Hub Group Inc
NASDAQ:HUBG
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Hub Group Inc
Earnings Call Analysis
Q3-2023 Analysis
Hub Group Inc
Hub Group, a leader in transportation management, has showcased resilience and adaptability in a challenging freight cycle. Leveraging a strategy focused on organic investment and capital efficiency, the company has evolved into a diversified entity, offering industry-leading services and generating significant free cash flow. These strategic initiatives have culminated in the expectation of one of the best years in the company's history, utilizing technology deployment and non-asset-based acquisitions to augment service offerings to clients.
Hub Group has taken affirmative steps to enrich shareholder value by authorizing a new $250 million share repurchase program, retiring its remaining $83 million program, and establishing a $0.50 per share annual dividend to commence in the following year. A 2-for-1 share split is also planned to enhance stock liquidity. These actions reaffirm the company's conviction in its intrinsic value and its drive to offer consistent returns on capital.
Despite a 30% decline in ITS segment revenue due to decreased intermodal volume and other market pressures, Hub Group has efficiently managed costs. The firm has navigated the adverse conditions by reinforcing its dedicated trucking growth and yield expansion and by optimizing its intermodal cost structure, enabling further conversions from over-the-road to intermodal transportation.
Hub Group demonstrated stability amidst recessionary conditions, securing over $1 billion in quarterly revenue and maintaining an operating income margin of 4.2%. Though the company experienced a decrease in segment revenues and an increase in certain operating costs, efforts in cost-containment and yield management have partially offset these challenges. Hub Group's financial discipline is reflected in its significant free cash generation and a constructive outlook on demand improvement.
Looking ahead, Hub Group projects a diluted EPS of $5.30 to $5.40 for the year with projected revenue approximately at $4.2 billion. The company is preparing for a full year of low to mid-teen declines in intermodal volume and focusing on improved operating efficiency and lower purchase transportation costs. These measures, along with an expected tax rate of 20% and unchanged capital expenditures of $140 to $150 million, position the company to generate over $250 million in EBITDA less capital expenditures.
The current market conditions signal a significant opportunity for Hub Group to convert business back to intermodal, supported by advantageous cost dynamics including fuel expenses and improved service levels. The company has seen improvement in volume trends month over month leading into October and is committed to leveraging its robust pipeline and strategic growth initiatives, including accretive mergers and acquisitions, to bolster its competitive positioning.
While current CapEx is estimated between $140 to $150 million, Hub Group anticipates a significant reduction next year, further enhancing its free cash flow. These preliminary indications suggest a focus on asset utilization and strategic growth through acquisitions and cross-selling, aligning capital outlays with long-term value creation.
A testament to Hub Group's operational dexterity is a reported 10% increase in equipment utilization from the second to the third quarter. The organization is also exploring strategies to expand customer engagement by cross-selling services, which forms a fundamental component of their growth plan for the upcoming year.
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Hello, and welcome to the Hub Group Third Quarter 2023 Earnings Conference Call. Phil Yeager, Hub's President and CEO; Brian Alexander, Hub's Chief Operating Officer; and Geoff DeMartino, Hub's CFO, are joining me on the call. [Operator Instructions]Any forward-looking statements made during the course of the call or contained in the release represent the company's best good faith judgment as to what may happen in the future. Statements that are forward-looking can be identified by the use of words such as believe, expect, anticipate and project and variations of these words. Please review the cautionary statements in the release.In addition, you should refer to the disclosures in the company's Form 10-K and other SEC filings regarding factors that could cause actual results to differ materially from those projected in these forward-looking statements.As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to your host, Phil Yeager. You may now begin.
Good afternoon, and thank you for joining Hub Group's Third Quarter Earnings Call. Joining me today are Brian Alexander, Hub Group's Chief Operating Officer; and Geoff DeMartino, our Chief Financial Officer.Over the past few years, we have transformed our earnings, returns and free cash flow profile through a clear strategy of organic investment into our core business, while enhancing capital efficiency through technology deployment and accretive non-asset-based acquisition. In ITS, we have created a lot of asset-intensive model that provides industry-leading service and value, while becoming more efficient through enhancements to our drayage and dedicated operations.In Logistics, we have built a service leading end-to-end solution for our customers that provide best-in-class scale and technology. This evolution of our business has resulted in Hub Group being a more diversified and resilient company with an improved customer experience as well as significant free cash generation.Our operating model changes have proven effective as we have managed through this challenging freight cycle with a full year forecast that we expect will likely be our second best year in our company's 52-year history.With that performance in mind and with the benefit of extensive feedback from our Board as well as existing and potential shareholders and equity analysts, we have taken the opportunity to reassess our capital deployment strategy. I'm excited to announce the results, which are also highlighted in the investor presentation, which is available on our website.First, we are establishing a long-term leverage target of 0.75 to 1.25x net debt/EBITDA. We are not in a rush to achieve this target, and we'll do so methodically as we continue to invest in our core business, grow via acquisition and return capital to shareholders.Second, we have received authorization from our Board for a $250 million share repurchase program while retiring our current authorization which had $83 million remaining. We believe this new and larger program demonstrates our commitment to returning capital to shareholders and the long-term value we see in Hub Group.Third, our Board has authorized a 2-for-1 share split that will be effectuated early in 2024 through a share dividend, which we believe will enhance liquidity in our stock and support long-term investments.Last, in the first quarter of next year, we plan to begin paying a quarterly cash dividend equal to $0.50 per share annually on our new share cap.The transformation of our business that I described earlier has provided us with the free cash flow and balance sheet profile that allows us to implement these 4 capital allocation initiatives, which will provide greater consistency regarding return of capital while allowing ample opportunity to continue