate.

With that, we'll open it up for Q&A. Operator?

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

Scott, best of luck in the future. It's been great working with you.

Thanks, Chris. Very much appreciate it.

So wanted to kind of touch base a little bit on the comments you made about the fourth quarter, maybe get a sense of volume flows in October? I guess, you can give us a sense of, maybe, what you're seeing? Sounds like maybe a little bit of deceleration around the business? It's if any specific geographic areas and maybe sort of what LTL tonnage looks like? Just trying to get a sense of maybe what the layer of land looks like for the month of October so far?

Yes, sure, Chris. It's Scott. October has been our biggest revenue month of the year. We had over $1.5 billion in revenue. We have not seen a holiday peak yet, either in North America or Europe. That could change quickly though. We have seen a big pickup in intermodal volumes. And in the middle of October, we started to see a big pickup in those intermodal volumes. LTL, our trends have remained relatively consistent. We do have company-specific initiatives that are specifically targeting the type of freight mix that we want. So we've been able to increase the amount of local freight, and that's continued into October. And then the general trends have stayed the same.

Okay. That's helpful. And then just thinking a little bit about the free cash flow. So obviously, a pretty meaningful step-up expected in the fourth quarter, north of $400 million. Wanted to get a sense of the key drivers behind that step-up in the cash flow? And then as you think about 2019, I don't think -- I just want to get a sense of how we can think about that type of run rate? Is that sort of pronounced seasonality? Which has always been good in the fourth quarter from a free cash perspective, something we can translate into 2019 or beyond. Are there some timing mechanisms and issues with the customer bankruptcy that are sort of moving things around within this year and maybe we shouldn't extrapolate that forward?

We do expect over $400 million in free cash flow in the fourth quarter. And you're right to say, fourth quarter, we do have -- it's very typically favorable for a working capital. In the back half of December, sales tend to slow, and it creates an inflow of working capital. And this year, we're gaining steam in a number of initiatives to optimize our AR and AP. In 2019, it'll depend on the timing of CapEx, when it comes in the year and then also the timing of the growth and what money you put into or get out of working capital.

Okay. That's helpful. And then maybe one last one. you just, sort of -- Brad, when you're thinking about the business and sort of the trajectory into 2019, you guys, you've given us some help in terms of how to think about the investments that you're making this year, and how they could pay off in terms of growth in the future here. Just want to get your updated thoughts around that. Should we still be thinking about the ability to continue to grow, sort of, the EBITDA line in that midteens type of range? Just want to get a sense of may be how we think about it, as we're standing here late in 2018?

Yes. 15% to 18% EBITDA growth is still the base-case scenario. And we could do even higher with a positive macro. If you look at Q4, even with the revised lower guidance, we're still planning to grow EBITDA over 19%. Now on the macro, that's a mixed bag. We see some things that are positives. We see some things that are negative. We look at expedite internally, because expedite is usually the canary in the coal mine, and revenue is up 20% year-over-year. So it's obviously a good guy. Scott mentioned that intermodal picked up in October. That's positive. Our retail customers here in Europe are optimistic. They're looking forward to big peak, although we haven't seen it yet. And in truck brokerage, the net revenue growth in October was in the mid-teens. So lot of positive things going on at the moment. On the cons side, we don't know how the China trade war, geopolitical situation is going to play out. January 1 is a big date on that. In brokerage, the load-to-truck ratio has been deteriorating, but we've had strong net revenue growth despite slowing shipments. Generally speaking, we're seeing good things. $918 million of new business in the quarter, up 43% year-over-year, 10.5% organic revenue growth. But we have our antenna up.

Our next question is from the line of Matt Reustle with Goldman Sachs.

Brad, just to touch on the macro a bit. When you look at where the business stands today, the EBITDA base today, how do you measure your sensitivity to macro? And obviously, you've this growing contractual revenue base in logistics business, we would think of that as fairly inflated from the cycle. But curious, about how you think about the risk, when you mention that 15% to 18% EBITDA growth next year? If you were to see the macro turn, how much downside is there to that number?

