XPO Logistics Inc

NYSE:XPO

Earnings Call Transcript 2018-Q3

[Operator]

Welcome to the XPO Logistics Q3 2018 Earnings Conference Call and Webcast. My name is Rob, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [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 securities laws, which by their nature involve a number of risks, uncertainties, and other factors that could cause actual results to differ materially from those projected in the forward-looking statements. A discussion of factors that could cause actual results to differ materially is contained in the company’s SEC filings. 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.

[Brad Jacobs, Chief Executive Officer]

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 the 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 startups in the quarter, bringing the year-to-date count to a record 90 startups 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 XPO Connect from scratch in April. Three months later, 6,000 of our carriers had opted in, and in the three months since then, we’ve expanded 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.

Company-wide, 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 2018. 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 is 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?

[Scott Malat, Chief Strategy Officer]

Thanks Brad, and thanks for the kind words. I’m very proud to have been part of the growth of XPO these last seven years. On our 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 and 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 dock workers 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 hundred weight 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 the 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 two 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 indirect loads.

In Last Mile, we grew revenue 12%, $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. It 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 UK was the leading driver, with significant revenue increases in both dedicated truckload and LTL.

Other highlights of 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 healthcare.

In Europe, we grew logistics revenue by 10%. If you exclude the impact of foreign exchange, our organic revenue growth and European logistics was 11.5%. The most rapid growth was in the Netherlands, the UK and Italy. Our operating income for logistics globally with $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 GreyOrange. These robots have helped our employees to be about four times 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 two more locations opening this month. Last week, the total volume that ran through XPO Direct was approximately 20 times greater than what we shipped weekly during the summer. Most of this is coming from e-commerce and omnichannel customers, but 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 three 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 two-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 and 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]

Thank you. [Operator Instructions]. Thank you. First question comes from the line of Chris Wetherbee with Citi. Please proceed with your question.

Chris Wetherbee

Hey thanks, and good morning, guys. And Scott, best of luck in the future. It's been great working with you.

Scott Malat

Thanks, Chris. Very much appreciate it.

Chris Wetherbee

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

Scott Malat

Yeah. 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, so in the middle of October, we started to see a big pickup in those intermodal volumes. In 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.

Chris Wetherbee

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. I 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 just wanted 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 or 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?

Scott Malat

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 working capital; in the back half, 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. 2019 will 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.

Chris Wetherbee

Okay. That's helpful. And if you’d just permit me one last question. Just sort of, Brad, when you're thinking about the business and sort of the trajectory into 2019, 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 year . Just wanted to get your updated thoughts around that. Should we still be thinking about the ability to continue to grow through the EBITDA line in that mid-teens type of range. Just want to get a sense of maybe how we think about it as we're standing here late in 2018.

Brad Jacobs

Yeah. 15% to 18% EBITDA growth is still the base case scenario and we can 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 negatives. We look and expedite internally, because expedite is usually the canary in the coalmine, 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 and in Europe are optimistic. They are looking forward to a 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 a lot of positive things going on at the moment.

On the cons side, we don't know how the China trade war and geopolitical situation is going to play out. January 1st is the 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.

Chris Wetherbee

Okay, all right. Well, thanks very much for the time this morning. I appreciate it.

Brad Jacobs

Thank you, Chris.

[Operator]

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

Matt Reustle

Good morning guys. Thanks for taking the question. Brad, just to touch on the macro 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 have this growing contractual revenue base in logistics business, we think that is fairly insulated 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 a macro turn, how much downside is there to that number?

Brad Jacobs

Well, I think that we will definitely outperform the market and 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 differentiate 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 the 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 organic growth is so high.

If your question is how do you think we will perform in a deep recession, I think revenue will go down, and 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 1.5 times. And the reason is we only have about $200 million -- $225 million of maintenance CapEx, and everything else is growth CapEx. So we'd have the ability to cut that back and of course, as the 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’d see a negative effect from there. And overall, we'll see a benefit in the downturn from the outsourcing trend. So that's how I look at the whole macro situation. Does that help you?

Matt Reustle

Yeah. 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 dialog. Can you elaborate on that a bit? Was the upgrades in the term loan becoming investment grade and the improvement in that cost a major step? How close are you in terms of some of these discussions?