to invest in our core business and execute on our acquisition strategy.Now turning to the quarterly results and outlook. As we discussed on our last call, we felt it [ though ] the third quarter would be our most challenging, and that did come to fruition. However, we saw improvement in demand throughout the quarter and increased tightness in the West Coast, indicating a need for some inventory replenishment. However, peak season has diluted and we do not anticipate a sharp inflection in demand in the fourth quarter.Demand was soft through July and August leading to volume declines in Intermodal. Rail services remained strong, and we executed improved volumes per business day in September while onboarding wins in shorter haul market. We continue to focus on improving operations on the street, reducing our cost to serve and maximizing the efficiency of our team. Although we have made significant progress, we still have opportunity to improve operational fluidity and reduce costs.We believe there is considerable Intermodal conversion opportunity in the upcoming bid season, and our commercial organization is focused on returning to growth. Our rail partners have remained committed to providing a great service product, and we believe that the combination of quality service, cost benefits versus truck and greenhouse gas emission reductions will lead to share gains from over the road and create improved balance and velocity in our network.Our Logistics business performed well, once again illustrating the resiliency of our model. We executed well in brokerage leading to share gains due to our strong service and value proposition, while driving new wins and organic expansion in our warehousing, Managed Transportation and Final Mile services. Our pipeline for Logistics and Dedicated opportunities is very strong, and we remain focused on excellent execution for our customers.While we are experiencing some improvement in demand, the length of time that will be maintained remains unclear. With bid season approaching, we are focused on returning to growth in Intermodal, leveraging our strong service and cost structure to drive conversion from truckload. As bid award realization rates improved, capacity attrition accelerates due to low spot rates and customer demand increases, we will be in a strong position to support those opportunities given our excellent team, created solutions and available capacity.We will maintain our focus on providing world-class service and efficiently operating our business while executing on our long-term investment plan.With that, I will turn it over to Brian to review our operating results.
Thank you, Phil. I'd like to start by thanking our talented team for their efforts and dedication in leading and executing through a changing freight environment and positioning us for growth with our customers. I will now discuss our reportable segments, starting with our Intermodal & Transportation Solutions.As Phil mentioned and we anticipated, our third quarter was challenging with ITS revenue declining 30%, driven by softer Intermodal volumes that declined 16%. Transcon volume declined 9%, local west declined 18% and the local east declined 14%.Continued soft import volume, elevated seasonal inventories and an oversupply of truckload capacity generated softer volume and lower accessorial revenue in the third quarter, which led to a decline in ITS operating income.Throughout the year, we have improved our cost structure and feel well positioned going into the upcoming bid season. In retrospect, we held the line on price for too long in 2023, which has impacted our volume. We have made the appropriate structural and process changes that are focused on regaining velocity and balancing our network, and feel confident in our timing and disciplined approach for the 2024 bid season.We continue to be pleased with our Dedicated trucking growth and yield expansion, along with a strong pipeline of confirmed wins scheduled to onboard in the fourth quarter and early in the first quarter of 2024.As I have mentioned in our previous calls, we have been improving our Intermodal cost structure throughout the year. Our new rail agreements are helping us move with the market to provide compelling volume for our customer base and rail service improvements that helped us better manage our equipment costs. On the [ street ], we have continued to improve our trade costs by increasing our in-sourced trade from 62% last year to 78% and have lowered our cost of third-party purchase trade.We continue to execute and see additional opportunity to improve our street economics through regional planning improvements and fixed cost reductions. We will continue to defend our incumbency and have incremental wins that will set us up for long-term success. In addition, the recent expansion of our cross-border rail solutions have already generated new wins that will expand in 2024.We'll continue to invest in our Intermodal business for the long term and are confident that these investments, along with improved rail service, will help support further conversions from over-the-road to Intermodal. While the near-term results are impacted by low volume, we are confident that our actions will position us for growth and deliver high levels of service for our customers with sustainable profitability.Now turning to our Logistics segment. As we continue our diversification strategy to deepen our value with our customers with our integrated approach to supporting an end-to-end supply chain, we were once again successful in expanding our Logistics operating income as a percent of revenue by 40 basis points. Despite the challenging freight environment, our brokerage team continues to stand out with growing volume and margin expanded throughout the quarter.Our third quarter brokerage volume was up 5%, led by share gains with existing customers and continued new customer onboarding. Our overall Logistics segment experienced a revenue decline of 12% in the third quarter, but has a strong pipeline of confirmed wins with onboarding in the fourth quarter and start of 2024. In addition, we continue to harvest cross-selling synergies with our most recent non-asset Logistics acquisitions.While we continue to drive Logistics growth, we are also improving our cost as we leverage our ability to establish new multipurpose Logistics locations to support our growth and lower our costs. As mentioned in previous earnings calls, these locations are strategic to our hub network of freight as they enable the continued growth of our LTL, Final Mile and e-commerce solutions and support inbound and outbound multimodal hub volume to service our customers' supply chain needs.We saw the benefits of these new locations in the west and central regions supporting the growth of our LTL solutions in the third quarter, and we expect this success to accelerate heading into 2024. We will also continue to invest in our non-asset-based Final Mile offering as we continue to onboard new customers and build more density, driving stronger service and enhanced margin performance.Our lLgistics pipeline remains strong with larger deal sizes and improved [ close ] ratios. Our non-asset-based Logistics growth strategy is playing out well, and we are in a great position to continue our trajectory of profitable organic growth and continue to integrate future acquisitions.With that, I'll hand it over to Geoff to discuss our financial performance.