Well, I think that we will definitely outperform the market in the competition in any macro. And I think that there's many mitigating factors in our favor. Scale works in our favor. The fact that we've got strong leading positions in the fastest growing parts of transportation and logistics, globally, helps a lot. The fact that we've got a lot of exposure to fast-growing e-com, helps a lot. The investments that we've made in technology that differentiates us in the eyes of the customer from our competition, that will help us a lot in any macro. And as you mentioned, in contract logistics, which is about 37% of our business, that's just a less cyclical business in general. And I would also mention the investments we've made in our global sales organization. We have a nice machine in sales, and that's one of the reasons that our new business pipeline and our organic growth is so high. If your question is, how do you think we'll perform in a deep recession? I think revenue will go down. I don't think it's going to go down steeply. I think it would go down 10%, 15%. I think EBITDA would go down, call it, 500 basis points more than whatever revenue went down. So if revenue went down 10%, I'd expect EBITDA to go down 15%. I would expect free cash flow to go up and up a lot, like up 1.5x. And the reason is, we only have about $200 million, $225 million of maintenance CapEx. Everything else is growth CapEx. So we have the ability to cut that back. And of course, as business slows, in a slowing environment, we get a benefit from working capital. So business unit wise, I would say, in a downturn, contract logistics, freight brokerage, some positive things in that in terms of margin. LTL, last mile, you see a negative effect from there. And overall, we'll see a benefit in the downturn from outsourcing trends. So that's how we look at the whole macro situation. Does that help you?

Yes. That's incredibly helpful. I appreciate that detail. And if I could just follow up, it looks like this morning, you made reference on the M&A market, valuations coming in a little bit, company is a little bit more open to dialogue. Can you elaborate on that a bit? Does -- was the upgrades in the term loan becoming investment grade and the improvement in debt cost a major step. How close are you in terms of these discussions?

The upgrades to investment grade for the term loan is a beautiful thing, but that really didn't affect any of our M&A activities. And M&A activity has perked up, particularly in the last few weeks. The reason that M&A discussions have become more lively is because valuations have come down, both with the public target -- targets that we're looking at, and with the private targets too. The sellers have just been generally more reasonable, generally more motivated and flexible. And the kinds of companies we're excited about, and we're attracted to, and that we -- if we can agree on price, agree on terms, we'd like to buy, are the ones that have long-term contractual relationships with customers, so there's recurring revenue streams. And as I said over and over again, we've remained disciplined, and we've sat on our hands for over a year to make sure that whatever we buy is both strategically compelling -- it's not just a deal, but it's a competitive deal, it makes a lot of sense - and it's very, very accretive for creating shareholder value. So I'm more optimistic about the timing of M&A than I have been in the past.

The next question is from the line of Ravi Shanker with Morgan Stanley.

Given the offsets, Scott, good luck with the move, and you will definitely be missed.

Thanks, Ravi.

If I can just kind of ask you about your growth, which has obviously been impressive, both the organic growth and the pipeline. One of the challenges with growing that quickly is, kind of, finding labor, and that has been a global problem. Just wondering if you guys are running into that issue and if that's constraining you at all, both in the U.S. and in Europe? And also, kind of just, given your -- the purchase of the 5,000 robots, kind of, at what point do you think you guys can take a step-function jump with the level of automation you have? Not just in software and services business but also in things like warehousing and contract logistics?

Okay. Well, you're going to get me going bringing up the robot, but let me address the labor issue first. So on labor, there absolutely is labor inflation here and in Europe, I mean, on the extremes. You go to Netherlands, it has 0% unemployment. So it's hard find -- not a lot of labor when it's 0% people unemployed. But everywhere, there's wage inflation, there's shortage of labor in every single country that we're operating in, in different degrees. The good thing is, we've built up a great brand, and we're getting literally over 80,000 applications a month globally for jobs. So we're on a run rate of 1 million applications a year for jobs in the business. So we've got a good recruitment organization, but there's definitely wage pressure, and you're going to see labor cost continue to go up for the foreseeable future, strictly due to supply and demand. Now robots. So robots, I'm quite excited about. So we made good progress on the 5,000 robots that we have ordered and the initial feedback -- the initial results we've gotten from them are that, they're dramatically improving 3 things: speed, accuracy and safety. And I had a fourth point to that: employee satisfaction. They're co-bots. They're collaborative robots that work collaboratively with our employees. They make employees 4x more efficient on their picks. 4x. And the job is just so much enjoyable for the human because less walking around, you don't have to walk -- they're goods-to-persons robot. So the robots bring the goods to the person. So you don't have to schlep all around the warehouse to move the goods. Less lifting, so less back injuries and fewer accidents overall. From our point of view, one really good feature about the partners that we've partnered with on the robots is that they're fungible, and that they can move between facilities. So as we see different peaks and ebbs in different warehouses, different contract logistics facilities, we can move them to different places. So I'm really excited about the robots. I think it's the future, and I think it's a win-win situation for employees and for the company. We do have about $6-plus billion of labor costs worldwide. So to the extent that we can automate, we want to automate. And there's a lot of good stuff going on in our tech investments, not just on the contract logistics side, but also in LTL and labor planning tools and Drive XPO and XPO Connect, all across the board. Lot of fantastic stuff going on and practical, pragmatic results-oriented technology investments.