Brad Jacobs

The upgrade 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 last few weeks. The reason that M&A discussions have become more lively is because valuations have come down, both with the public 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, 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 compelling deal, it makes 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.

Matt Reustle

Understood. Thank you, guys.

Brad Jacobs

Thank you.

[Operator]

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

Ravi Shankar

Thanks. Good Morning, everyone. And just on the outset, Scott, good luck with the move, and you will definitely be missed.

Scott Malat

Thanks, Ravi.

Ravi Shankar

If I can just going to 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 US and in Europe? And also kind of just given your -- the purchase of the 5,000 robots, at what point do you think you guys can take a step function jump with the level of automation you have, not just in any kind of software and services business, but also in things like warehousing and contract logistics?

Brad Jacobs

Okay. You are going to get me going bringing up the robots, but let me address the labor issue first . So on labor, there absolutely is labor inflation here and in Europe, I mean, on the extreme, you go to Netherlands and it has 0% unemployment, so it's hard to find a lot of labor when it's 0% people unemployed, but everywhere there is 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 a 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 costs 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 three things: speed, accuracy and safety – and I will add a fourth one to that: employee satisfaction. They are “cobots ” – they’re collaborative robots that work together with our employees. They make employees four times more efficient on their picks – four times! And the job is just so much more enjoyable for the humans, because less walking around – they're goods to persons robots, 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 are 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 billion plus 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, in labor planning tools, in Drive XPO and XPO Connect, all across the board, lot of fantastic stuff going on in practical, pragmatic, results-oriented technology investments.

Ravi Shankar

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 percentage of your transactions in 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 ?

Brad Jacobs

More than half – So we'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 are customized for the carriers’ 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 startups and some of the new entrants. Some of those new entrants are not going to work, 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 five, six, seven 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 the United States – and TQL and Echo and the large established, for lack of a better word, “bricks-and-mortar” truck brokerage, but all of them are also going electronic as well. We are leading the pack on that.

Ravi Shankar

Very good. Thank you so much.

Brad Jacobs

Thank you.

[Operator]

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

Scott Schneeberger

Thanks. Good morning. 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 wary 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? Thanks.

Brad Jacobs

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, is up 18%. We had double-digit revenue growth in each of the main verticals. So e-com, tech, consumer packaged goods, ag, industrial, healthcare, each one of those verticals, double digit growth; it's very spread across the board. So what does that tell you? That tells you that our value proposition is strong. And if you look Europe Supply Chain, organic revenue is up 11.5% and despite the severe labor shortage in the Netherlands, it's our fastest-growing supply chain market in Europe, but UK, France, Italy, they're all growing fast too. You saw in our prepared remarks that we had a record number of contract start-ups year-to-date. It was spread roughly evenly, about 46 – not about exactly – 46 in Europe, 44 in North America. And we’ve got another 22 contract logistics start-ups expected in the fourth quarter, split even between Europe and North America. So supply chain is growing very fast.

Scott Schneeberger

Thanks, Brad. I appreciate that. 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, just to give us a feel about modeling going forward? Thanks.

Scott Malat

Yes, it is Scott. The incremental margins are generally 12% to 13%, but it does depend on what part of the business we grow in. So in some parts of the business, like LTL, we’ll have incremental margin is over 30%, in some asset light parts of the business we’ll have 6% or 7% incremental EBITDA margins. In terms of contract logistics, the likely movement of margins is probably on the upside, moving 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 with our robotics and improvement in efficiencies and the data-driven tools that we've deployed, we would expect margins would likely go up.

Scott Schneeberger

Great. Thanks very much, guys.

Brad Jacobs

Thank you, Scott.

[Operator]

The next question comes from the line of Allison Landry with Credit Suisse. Please proceed with your questions.

Allison Landry

Good morning. How are you guys?

Brad Jacobs

Good.

Allison Landry

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

Scott Malat

Thanks, Allison.

Allison Landry

On the Q4 free cash, just thinking about the sequential step-up from roughly $170 million to $410 million, 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?