Thank you, Brian. Despite recessionary freight market conditions, we generated revenue of over $1 billion for the quarter and an operating income margin of 4.2%. Our diluted earnings per share for the quarter was $0.97. We generated $88 million of EBITDA and ended with over $400 million of cash on hand. During the quarter, we purchased 208,000 shares of our stock for $17 million. Our purchase transportation and warehousing costs declined slightly as a percentage of revenue as compared to the prior year, reflecting our focus on cost containment and yield management.Salaries and benefits costs rose from the prior year as we expanded our driver count by 12%, which has enabled a large increase in our in-source freight percentage. In addition, the inclusion of TAGG Logistics for a full quarter added $4 million of expense as compared to the prior year. This increase was offset by lower office employee costs and lower incentive compensation expense as our office head count declined by 12% as compared to the prior year.G&A costs decreased by over $10 million due to lower legal and use tax expenses and a lease impairment charge in the prior year. Depreciation and amortization expense increased as compared to prior year due to growth-oriented investments in equipment and technology as well as the acquisition. Gain on sale was minimal this quarter, whereas the prior year benefited from very strong used truck pricing.Logistics segment revenue of $450 million was down 12% from prior year, but increased 2% from the second quarter. Segment operating income of $29 million was 6.3% of revenue, a 40 basis point improvement from the prior year. While brokerage volume grew 5% and productivity was up by over 40%, revenue per load was down 21% as compared to the strong conditions we experienced in 2022, which impacted our profitability in the quarter. This headwind was offset by growth in profitability in our Managed Transportation, Final Mile and consolidation businesses as well as a full quarter of results from our fulfillment business.The benefit of our long-term acquisition strategy and cross-selling initiatives are showing in our results, with Logistics segment operating income accounting for nearly 70% of total. Our Logistics offering provides a more stable earnings stream and improves our positioning as a broad supply chain solutions provider with a strong sales pipeline and several large recent wins which will drive profitability into 2024.ITS segment revenue of $595 million was down 30% from prior year due primarily to lower Intermodal volume and a 20% decline in revenue per load. Operating income margin declined to 2.3% as the impact of Intermodal price declines and reduction in profitable accessorial charges more than offset improvements in drayage, rail and equipment costs.While soft demand conditions and a funding capacity weighed on price, the operating team performed well in reducing controllable costs and driving efficiency, and we saw the benefits of our new flexible rail contracts.We are realizing the cost benefits of in-sourcing drayage with every 100 basis point increase worth approximately $1.5 million annually over the course of a cycle.Profitability within our Dedicated service line has significantly improved in 2023, reflecting improved yields and leveraging of operating expenses. Our updated guidance for 2023 assumes market conditions decline throughout the remainder of the year, with softness following the Thanksgiving holiday [ per ] more typical seasonality in our Intermodal and brokerage services with stability in our more contractual service lines.For 2023, we expect to generate diluted EPS of between $5.30 and $5.40 per share. We expect revenue will be approximately $4.2 billion for 2023. For Intermodal, we're forecasting volume will decline lower double-digits to mid-teens for the full year. The remainder of the year will reflect the impact of lower prices and less accessorial and surcharge revenue, which will be partially offset by lower purchase transportation costs and improved operating efficiency.We expect a tax rate of approximately 20% for the year. Our capital expenditure range is unchanged at $140 million to $150 million. Based on this guidance, we would expect to generate EBITDA less capital expenditures of over $250 million in 2023.Over the past several years, we have made important strategic changes to our business, including our focus on yield management, asset utilization and operating expense efficiency, which has significantly improved profitability and returns.We've also completed several acquisitions to build out our Logistics offering and drive more stability in our earnings. While we compete in a cyclical marketplace, these actions have driven a step change in our trough to trough results, with operating margin growing from 2% in 2017 to 6% today, along with an improvement in free cash flow to over $250 million as compared to [ $60 million ] in 2017. These strategic changes have positioned Hub Group for success in both the short and long-term time horizons and in soft and strong demand environment.With that, I'll turn it over to the operator to open the line to questions.
[Operator Instructions] Our first question is from Scott Group of Wolfe Research.
So, I want to try and focus on this -- the ITS margin. And we don't have a lot of history to know what it looked like in prior troughs, but it was 10% a year ago in Q3. Now it's 2%. It doesn't feel like we're seeing the benefits of different rail contracts or more flexibility like we've talked about. And it looks like the Q4 guide implies margins take another step down from here. So, why are we not -- I guess, why aren't we seeing the benefits of all the stuff that you've talked about in margin? And where do you think we go on margin from here?
Yes. Sure, Scott. I'll start. So I think we have executed well on cost out. If you look at the quarter year-over-year, we saw cost per dray dropped 27% year-over-year. Our rail contract did actually help us offset some of the pricing pressure. I think when you're looking at the prior year numbers, those were also somewhat inflated with high accessorial revenue as well as gains on sale which came out. So if you normalize those, I think you are seeing a more consistent earnings pattern.Obviously, pricing has been somewhat more aggressive than we would have anticipated. And I think Brian did a good job of calling out in his prepared remarks that we didn't necessarily move quickly enough on pricing in the first portion of bid season this time last year, which -- we wound up losing some share to over the road. We now have an opportunity to garner some of that back. And given some of the spreads that we're seeing, I think we have a significant opportunity to do so.We have a higher asset count today. And when it is not moving, you're going to see degradation in overall margins. And so our goal is to get velocity back into the network through the upcoming bid season, and then I think you'll really start to see the benefits of those rail contracts.