Got it. That's really helpful. Can I just ask you, on that same note, on the brokerage side of the business. I think, for the last several quarters now, you've grown that business double digits with declining headcount, which is impressive. What percent of your transactions of that business would you say are automated? And kind of, do you think you have the full suite of capabilities there to kind of match any of the new tech guys in that space?

More than half. So I'll repeat that. Over 50% of our loads in truck brokerage today are offered to our carriers electronically. Not from someone talking on the phone to a dispatch, talking to a driver. Automatically, electronically, over the computer. And they're customized for the carrier's preferences. So we're very much at the cutting edge of technology in terms of truck brokerage, and we firmly intend to stay at that cutting edge. Now, you asked about some of the start-ups and some of the new entrants. Some of those new entrants aren't going to work, but some of them will over time. But today, at this moment, if you add up all the new entrants who've come in over the last 5, 6, 7 years, you don't even get to $1 billion of revenue in aggregate. So our competition today is, of course, C.H. Robinson is much larger than us in truck brokerage, at least here in United States. And TQL and Echo and they're large established, for lack of a better word, bricks-and-mortar trucks brokerage. Like all of them are also going electronic as well. We're leading the pack on that.

The next question is from the line of Scott Schneeberger with Oppenheimer.

And Scott, congratulations on your new chapter. I guess, I'd like to start out in contract logistics, as you ramp, should we be more weary as you ramp up, and you're putting so much new start-up pressure on the business that there could be margin disruption going forward. Brad, could you just address that?

In contract logistics, there's a lot of positive momentum. If you look at our revenue globally, it's up 13% year-over-year. North American supply chain, in particular, was up 18%. We had double-digit revenue growth in each of the main verticals. So e-com, tech, consumer package goods, ag, industrial, health care, each one of those verticals, double-digit growth. So it's very spread across the board. So what does that tell you? It tells you that our value proposition is strong. And if you look in Europe supply chain, organic revenue is up 11.5%. And despite the severe labor shortage in the Netherlands, that's our fastest growing supply-chain market in Europe. But the U.K, France, Italy, they're growing fast too. You saw in our prepared remarks that we had a record number of contract start-ups year-to-date, which is spread roughly evenly, about 46 in -- not about. Exactly. 46 in Europe, 44 in North America, and we got another 22 contract logistics start-ups expected in the fourth quarter, split even, even between Europe and North America. So supply chain is growing very fast.

Yes. As you say, that it was -- yes, the question was about, obviously, you want to get as many of those on, and it's going well. Just curious about the margin impact in given quarters? But let's take that a higher level. On the total business, under the assumption current business conditions persist, and you continue to ramp up new contracts, transportation and logistics, how do you conceptually think about the incremental EBITDA margin for the overall business? Do you think it gives us a feel about modeling going forward?

Yeah, it's Scott. The incremental margins are generally 12% to 13%, but it does depend on what part of the business we grow. So in some parts of the business like LTL we'll have incremental margins over 30%. In some asset-light parts of the business, we'll have 6% or 7% incremental EBITDA margins. In terms of contract logistics, well likely movement of margins is probably on the upside, moving on -- moving in the upside. We have continued to have, as you had said, the impact of new starts on margins. But that's been happening over the last few years. So we -- with our robotics and improvement in efficiencies and the data-driven tools that we've deployed, we would expect margins would likely go up.

The next question comes from the line of Allison Landry with Credit Suisse.

And Scott, congrats. We're definitely going to miss you.

Thanks, Allison.

On the Q4 free cash, if I -- just thinking about the sequential step-up from roughly 170 to 410 or whatever it is, how much of the $240 million sequential increase is what you would consider the seasonal inflow versus some of the initiatives for working capital efficiency?