Scott Malat

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 of 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 harder on those terms. We're changing the comp plans, including working capital incentives. We're increasing factoring programs and it makes economic sense. There is a big focus on collections teams: rightsizing the teams, putting new systems to manage processes focused on driving timely payments, faster invoicing. We've also focused on the payables, so negotiating better terms with suppliers, moving 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.

Allison Landry

Okay. But no way to really think about sort of how much each will contribute?

Scott Malat

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

Allison Landry

Okay, all right. 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 that revenue, the $1 billion revenue target for the next three to four years. Could you help us think through the margin and the ROIC profile on this business?

Brad Jacobs

Allison, it's Brad. I don't, for competitive reasons, want to put that out there, but I will tell you that we are making good progress in XPO Direct. We had 75 facilities in that network last quarter. We are up to 94 now, opening two more this month. Just to give you the flavor for the trajectory, last week, the total volumes moving through XPO Direct was 20 times 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 would expect those volumes to accelerate. Of course it will accelerate in the peak, but we also expect a significant step up in Q1. The customers are not just e-com, they are not just retail, we also have some manufacturers and we like that, because that's going to spread out across the year, so they have a different peak. So lots of good activity there, but I don't want to share with you exact margins and ROICs.

Allison Landry

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

Brad Jacobs

Yes. Yes, I do. Are you there? Well, we lost her.

[Operator]

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

Amit Mehrotra

She didn't like your answer, so she just hung up on you guys.

Brad Jacobs

Yes, it happens.

Amit Mehrotra

Yes, let me let me pile on, Scott, and just congrats on all the success. Thanks. You've been such a great help and I appreciate and wish you the best. But Brad, last quarter you did provide a way to think about top-line 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 2019.

Brad Jacobs

The short answer is no. The long answer is, we're still doing a very highly choreographed kabuki dance within 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 metric, numerically on what the ROI is going to be. And also how important are they long-term to our strategy and to differentiating ourselves from the perspective of customers? And then we determine how much CapEx we are 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 stay tuned, we haven't figured that out yet, we haven’t answered that. That's part of the budgeting process, and when we're done with that, we'll communicate that.

Amit Mehrotra

If it's OK, 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, or I don't think the market wants to be surprised by saying that that goes to 5% because you have all those high ROIC projects. So any help on thinking about just philosophically where you think CapEx intensity goes, and should that change relative to where we are today?

Brad Jacobs

Well, it's surely 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, do acquisitions, 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 that 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 the extreme on either level. We’re not going to go to extreme, where we suddenly take all our free cash flow and put into CapEx, even though that would, long-term, create a huge amount of growth. That’s not our business plan. And we’re not going to the contrary either, we’re going to find a middle path.

Amit Mehrotra

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 three years. I think last quarter, you said $1 billion in three to four years, maybe I’m just reading too much into that, but as the earnings trajectory increased for XPO Direct, just given the success you’re having to-date?

Scott Malat

No. It’s been very much on track and it’s ramping up this quarter much more significantly and then on into 2019, as we move forward and “three to four years” gets closer to “three years.”

Amit Mehrotra

Okay, one last question from me on M&A, just a follow-up to an earlier question. I mean, I agree multiples have come down; just a bit surprised by talking about how things are heating up a little bit, because XPO’s multiple, you could argue, has 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 deal?

Brad Jacobs

So all of the above, nothing’s changed at all from what we’ve said in the past. What’s changed is, externally, sellers are a little more motivated, a 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 were ready to sell in the future, but they weren’t ready to sell today, in the present. So we’re just developing a relationship and gaining mutual trust and getting know each other more and more, but they just weren’t ready to make a deal. And now more people are getting a little more motivated to do a deal. With respect to the two companies that you mentioned, we’re not aware of any kind of targets that we’re looking at that they are also in the mix, and in fact, in 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 one-to-one 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.

Amit Mehrotra

Got it, okay. Thanks for the update, guys. Have a good day. Appreciate it.

Brad Jacobs

Thank you.

[Operator]

Our next question is from the line of Kevin Sterling with Seaport Global. Please proceed with your questions.

Kevin Sterling

Thank you. Good morning, Brad and Scott.