And so if -- as we approach bid season, it sounds like you want to recapture some share. Do you need to -- does price need to go lower from here in order to do that? Or do you think there's an opportunity to regain share but also improve price? I would think that's hard to get both, but curious of what you guys think?
Sure. So Brian address some -- in his prepared remarks. Once again, I think some of the structural changes we made with our pricing group following some of the share losses to truck initially in this season. And since then, we've actually performed quite well and have really seen some nice wins come online, in particular, in some shorter-haul markets.So we feel that our current pricing methodology actually is working, and we won't have to go much lower. I think you also look at the spreads that we're seeing right now between OTR and [ minimal ] contract rates. It's up in the mid-30s at this point. So we think with the combination of really strong service products, higher fuel prices and some uncertainty around what truckload capacity in the spot market will look like, there is a significant opportunity for Intermodal conversion, and we're planning to focus on that and capture that.
And then just lastly, so maybe, Geoff, are we thinking about this right that the guidance implies closer to like 1.5% margin in ITS in Q4? And if that's right, how should we think about those segment margins into next year?
No, it wouldn't be that low. I would say it's going to be pretty consistent with where we are today from a margin percent. I think we are going to see some pressure towards the end of the year on the brokerage side. I think we performed well in Q3, and we are starting to see that often. I would say our business model, as you know, within Intermodal is very asset light from an equipment perspective.We do, like most companies have some level of fixed costs on the operations side. So if you think about incremental volume from a contribution margin perspective, those numbers are in the upper teens area just on the contribution margin. And that's with flat price. Obviously, price is very, very impactful. A 1% price increase on today's financial profile is worth nearly 100 basis points in operating profit. So we are focused on returning fluidity into the network and then pricing will be incremental upside from there.
Our next question is from Jon Chappell of Evercore ISI.
Phil, to your answer before on holding price too long, and Brian's commentary on that as well, you mentioned that you lost share, you think, to over-the-road. But as we try to determine how long you'll be bouncing along the bottom with Intermodal pricing, can you speak to the competitive landscape among your Intermodal competitors? Is that what's driving the race to the bottom or is it just over capacity in truckload and you feel that once that stabilizes, the whole Intermodal industry can get a bit of the floor?
Yes. I think it's mostly the overcapacity in the truckload market. We are seeing some really nice wins that we've brought on lately. It was just later in the overall bid season. And as you know, our bid calendar in the first quarter will reprice over 40% of our total business. And so that's where we felt as though last year we didn't have a great overall service product, and we try to hold the line on price, and that's where a lot of that share went to over-the-road.So we believe that there are a lot of questions out there from our customers on how they're going to -- as demand returns and they need to replenish inventories how they're going to move that product. We're displaying a very strong rail service product. We're showing that fuel prices are up and that the spread between contract rates are expanding. So we think we have a very strong value proposition to bring to our customers and having a lot of great conversations on conversion.
And then so if we think about now you've transitioned a little bit. So you hopefully stem the share loss. I don't recall you giving the monthly breakdown of the Intermodal volumes, but maybe that will help with as [ we ] went through the third quarter and we're mostly through October now, maybe where you stand there?
Sure. Yes. So July was down 13%. August was down 19% and September was down 15%. October thus far is down 9%. One thing I think that is worth highlighting is when we came out of Q2, June to July, we actually saw a 3% sequential increase in demand. We then July to August saw an 8% decline and then August to September, a 9% ramp. What occurred in August, which I think was very impactful in the back half of August and really cost us, we think, 2 to 3 percentage points on total volume for the quarter was Hurricane Hillary. And obviously, it was very impactful to the Western portion of our network. And so that was something we didn't call out specifically, but I think it's important to reference as we think about the volumes for the quarter.
Our next question is from Jason Seidl with Cowen & Company.
Want to just talk conceptually about next year. You guys announced that you have a pending dividend out here. Most companies don't put out a new dividend announcement if they think the business is going south. So how should we think about the potential for earnings growth with the backdrop of 40%, call it, of your business coming due in 1Q, improving rail costs on your side and sort of an increase in your percentage of an internal dray?
Sure. No, I think it's a great question. And I think I'll start and let Geoff and Brian fill in. I think it's a little early to give anything too concrete. We're in our budgeting process. What I'll try to do is kind of frame it up. As we look at the market, I think we're seeing some form of peak season, which is great. We're starting to see capacity exits in a more balanced spot market. Inventories are coming more back in line. I think from Intermodal, I referenced fuel prices increasing is normally a good thing for conversion. Our service levels even with increasing sequential volumes are holding up very well, and I mentioned that OTR versus Intermodal contract spread.I think when you look at Hub, we're far more efficient. Head count is down 12% year-over-year. I mentioned our cost per dray. We're going to have far lower capital expenditures going into next year. And I think if you layer in some accretive M&A and the capital allocation plan, barring some sort of consumer recession, we're going to be targeting earnings and revenue growth. I think the only thing that remains unclear is the timing and recovery of demand, but we'll certainly obviously have more specifics for you on the fourth quarter call, but I'll let Brian and Geoff fill in.