There's -- typically, in seasonality, we put in, what, $450 million of working capital so far this year. So a lot of that will come back to us naturally. In terms of the initiatives, well, there's just a lot different things we're doing. We've invested that $450 million. Now there's a large effort working to offset customers that are looking to extend payment days. We're negotiating hard around those terms. We're changing the comp plans, including working capital incentives. We're increasing factoring programs, so it makes economic sense. There's a big focus on collections teams, rightsizing the teams, putting new systems to manage processes, focus on driving timely payments, faster invoicing. We've also focused on the payables, so negotiating better terms with suppliers. Moving supply -- some supplier payments to credit card, providing supply chain finance programs, not paying earlier than we need to. So there's a lot of things going on.

Okay, but no way to really think about, sort of, how much each will contribute?

No, I mean, of the $450 million, that's obviously a lot larger than what, we generally think of general think of working capital usage of around 8% of the growth in sales. So the excess there, a lot will be -- a lot of that excess will be coming back, just seasonally.

Okay. That's definitely helpful. And in terms of the XPO Direct, it really sounds like that business is ramping up fast, and you've had the revenue, the $1 billion revenue target for the next 3 to 4 years. Could you help us think through the margin and the ROIC profile on this business?

Alison, it's Brad. I don't, for competitive reasons, want to put that out there. But I will tell you that we're making good progress in XPO Direct. We had 75 facilities in that network last quarter. We're up to 94 now, opening 2 more this month. Just to give you the flavor for the trajectory, last week, the total volumes moving through XPO Direct was 20x the weekly rate we had in September, and we have lots of blue-chip customers that are piloting it. And as they test it and become more satisfied with it, I'd expect those volumes to accelerate. Of course, it will accelerate into peak, but we also expect a significant step-up in Q1. The customers are not just e-com, they're not just retail, we also have some manufacturers, and we like that because that's going to spread out across the years, 'cause they have a different peak. So lots of good activity there, but I don't want to share with you exact margins in ROICs.

Okay. Maybe I could ask just ask it this way, longer term, would you expect the margins to be accretive?

Yes. Yes, I do. Are you there? Al?

We lost Ms. Landry's line. Our next question comes from Amit Mehrotra with Deutsche Bank.

Let me pile on, Scott, and just -- congrats on the -- all the success. You've been such a great help, and I appreciate it and wish you the best.

Thanks.

Brad, last quarter, you did provide a way to think about topline growth and EBITDA growth beyond 2018. And I think you, sort of, touched on that in the answer to Chris Wetherbee's question. But I guess, the missing piece has been the CapEx, and I know you're kind of in the middle of a budgeting process. But given now we're pretty close to the end of the year, any help with respect to initial thoughts on where CapEx may go relative to that kind of $460 million, $465 million this year, just to help us frame up the free-cash story for '19?

The short answer is no. The long answer is, we're still doing a very highly choreographed kabuki dance in our organization during the budgeting season, where we have lots of requests from every single business unit and every single shared services for CapEx, that they make great cases for, have high ROIs and particularly on technology projects, and we have to just decide where we're going to draw the line and we stack rank all of them. We stack rank them just metric -- by metrics, numerically, on what the ROIs are going to be. And also, how important are they to long-term, to our strategy and to differentiating ourselves from the perspective of customers. And then we determine how much CapEx we're going to spend. But that is definitely a big tension internally inside the company of, how do you balance investing in great CapEx projects, but also delivering on free cash flow because it's a zero sum game. So with that, stay tuned. We haven't figured that out yet. We haven't answered that. That's part of the budgeting process. And we're going with that.

We'll communicate that.

Yes, if it's okay, let me just push back on you a little bit on that because you don't have to give out a number, but you can talk philosophically about the CapEx intensity of the business. So right now, one of the unique selling points of XPO is all the organic growth coming in at CapEx and under 3% of sales. And so I just -- I don't want to be here, I don't think the market wants to be surprised by seeing that, that goes to 5% because you have all those ROIC -- high-ROIC projects. So any help on, I'm thinking about just philosophically, where you think CapEx intensity goes? And should that change where -- relative to where we are today?