Scott Malat

Good morning. And remember, Kevin, even Steph Curry misses a shot once in a while.

Kevin Sterling

He does and you’re absolutely right. And let me jump on, Scott, to say congratulations and wish you the best of luck there in Europe. I’ve enjoyed working with you over the years and I tell you seven years flies by, doesn’t it?

Scott Malat

It really does. Thanks, Kevin.

Kevin Sterling

And Brad, most of my questions have been answered, but you guys highlighted the growth you’re seeing in intermodal right now and some 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?

Brad Jacobs

It’s certainly not rail service; that we can agree on. It is up though. Revenue’s up double digits in intermodal, and this is the second consecutive quarter that we’ve had double-digit revenue growth. What’s driving it is higher yield, so we’re getting more revenue from that, and new business wins. We are gaining more market share, mainly due to the cross-sell with customers that we have in LTL and brokerage. And I would 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 are thinking about long-term alternatives and diversifying a little bit, not having just truck as a supply chain alternative, but also looking at intermodal.

Kevin Sterling

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

Brad Jacobs

Yes, absolutely. And that’s been going on for about the last year with quite a number of customers.

Kevin Sterling

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

Brad Jacobs

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

Kevin Sterling

Got you. That’s all I had. Thanks for your time this morning. Scott, congratulations and best of luck to you.

Scott Malat

Thanks, Kevin.

[Operator]

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

Brandon Oglenski

Hey, good morning. And 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 wanted 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 you talk about margin targets and where you want to see the business?

Brad Jacobs

Yes. There will always be cost-out opportunities, because even though we’re running the company very, very well, there is always inefficiencies to find, there is always waste that can be removed, there’s always process improvement, there’s always some places where we’re over-staffed, some places where we’re understaffed, some places where we’re just not managing overtime perfectly, there are some places where we’ve got excellent safety – years without an accident or an injury! – and there’s other places that we can still improve on safety. So I mean, if you go down the whole list, this what we do for living, is we honestly self-assess where we are 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 is appropriate to do so, and there’s still lots of opportunity to do that. Now, it won’t be the same costs every year. There will be different opportunities and costs, but there’s always opportunities to improve the margins in every part of our business. Now, did I missed another part of your question? Was there another part, Brandon?

Brandon Oglenski

Well, I guess if we go back a year or two, I mean, it was pretty clear, and I think the targets were clear from you guys that you want to get about 100 basis points of margin improvement in the year; is that just not the case anymore?

Brad Jacobs

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, through 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. In simple financial terms, that is still our model, and it always will be.

Brandon Oglenski

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 sale, I think was it last July, and we haven’t obviously seen a 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 a deal closes, as opposed to trying to do post-deal financing.” But what we’ve seen you do with cash management, I think you’ve paid down quite a bit of debt here. So, should we be thinking that the opportunity to use the cash isn’t that quick, or this is just a better use of the balance sheet right now?

Brad Jacobs

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 were paying on interest, because there’s no corporate finance 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’re actively looking at M&A candidates. We have been for a while now. We don’t feel a gun to our head to do an M&A deal, but we want to do an M&A deal, but we only want to do a M&A we love. And be patient, we will definitely get there.

Brandon Oglenski

Okay, thank you.

Brad Jacobs

Thank you.

[Operator]

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

Todd Fowler

Great. Good morning, everyone and, Scott, congratulations; and Tavio, congratulations to you as well.

Scott Malat

Thank you.

Todd Fowler

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?

Brad Jacobs

It was mid - low-single digit million EBITDA.

Todd Fowler

On a full-year basis it was low-single digit of EBITDA?

Brad Jacobs

Yes, which is something that really bothered us because here we’re making low-single-digit million EBITDA and let our hearts get ahead of our minds in trying to support the customer ended up writing off $16 [ph] million, but c’est la vie.

Todd Fowler

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?

Brad Jacobs

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.

Todd Fowler

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 the law of large numbers comes into play, but how should we think about your ability to continue to grow that business, and as you 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?