Sure. Yes. No, Jason, I think what we see going into next year, and we talked a little bit about it earlier this year too about the inventories and a lot of that inventory has to burn off more seasonally. So while there was some bloated inventories earlier this year, just took a full seasonal cycle to burn off. And so as we push through the holiday season and enter into the spring, we see that, that's going to be a reset in a good position to be replenished.And as we do that, we'll see our Intermodal volumes grow. We called out our brokerage, which is a standout in the marketplace. Despite all these market headwinds, they stood out really well with that 5% growth and really continued growth going into next year as well.And then our Logistics services, we continue to see a really strong demand for all of our Logistics services with our Managed Transportation, what we bring to the table with our consolidation and fulfillment locations that I've mentioned that we're adding and investing with new buildings. We're working kind of left to right, adding 2 in the West earlier this year, 2 in the Midwest and we're going to finish out the year working into the east and going into 2024.As well as our Final Mile. So we continue to win service awards from our customers in our Final Mile offering. We're bringing on new logos and diversifying that customer base. And our non-asset-based model in Final Mile has proven to be really great for flexing and growing with our customers. And so we're going to see continued success there as we invest in that from a growth perspective. But yes, those are the big areas that we'll continue to focus.Phil mentioned a lot of the over-the-road conversions into the previous question. There's still over 56 million over-the-road truckload volume that's out in the marketplace that is eligible for Intermodal conversions, and we're highly focused on delivering on that growth and converting it in the right cost structure.
How should we think about your rail partners? There's obviously been some talk about improved rail service. I'm happy to see that, but I'm not giving it as much credit because we haven't really seen the improved rail service with improved volume. So how confident are you guys if we do see volumes come back at some point in '24 that your rail partners will be able to handle that increase?
Yes. I think you're seeing a good [ test ] right now with some sequential volume increase in pretty short order, which I think has been a good [ test ]. We're hoping that this is more prolonged and continues to move forward. I agree with you, we have to continue to show our customers that. But at the same time, I think you're seeing the commitment in hiring and resourcing to handle that demand. And so we believe we are going to be in that position. And it's a massive opportunity for us and our rail partners. And I know all of our conversations are related to growth at this point in time.
One final one and I'll turn it over to somebody else. Phil, I think you mentioned accretive M&A. Can you maybe give us an update on the M&A market? Are you still seeing a lot of stuff being put up for sale? And what do the multiples look like, say, compared to 1 year ago?
Sure. I'll start and I'll let Geoff go in. We haven't seen as many companies coming up for sale just given some of the challenges in the broader market and obviously, interest rates increasing. So -- And there's been somewhat of a disconnect on overall value. But I think what we've been able to do is continue to go out and find interesting and exciting off-market opportunities and where we have a very strong pipeline right now, and we're certainly working towards closing something we hope in the near term.
I'll just add. It's a key part of our strategic growth plan. We highlighted that today in the context of the overall capital allocation plan. I think we have a good pipeline and we're continuously evaluating. And again, we've had more success on those outreaches that we've generated and we think we're a good buyer in this market.
Our next question is from Brian Ossenbeck of JPMorgan.
So maybe just to come back to competition on the Intermodal side. So can you talk about more of what you're going after here? Is this really some of the things you think left the rail network with poor service? And this is really just over-the-road conversion. Maybe you can give some context in terms of where that spread is versus history? I mean, is service good enough to get this back? Or is this really more of a play on price and getting a little bit more of that density you might have not had as much as you wanted before?
Sure. So I think you could imagine, given the market conditions that it's obviously a competitive marketplace. But I think what we're seeing, our very savvy customers are focusing on total costs, including fuel expenses and rate. And so we are seeing some nice conversions outside of bid cycles right now back to Intermodal, taking advantage of the improved service product in some of those shorter hauls.When you think about the spread that we're seeing between contract and both from Intermodal and over-the-road right now, in longer length of haul, it's up near 40%. In the shorter length of haul, it's getting closer to the high teens and 20 percentile. But in aggregate, really in the mid-30s. And so that's what we're trying to go to our customers, both in advance of RFP events and during them and highlight that differential as well as the strong service levels. So, we think that the opportunity for conversion is significant, both in the short and longer haul, but -- and we're very focused on getting that back.
Yes. I'll just add on that too. We'll continue to focus and target the cross-border. We've started that process already. We have some confirmed wins, and we expect those to expand going into next year. We have a superior product on the rail with our partners there on service and transit and also diversified offerings as well there, too. So that's something that we'll continue to target as we grow into 2024.
And then in terms of capacity boxes, and as rail service comes back, there could be more boxes effectively out there, what are you doing in terms of your storage? And how do you view CapEx and the investment on the slide deck? You've got more color in terms of the longer-term viewpoint, but how does that investment translate here to the rest of this year and I guess, into next year?
Sure. Yes Brian, we've got -- we have boxes stacked now. I think a lot of the industry does right now. We started to actually unstack a little bit as we've started to handle and manage through this muted peak. We'll evaluate as we finish out the year how we manage that as we enter the year. But certainly, as that volume returns, we'll be bringing down that stack.We mentioned about our discipline around targeting balance in our network and getting the most utilization out of that equipment. And as that improves, we'll be able to evaluate what we need. As we go into next year, Geoff, maybe you want to talk a little bit about our CapEx plan on that?
Sure. We'd expect for this year -- our guidance is $140 million to $150 million. Our preliminary thoughts for next year would be a pretty big reduction in that. I think on the container side, we probably would be looking to add to the fleet next year. And then we do have a smaller replacement cycle on the tractor side. So certainly something [ stock ] of $100 million next year, which would have a pretty big impact on our free cash flow.
Well, the only other thing that I would highlight is that we've seen utilization improve by 10% sequentially from Q2 to Q3. So we are getting more out of the existing equipment. We still have our ways to go, but it is good to see progress on that very key metric.