Well, it's certainly not going to 5%. I can put that to rest. But there is a school of thought that says, let's just keep pumping out all this free cash flow, use the free cash flow to pay down debts, to do acquisitions, to invest in the business - just to grow in general. And there's another school of thought that says, that's fine, but maybe you can decrease the cash flow a little bit and take some of the cash flow for CapEx and to invest more in technology that has high ROIC. But not in the extreme. We're not going to go to extreme on either level. We're not going to go to extreme, where we suddenly take all that free cash flow and put it into CapEx, even though that would, long term, create a huge amount of growth. But that's not our business plan, and we're not going to do the contrary either. We're going to find the middle path.

Right. Okay, that's helpful. That's really helpful. And then just one quick follow-up on XPO Direct. Scott, I don't know if I heard this correctly, but you said $1 billion in 3 years. I think, last quarter, you said $1 billion in 3 to 4 years. Maybe I'm just reading too much into that, but has the earnings trajectory increased for XPO Direct, just given the success you're having to date?

No. It's been very much on track. And it's ramping up this quarter very -- much more significantly and then on into 2019, as we move forward in 3 to 4 years, it gets closer to 3 years.

Okay. One last question for me on M&A, just a follow-up to an earlier question. I mean, I agree multiples have come down. I'm just a bit surprised by talking about how things are heating up a little bit because XPO's multiple, you could argue, have come down as well along with the potential targets. There's, obviously, a transition in the Chief Strategy position. The M&A environment has gotten more competitive with DSV and Geodis. Both have recently talked about their own M&A ambitions in the European logistics space. So can you just help us think about that? And given things are heating up, maybe you can just update us on, how you're thinking about what the company will pay, leverage sizing, and maybe the asset intensity pro forma for a deal?

So all the above, nothing's changed at all from what we've said in the past. What's changed is, externally, sellers are a little bit more motivated, little more ready to do business. Many of the ones we're talking to in the past, just haven't been ready to sell. I mean, they're ready to sell in the future, but they weren't ready to sell today in the present. So we're just developing relationship and gaining mutual trust and getting to know each other more and more. But they just weren't ready to make a deal. And now more people are getting more motivated to do a deal. With respect to the 2 companies that you mentioned, we're not aware of any targets that we're looking at that they are also in the mix. And in fact, almost all the ones we're talking to, we're the only suitor talking to them because we avoid processes, we avoid auctions. If you look at Norbert Dentressangle, if you look at Con-way, these were not auctions. These were 1-to-1 proprietary discussions that we worked together to come to a win-win deal. So we don't have -- we try to avoid the competitive situations. That's not our preference.

Our next question is from the line of Kevin Sterling with Seaport Global.

And let me jump on, Scott, and say, congratulations. I wish you the best of luck there in Europe. I've enjoyed working with you over the years. And I'd tell you, 7 years flies by, doesn't it?

It really does. Thanks, Kevin.

And Brad, most of my questions have been answered, but you guys highlighted the growth you're seeing in intermodal right now, it's a real strength. And rail service, as we all know, is still not that good. So what do you think is driving this growth in intermodal despite what many might consider lackluster service?

Well, it's certainly not rail service. That we can agree on. It is up though. Revenue is up double digits in intermodal, and this is the 2nd consecutive quarter that we've had double-digit revenue growth. What's driving it is higher yields, so we're getting more revenue from that, and new business wins. We're gaining more market share, mainly due to cross-sell with customers that we have in LTL and in brokerage. And I will also say, some customers have more of a proclivity to put up with the rail service situation because even though the market is not as tight as it has been in truck, it's still tight. And so they're thinking about long-term alternatives in that and diversifying a little bit, just not having just truck as a supply chain alternative, but also looking at intermodal.

Yes. So do you think we are seeing some truck conversion to rail?

Yes. Absolutely. And that's been going on for the past -- the last year with quite a number of customers.

Yes. And obviously, you guys, you continue to put up impressive net-revenue numbers in truck brokerage. Are we seeing, are you seeing, among your customer base, shippers, like, leaving the spot market, looking to lock in? You have contracts with truckers because they are fearful of getting capacity tightening. Obviously, we're seeing some truck conversion to intermodal. Are you seeing, kind of, there's still bit of a change in shipper behavior, possibly moving out of the spot market into the contractual market and dedicated market within truck?

Certainly. You've seen in the last, I'll call it, even 6 months, a significant shift from spot exposure to contractual business. And our proportions have basically flipped. And right now, we're roughly 45% spot, 55% contractual. If you'd have asked us that, early in the year, would've been the exact opposite. So yes, customers are looking -- absolutely preferring more to do long-term contractual business than spot. Now they can't -- many customers can't go to 100% spot -- 100% contractual because they don't know what their volumes are going to be. So there's ebbs and flows, and they rely on the spot market for those peaks.