Brad Jacobs

It’s 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 are just zealous with making sure that our customer service levels are extremely, extremely high. I believe that we will continue to grow that business double-digits, between 10% and 15%. You may have a quarter here there that’s higher than that, but 10% to 15% is the right band to look at for growing 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 that business would 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 are told this by our customers 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 won’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 are at $1.1 billion revenue level now – then life will be good.

Todd Fowler

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

Brad Jacobs

You said it more succinctly than I did. Thank you, yes.

Todd Fowler

All right, Brad. And then just a last one from 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 bit more balance between growth and particularly growth at the field accounts, that can be more profitable, and then the rate of margin improvement from kind of self-help and cost takeout slows, or how do we think about both at the top-line growth in LTL and the margin improvement into 2019?

Brad Jacobs

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 OR 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, that’s more profitable freight. And you mentioned the investment in the local sales force. I’m very happy we did that and the proof is in the pudding : 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 four categories of technology that we’ve been investing resources in and are super, super excited about, 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 come into the cross dock and, for the most part, they’re put in the right trailer or sometimes not the right trailer, and sometimes they’re 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, with the optimal sequence in the placing of it. And the efficiency for freight movements as a result of that is very significant, and of course it’s going to minimize damages.

The second bucket of technology in LTL that we’re excited about is advanced linehaul algorithms, and the reason we’re emphasizing that is, when we stepped back and did a strategic view of LTL a few months ago, and we went around the room and said, what are the biggest levers we can push to improve our LTL business even more and take it to the next level? Quite a lot of people independently said, let’s build more pures , let’s build more direct loads, so that we don’t have trucks going around God’s creation in every which direction, but we are 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 the load optimization - route optimization for 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, they are so much ahead of us, and we are committed to catching up and surpassing them. So we’re using machine learning to predict price elasticity. Old-school: LTL RFP comes in, takes a week, sometimes two weeks, you look at some of our competitors, it’s sometimes even more than two 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 our 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 another- if you look at the waste management industry, they are light years ahead of us in LTL. All across the board, they get many more stops per hour, and it’s more Waze-like-based , it’s more real-time, taking into consideration traffic patterns, taking into consideration how the day’s going for each truck, and then changing that all day long. So the upshot of that, doing dynamic route optimization on the P&D, is going to increase stops per hour a lot. So those four categories of LTL tech innovations are really important drivers to our business long-term.

Todd Fowler

Yeah. That’s helpful. I think that we’ve all known that opportunity has been out there in the industry in general, and it’s interesting to hear you guys moving forward with that. So I look forward to a service center tour at some point in the future. So thanks for the time this morning, guys.

Brad Jacobs

Thank you.

[Operator]

Next question is from the line of Ariel Rosa with Bank of America. Please proceed with your question.

Ariel Rosa

Hi, good morning guys. And just to echo everyone else’s comments, Scott it has been great working with you. Good luck on the next phase.

Scott Malat

Thanks very much.

Ariel Rosa

So, just - I wanted to say on this LTL point, you had mentioned the strong incremental margins in that space, and I’m wondering, you’ve had a strategy for a long time, 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?

Scott Malat

Absolutely. And 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 cost, 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 we 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.

Ariel Rosa

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

Scott Malat

I think you’re already seeing the local accounts in the positive territory, positive three. We will have 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.

Ariel Rosa

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?

Brad Jacobs

I don’t think you should look at it as a floor. I mean, if we have China tariffs and the 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 go downwards. So I wouldn’t say it’s a floor. In a macro that’s resembling anything like the positive macro we’ve been experiencing this year, yeah, 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.

Ariel Rosa

Okay. That makes sense. And then just last one on my end. I think in the last quarter, maybe it was two 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 are kind of actively engaged in dialogs 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 would look at? Do you maybe take a step back and reevaluate a broader set of opportunities?

Brad Jacobs

Not really. The ones that we’ve got shortlisted right now, and you recall we shortlisted them from hundreds and hundreds of ones that we looked at over the process, I like them all. I mean, they’re all really good deals, we’ve 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 are revisiting the whole list of ones that we rejected.

Ariel Rosa

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?

Brad Jacobs

Correct. That’s correct.

Ariel Rosa

Okay, terrific. Sounds good. Thanks for the time.

Brad Jacobs

Thanks, Ari. 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.

[Operator]

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