Just one quick follow-up on balance sheet and the leverage. And so you talked about not being in a hurry to get to that new market. But maybe you can just give some thoughts in terms of how you and the Board are looking at going through that process? And if there's anything we should sort of pencil in for buybacks here in the near term?
Sure. So we're going to be very thoughtful around that. As we mentioned, we have some very interesting acquisition opportunities that we're continuing to look at. I think it will take likely [ 2 ] to get us to the middle of the leverage target that we laid out. But we are going to be thoughtful on the approach, I think -- and as we did roll out the new repurchase plan, assuming that we would execute on it, I don't think there's anything to build into the model. We certainly didn't in our forecast. But at the same time, we will be opportunistic with it and utilize the very strong balance sheet that we have effectively. Geoff, do you want to add anything?
Yes. I think we'll -- again, it will be -- the use of the [ authorization ] will be tempered by our outlook for both CapEx and acquisitions.
Our next question is from Bascome Majors of Susquehanna Financial Group.
If you look at the guidance and results for 3Q and 4Q, you're at $1 or so earnings run rate. You typically do less seasonally in the first half than you do in the second half. So barring some super seasonal outcome in the first half of next year, you've got a lot of catch-up to do in the second half. Can you walk us through what has to happen to deliver the earnings growth that you hoped for preliminarily next year from the starting place we are today? And just any other thoughts to help us kind of level set expectations for next year now rather than waiting until February?
Sure. So I do think we are seeing some peak season. We need to perform in the upcoming bids. That is a key priority. I think capacity continuing to exit and the spot market staying relatively balanced. I think the consumer is staying resilient. All those pieces are certainly going to support that. We need to successfully onboard a lot of the Logistics wins that we have, and we need to get our Intermodal fleet moving again.We're having a significant portion of stack. It's not optimal for earnings growth. I think if you layer in [ us ] then executing on the capital allocation plan and acquisition strategy, that should frame up earnings growth. I do agree with you. It will likely be driven by execution in the latter portion of the year. We would hope to see some increase in demand in the spring to help drive that. And we think -- we do see that we're in an excellent position to go out and execute.
I'll just add one item to that, too, is we've created a really long tail of customers that we are cross-selling into right now. And as we look at it from a revenue perspective, 80% of our revenue is using 2 or more services of ours. But as we look at that customer count, 80% of those customer count is only using one Hub service. So that's a big part of our growth plan is continuing to cross-sell that's been underway and it's going to accelerate as we go into next year.
Can you update us on where big compliance is? And I apologize if I missed that earlier. And just maybe anecdotally, how are these conversations going with your customers? It seems that the economic case for Intermodal from your earlier discussion is very attractive, but the reality is it's just not converting. What is holding that back and what has to happen to change that in your view?
Sure. In regards to the big compliance, we started the year at about 70%. We finished last year at 81%. We did see that compliance improve throughout the year, finishing out Q3 at around 78% compliance. And we think a lot of that was the shippers starting to realize where their balance was at, where their demand was going to be. A lot of those conversations with them is about the seasonality of their inventory. And as that starts to rebuild, they know that, that over-the-road capacity is going to be exiting and needs to come back into the rail.And they want to have that assurance that the service is going to be there that we've talked about. And as Phil mentioned, we've seen the continued investments from our rail partners to ensure that, that service is going to be there. And from a -- to be a little bit more tactful in that, too, we've been confident in that service. So we've improved our transit times that we submitted those bids and have a lot more confidence in those competing very well against over-the-road.Yes. And just one piece on that before we go into the next question, too. I think in regards to those customers, too, we saw capacity exit with the departure of yellow. And we've been really successful, one, in protecting our customers with that, but then also providing solutions for them to consolidate that LTL through our network -- our Logistics network and convert that into Intermodal as well. We see that piece growing for us and for our customers going into next year as well.
Our next question is from Justin Long of Stephens.
And maybe I'll start with one for Geoff on the guidance. Last quarter, you talked about the tax rate for the fourth quarter being in the mid-teens. It looks like based on the guidance you gave today, it could be a little bit lower than that. So I was just wondering if you could provide an update there? And just given the decline in the tax rate, it also seems to imply that operating income will probably take a step down from 3Q to 4Q. So I was wondering if you could comment on what's driving that? It sounds like Logistics margins may be down a bit, but I wanted to make sure I wasn't missing anything else.
Sure. Yes, your math is correct. And the tax rate we think in Q4 will be around 10%. That's driven by a change in state apportionment, a project we've been working on all year. So Q4 will be low as we file the 2022 file tax returns. To your point on the operational side of the earnings, we're expecting seasonal strength in October is going to fall off, as it usually does in the latter half of Q4. We are expecting some more softness on the brokerage side. And of course, brokerage is in our Logistics segment. So it's really the transactional parts of our business between Intermodal volume, brokerage volume and some tailing off in profitability into Q4.The rest of our Logistics segment, we think, will continue to perform based on recent wins that are being onboarded but not enough to overcome the performance of the other 2 pieces we talked about.
Yes, we certainly wanted to be conservative in the approach on what we think volumes will be just given that -- it does remain somewhat unclear, right? And there's certainly upside to that if we see the demand continue right up to and through the Thanksgiving holiday, that is certainly upside. And so we'll -- but felt as though with the guidance, we should be conservative.
And maybe as a follow-up for Brian. You talked about some onboardings and logistics in the fourth quarter and early next year. Is there a way to think about the collective impact if these onboardings could have to the top line? I just wanted to get a sense for how you're set up for potential growth in that segment as we move into next year?