The next question is from the line of Brandon Oglenski with Barclays.

Scott, equally happy to see you go, but sad not to work with you again. Brad, I guess, if we could unpack 2018. Going into the year, we thought you'd see a bit more margin expansion, maybe a little bit less core growth. I know we talked about this a few quarters ago, you guys wanting to reinvest in the business and tackle some of those opportunities. Is that the way we should think about 2019 too? And I guess, if I could be a bit more skeptical, I could argue that maybe the low-hanging cost opportunities just aren't that easy -- or you've accomplished a lot of them. So can we talk about margin targets and where you want to see the business?

Yes. That -- there will always be cost-out opportunities because even though we're running the company very, very well, there's always inefficiencies to find. There's always waste that can be removed. There's always process improvement. There's always some places where we're overstaffed, some place we're understaffed, some places where we're just not managing overtime perfectly. There's some places where we've got excellent safety, years without an accident or an injury. There's other places that we could still improve on safety. So I can -- we could put on a whole list, and this is what we do for a living. And we honestly self-assess where we're doing well, and where we can do better, and then we mobilize our resources to do better. And controlling cost is absolutely important because our customers, themselves, have huge pressure on them to grow their margins, and they look to their vendors, they look to their suppliers, to help them with that. So we're always looking to take cost out wherever it's appropriate to do so. And there's still lots of opportunities to do that. Now, it won't be the same costs every year. There'll be different opportunities in cost, but there's always opportunities to improve the margins in every part of our business. Now, did I miss another part of your question? Was there another part, Brandon?

Well, I guess, if we go back a year or 2, I mean, it was pretty clear, and I think the turns were clear from you guys, that you wanted to get about 100 basis points in margin improvement a year. Is that just not the case anymore?

That is the case now. That is our goal. We haven't finished the budget process. We haven't given guidance for next year. But in general terms, one of our big goals in life is to grow the margins, grow the top line, and that's how the profits come. So we want to grow the top line, continuing nice healthy organic revenue growth through price and volume, and we want to be running the business better and reducing costs so that our margins expand, and as a result of that, showing nice healthy profit growth. That's, in simple financial terms, that is still our model, and it always will be.

Okay. I appreciate that. And then quickly on the balance sheet side, and I guess, it's kind of related to M&A as well. You did that equity sell, I think it was at last July, and we haven't, obviously, seen an M&A deal since then. But I think the notion then was that look, we want to raise the equity to have it ready to go, when and if the deal closes as opposed to trying to do a post-deal financing. But what we've seen you, you know, with cash management, I think you've paid down quite a bit of debt here. So should we be thinking that that's just -- the opportunity to use the cash isn't that quick? Or this is just a better use of the balance sheet right now?

The latter. So we paid down debt because it didn't make any sense to have cash sitting on the balance sheet, earning less than we're paying on interest. It's just -- there's no, there's no, in a corporate finance sense -- no argument to do that. So we used the cash that we had to pay down debt. That was completely divorced from what we're doing in M&A. In M&A, we are actively looking at M&A candidates. We have been for a while now. We have -- we don't feel a gun to our heads to do an M&A deal, but we want to do an M&A deal. But we only want to do an M&A deal we love. And be patient, we will definitely get there.

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

And Scott, congratulations and Tavio, congratulations to you as well.

Thank you.

I guess, just maybe a housekeeping one to start. Brad, do you have -- what is the annual EBITDA run rate from the customer bankruptcy that happened here in the quarter?

It was mid -- low single-digit millions EBITDA.

On a full year basis, it was a low single digits of EBITDA?

Yes, which is -- which still really bothered us because here, we are, making low-single-digit millions in EBITDA, and we let our heart get ahead of our mind in trying to support a customer and ended up writing-off $16 million. But c'est la vie.

Okay. Got it. And then -- so we think about the growth rates going forward though it's not a huge comp to overcome that on an annual basis?

It's a rounding error, but it made us miss the quarter, which is something we work really hard not to do. So on a long-term basis, it's really just -- it's nothing. It's a few million bucks.