Sure. Yes. No, Justin, I appreciate that question. And we love our Logistics wins for a lot of reasons. One, it's great to continue to get out there and win. But a lot of what we see within our Logistics wins is that it helps see the other lines of business and create that overall Hub network of freight. So as we win in the Final Mile, we're able to leverage our assets for the middle mile management of that. As we onboard these new buildings that I've mentioned, we're again leveraging our assets to manage the inbound and the outbound across all modes of transportation.And then it also just continues to add that long tail of customers that we cross-sell into and provide more solutions for as we do that and we get deeper with our customers. They become less price sensitive, they become more sticky and our retention continues to go up. We've seen our deal sizes continue to grow in Logistics.And I'll also mention on the Dedicated. From a contract win perspective our Dedicated product continues to stand out against some of the headwinds, but strong pipeline, continued demand. Our win ratios are the highest we've seen them. Our largest Dedicated win of the year will onboard right before the turn of the calendar and set us up really well going into next year.
Our next question is from Bruce Chan of Stifel.
Just a look at the brokerage side of things for a minute here. It seems like the market is going to be grinding lower for a bit longer. And just assuming that's the case, I want to see if you have any more opportunities for cost rightsizing there, whether it's head count related or technology-related or maybe something else?
Sure. Yes. No, Bruce, I appreciate the question. And one of my favorite guiding principles that we say here at Hub is that we innovate with a purpose, right, and that we direct our IT investments in a meaningful way that focuses on our customers, our carriers and our team members that drive profitable growth. And that's exactly what we've seen in our brokerage. And Geoff called out some of those productivity gains that we saw. While we did see volume grow, we saw that grow on top of a lower cost base and drive more efficiency in our overall operations.So we do sense some more headwinds coming in the fourth quarter. We feel well positioned to handle those. But with some of the softer volume, we'll make sure that we're scaled appropriately and that, again, our investments are appropriated towards driving that profitable growth.
I was just highlighting one thing around our program is that our commission model really incentivizes volume growth around -- we obviously pay off of gross profit dollars, but we also incentivize volume growth and handling additional volumes, and that has really allowed us with the growth that we've seen to remain very lean in our operation and not have to add additional head count and actually become more and more efficient.And I believe we saw about 20% in aggregate productivity improvement year-over-year in our brokerage. And so, really significant improvement there. And we still have a long way to go and need to return to growth, but that will come as the market does, but we'll keep focusing on taking share as well.
And I was just going to ask with that 5% volume growth, was that related to some of those incentive programs? Or is it fair to say that was tied more to disruption from yellow in the LTL market?
A little bit of both. Like I said, we saw a lot of growth in our customers from that yellow exit, and we protected our customers from that. We did pick up volume there. But we also get new logo wins. Our brokerage teams add anything more from 80 to 100 new customers a month. And so as we do that, then we cross-sell into those. And our brokerage also offers a diversified subset of modes as well. So outside of just driving our top tank acquisition really built out, a nice temperature-controlled offering as well as our LTL rates that we bring to the table, flatbed and other sub modes that become very meaningful to our customers. So it's a good overall balance of growth.
And then just a final follow-up before I turn it over. We had a fairly high-profile competitor exit in that space last week. Just want to get your take on that and whether you anticipate any major changes in the market as a result?
Sure. I wouldn't reference any major changes. I think it's just an indication of how challenging the market can be and having brokerage as a key capability that you can bring to customers as part of a full suite of services, I think, is very important and something that we've tried to utilize. We think our model works and we are continuing to invest in the brokerage products. So feel good about our positioning for the long term there.
Our next question is from Thomas Wadewitz of UBS.
Wanted to ask you about the ITS operating margin and just how we should think about the potential levers for improvement? I know you've talked about volume and being a bit more aggressive with some of the bids and winning volume. Is that kind of a key lever to see improvement of the level in third quarter? Or is it more appropriate to think about pricing being the lever and you kind of wait for potential improvement in rates in the bid season next year and second half? Just wanted to get a little more perspective on what really kind of drives potential improvement in the timing as well?
Sure. I think we have a good feel for the market at this point and have positioned ourselves while we've seen some nice wins, as I mentioned, in the latter portion of this season and even some out of market opportunities. So I don't think it's taking rates lower, and we're -- currently have that pricing fully baked. What I think we see is the opportunity, is this time frame last year, which I referenced, about 43% of our freight is pricing effective in Q1.That is a significant opportunity where we lost shares over the road. And given some of the question marks around the spot market as well as customers taking a deeper look at fuel prices and aggregate cost, I think, presents an opportunity to leverage the strong service we've had and that disparity in contract rates to garner some of that volume back.
So you think that if you get the volume back in 1Q, 2Q, that could be a meaningful margin lever, or you think it's further out than that?
Yes. We -- Getting the container fleet unstacked and driving more velocity in the network will reduce the fixed cost and help us really with the efficiencies we've gained and head count drives a better flow through to the bottom line.
And then I guess on the brokerage side, I mean, it's -- your results in brokerage looked very good, the 5% volume growth in the tough market. So kudos for executing well in that business. I wanted to see if you could give us a sense of the mix of spot and contract? And how you think about the risk that eventually, the cycle is going to happen and spot rates are going to go up? And that can be a risky time for brokers just in terms of the gross margin percent pressure and potentially impact the profitability from that. So what's the split look like? And how much of a potential headwind is that spot rates move up in first half next year?
Sure. Yes. I'll kind of start. Even last year -- so as we look at last year, we moved -- our brokerage was about 60% spot and 40% contracted. Throughout this year, we were very focused on growing in our contracted volume, and we saw that kind of level off right around half and half. And what's really good about the growth within our contracted volume is we really leverage that volume with our carriers and the way that we purchase that transportation to really make sure that we can contain that spot capacity and price.And so we feel well positioned that, as that spot starts to grow, our capacity in the truckload marketplace starts to exit and it starts to press up. But we have a really good model and a good balance with those carriers to keep that contained, but while also making sure that we're recovering it with our customers as well.
So you don't think we should anticipate pressure if spot rates rise or it's manageable amount of pressure?
It's manageable in our model.
[Operator Instructions] Our next question is from Ravi Shanker of Morgan Stanley.
This is [indiscernible] on for Ravi. I wanted to circle back to the capital allocation announcement, specifically calling out on the acquisition front. It doesn't feel like that's super new for you guys. So just wondering if you're trying to signal anything different going forward in terms of pace of transaction or type of transaction that you guys are looking for going forward?
I think the announcement today is really just formalizing things we've been working on. So M&A has always been an element of our growth strategy, particularly in the non-asset parts of our business expanding that Logistics' offering. We've always had the strategy to invest in our Intermodal fleet containers and tractors. We'll continue to do that. I think you've seen us be more opportunistic on the return of capital to share repurchases, and we are today announcing or we're signaling a more rigorous framework around that.So really no change in the pieces. I think just more of a framework to measure our return of capital performance by. I think we all feel good about our acquisition pipeline and we're optimistic to get an acquisition completed in the short term here.
And if I could squeeze one more and switching gears a little bit on the drayage insourcing and some of the other kind of cost or process initiatives. Can you just frame up for us at all sort of the cost benefits that you guys are seeing? And maybe how to think about incremental margins in that business going forward in the next up cycle when it comes? Do you think it can be structurally improved on the back of these?
Yes. So we have a pretty strong focus on operating efficiency within our head count and within our -- kind of below the transportation part of our P&L. Within transportation, I think having those -- that in-sourced number around 80% may drift down in a stronger market. But we felt like that's the right balance of fixed costs. Right now, third-party costs are pretty low. It's a very different story last year in a stronger market. We like to have that [ flex ], but also the ability to in-source on our own fleet.As we do more volume, we are able to leverage our fixed cost as we improve that productivity in our tractors and on our drivers. I referenced earlier, a contribution margin just on today's cost structure. An incremental load with no change in price is going to deliver north of 15% incremental flow-through operating margin.
Our next question is from David Zazula of Barclays.
Sorry to beat the dead horse on brokerage volumes, but I just want to understand a little bit. You guys said you're seeing peak and you gained 5% in volumes this quarter, but it sounds like you're talking about potentially some pressure in the fourth quarter. So I mean, is that a factor of customers going away from brokerage on a temporary basis? Or can you talk about what is driving the volume outlook for brokerage in the fourth quarter?
Some of that's really just the decline after Thanksgiving of what we'll see just in a softer tail off of the year from what we're expecting in overall volumes. But I think we're continuing to driving the cross-sell and where we're growing with our brokerage internally as well. So yes, we still think it will continue to stand out in the marketplace in the fourth quarter, but are just anticipating some of that softness as we wrap up the year.
And then if I could just get one follow-up. You mentioned some Dedicated wins. I know you've had some competitors that have lost existing customers. Can you talk to your Dedicated retention rate and how it compares to history?
Yes. No, we've -- [indiscernible]. We have done very well with our retention. We have retained our customers. I think our model for doing so, as I mentioned before, is that we see a higher retention when we're offering multiple lines of service. So while our Dedicated service and assets and management and efficiencies are all really important to our customers, we find that if we can have them cross sold into multiple lines of service, it helps drive that overall operating efficiency, but it also helps with that retention.But we focus on being a very strong operator and making sure that we pass those efficiencies along to our customers and that we position to retain, but it's also helped us in the bid cycle. And so we've seen a higher rate of our wins on these because they are highly competitive. And our deal sizes are growing. I mentioned one of our largest ones will be onboarding later in this quarter and is setting us up really well for next year. And those are organic as well as new logo customers that we're winning in.
Our next question is from Brian Ossenbeck of JPMorgan.
Just a real quick one. I think you mentioned accessorials were down. Just wanted to see if that was a sequential comment or year-over-year? I think there's been some providers who have seen a little bit more come out than they initially thought and you guys took a pretty big hit earlier in the year. So where do you stand on accessorials right now? And are you kind of at a run rate you expect to carry into next year?
Yes. Sequentially, on the revenue side, it's flat. The big step down is year-over-year. We do have accessorial cost as well, which we have been reducing sequentially, but not enough to offset the revenue fee.
And did this cost come out with more volume, with more fluidity, I guess, better service?
Yes, we would expect them to, yes.
I would now like to turn the conference back to Phil Yeager for closing remarks.
Great. Well, thank you for joining our call this evening. And just to wrap up, despite headwinds in the broader Logistics market, we believe Hub Group is extremely well positioned to drive long-term growth and returns through our focus on providing best-in-class service, continuing to operate efficiently and investing in our business through accretive acquisitions and long-term organic growth. We believe this investment approach, along with our focus and consistently returning capital to shareholders is going to create long-term value. So I want to thank you again for joining our call this evening. And as always, Brian, Geoff and I are available for any questions.
This concludes today's conference call. Thank you for participating. You may now disconnect.