Got it. Understood. Okay. And then for kind of my main questions, with the growth rate here in final mile, up 12% on a revenue basis here in the quarter, and I know you talked about doing a little bit north of $1.1 billion on a full year, how do you think about the final mile growth rates going forward? I think when you talked about that market in the past, it had kind of been mid-teens, one of the faster growing markets, I know that the business is getting bigger at this point. So just a lot of large numbers comes into play. But how should we think about your ability to continue grow that business? And as you should think about that longer term, is it more a function of the comps? Or is it that there's more competition and more mix in those things that are going on?

It certainly not more competition. It's self-imposed, in that particularly in last mile, the level of customer satisfaction is really important to the customer. We're going right into their customers' houses and apartments. And so we're just zealous with making sure that our customer service levels are extremely, extremely high. I believe that we'll continue to grow that business double digits between 10% and 15%. You may have a quarter here or there that's higher in that. But 10% to 15% is the right band to look at for going at last mile. If we grew that business as much as the opportunity is, which would be over 20%, it would be short-term thinking because our service levels would come down. And then our -- and then that business will go away from us. We are at a certain size, certain scale in last mile. We have a certain level of density. We have a superior cost structure. And most importantly, we have the highest level of customer service. We're told this by our customers, when they -- in the QBRs, when they show us the stack rankings between us and any other providers, if it's one of our customers that use another provider. And we're almost always, I don't say always, but almost always top-ranked in terms of customer -- in terms of net promoter scores with the customers. And that's very, very important for us to maintain. If we stay at that 10% to 15% top line growth, and you're right, we're at a $1.1 billion revenue level now, then life would be good.

Okay, got it. So the growth opportunity is there, but you have to balance it with the service that you're providing?

You've said it more succinctly than I did. Thank you. Yes.

Al right Brad. Then just the last one for me. As you think about the LTL business going into 2019, it sounds like the margin improvement that you laid out this year, the 150 to 200 basis points, you're clearly going to achieve that. Same sort of thing though, I mean the comparisons become more difficult. Is that more of a function now, that you're going to harvest some of the investment on the sales side, and so there's a little more balance between growth and particularly growth at the field accounts, that can be more profitable? And indeed the rate of margin improvements from kind of self-help and cost takeouts slows. How to we think about both the top line growth and LTL and get the margin improvement into '19?

Well, if you look at where we were in the quarter, let's start there. We grew operating income 24%, and we improved operating ratio by 230 basis points with the best third quarter overall in 30 years. So we're in a good place where we are. On the top line, pricing on contract renewals was up 5.3%. So that's also healthy going forward. Tonnage was down, though. Tonnage was down 1.5%, which is in-line with recent quarters and consistent with our strategy of selectively targeting the more -- the freight that fits our network the best, more profitable freight. And you mentioned the investment in the local sales force. I'm very happy that we did that. And the proof's in the pudding, where our local tonnage was up 3% in the third quarter. But where the real juice is, long term for us in LTL, is in technology. And there are 4 categories of technology that we've been investing resources in and are super, super excited about, that in -- that together, we expect them to contribute about $100 million of operating income benefit over the next couple of years. And those are AI-based load-building tools. So what I mean by that is, old-school LTL, the pallets committed the cross-dock, and for the most part, they are put in the right trailer or sometimes, not the right trailer, and sometimes, they are placed in the right sequence in the trailer and sometimes they're not. We are doing this all now going forward through IT, through technology. So that the right freight is loaded in the optimal trailer and in the optimal place in the trailer, the optimal sequence in the placing of it. And the efficiency for freight movement, as a result of that, is very significant and of course, it's good to minimize damages. The second bucket of technology in LTL, that we're excited about is, advanced linehaul algorithms. And the reason we are emphasizing that is, when we stepped back into the strategic view of LTL, a few months ago, and went around the room and said, what is the biggest leverage we can push to, and prove our LTL business even more and take it to the next level. Quite a lot of people independently said, "let's build more cures." Let's build more direct loads, so that we don't have trucks going around God's creation in every which direction, but we're going more from point A to point B. And for that, the first category that I mentioned, which is getting the right freight in the right trailer, helps with that, but also getting the algorithms to then program -- load -- the route optimization, the linehaul is also a big plus. The third area of LTL tech innovation that we're excited about is pricing algorithms. And when you look at the hotel industry, you look at the airline industry, there's so much ahead of us. And we were committed to catching up and suppressing them. So we're using machine learning to predict price elasticity. Old school, LTL, RFP comes in, takes a week, sometimes 2 weeks. You conserve our competitors, sometimes, it's even more than 2 weeks to get a response back from that, and it's not even perfect. We want to be able to give almost instantaneous responses to RFPs as they come in. And we want to be using up-to-the-minute current real time supply demand information and take into consideration, what are capacity is. Which is similar to what we did at my last company in the equipment rental business. Then the fourth area that is a big -- to answer your question about what's the big strategy going forward for the uplift, is dynamic route optimization for the P&D. And if you look at -- you'll get -- if you look at another, if you look at the waste management industry, they're light years ahead of us in LTL. All across the board, they're much -- they get many more stops per hour, and it's more Waze-like base. It's more real-time, taking into consideration traffic patterns, taking into consideration how the day is going for each truck and then changing that all day long. So the upshot of that, doing dynamic route optimization on P&D is going to increase stops per hour a lot. So those 4 categories of LTL tech innovations are really important drivers to our business long term.

Yes. That's helpful. I think that -- we've all known that the opportunity has been out there in the industry in general, and it's interesting to hear you guys moving forward with that. So I'll look forward to a service center tour at some point in the future.

Next question is from the line of Ari Rosa with Bank of America.

Just to echo everyone else's comments, Scott, it's been great working with you. Good luck on the next phase.

Thanks very much.

So just -- I wanted to say on the -- this LTL point, you mentioned the strong incremental margins in that space. And I'm wondering, you've gone -- you've had the strategy for a long-term of kind of calling customer accounts and focusing on more regional freight, but given the strong incremental margins, would it make sense strategically to maybe be looking to grow that business a little bit more aggressively? And not seeing, kind of, the declines in shipments and tonnage that we've been seeing?

Absolutely. That's one of the reasons why we added to our local account executive sales force. We added over 200 sales and sales support to grow the business. But we don't run the business by incremental margins. We run the business with fully allocated costs. We do a service and we work very hard for the customer. And we earn a fair return for that. So we don't run it on incremental basis, which you could always do. You could always make the case, well, let's just throw another pallet onto the truck and make more money. We look at it as fully allocated cost, what's profitable.

Okay. Makes sense. And so at what point do you think you see that inflection in terms of starting to return to volume growth?

I think you're seeing the local accounts in the positive territory, positive 3. But to take a look at what our opportunities are, what are the most profitable freight next year, but likely, there'll be less cutting of unprofitable accounts next year than we did this year.

Got it. And then, Brad, you had mentioned the 15% to 18% EBITDA growth target. Not to beat a dead horse, but I'm curious to hear what your thoughts are on the kind of variability of that number depending on the macro environment? Should we see 15% as a floor? Or should we expect some fluctuations year in, year out?

I don't think, you should look at it as a floor. I mean, if we have China tariffs and trade war actually continues for a long, long period of time, everybody is going to get hurt. Everybody, globally. And including our competition, including us. We're not going to be the only company that grows and everybody else is seeing GDP growth go downwards. So I wouldn't say it's a floor. In a macro that resembling anything like the positive macro we've been experiencing this year, yes, you should see 15% or more EBITDA growth. But in a negative macro, while we will absolutely outperform the competition, outperform the market because of all the characteristics of the company, we're not going to grow 15% to 18% in a recession. That's not going to happen.

Okay. That make sense. And then just last one on my end. I think, in the last quarter, maybe just 2 quarters ago, you said -- you talked about narrowing down the M&A list, and I think you had mentioned that it was something under 10 targets that you were kind of actively engaged in dialogues with. Given some of the changes around valuations and the volatility that we've seen in the market, does it change your view in terms of the customer list or the acquisition target list that you'd look at? Do you maybe take a step back and reevaluate a broader set of opportunities?

Not really. The ones that we've got shortlisted right now, and we -- if you recall, we shortlisted that from hundreds and hundreds of the ones that we looked at over the process- I like them all. I mean, they're all really good deals. You just got to get the right price and the right terms. And we also have to have a willing seller. So as soon as the stars line up on those scores, we'll do the deal, but it's not like, we're revisiting the whole list of one's that we rejected.

Got it. But it's safe to say that you guys have actively engaged all of the people on that list in some form of dialogue? Is that correct?

Correct. That's correct. All right, well we're over the hour. Once again, we have to increase our brevity skills. But thank you all for your interest, and look forward to talking to you in 90 days. Have a great day.

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