Hub Group, Inc.

Hello, and welcome to the Hub Group third quarter 2020 earnings conference call. Dave Yeager, Hub CEO, Phil Yeager, Hub's President and Chief Operating Officer, and Jeff DeMartino, Hub's CFO, are joining me on the call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. In order for everyone to have an opportunity to participate, please submit your inquiries to one primary and one follow-up question. 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 the 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, Dave Yeager. You may begin.

Good afternoon, and thank you for participating in Hub Group's third quarter earnings call. I'm joined today by Phil Yeager, HUB's President and Chief Operating Officer, and Jeff DiMartino, HUB's Chief Financial Officer. I'd like to begin by acknowledging the men and women of HUB Group. During this pandemic, they have continued to provide great service to our valued clients while protecting their health and that of their families. Today, we announced that our third quarter volume in earnings grew significantly versus Q2. We've gone from a market that was extraordinarily surplus, which resulted in reduced pricing, to a highly constrained market with capacity at a premium and spot truck pricing at elevated levels. Our rail partners have been very resilient and have managed the significant sequential increases in intermodal volume extremely well. Anytime you have massive increases in volume, issues do arise. But our rail partners, being the Union Pacific and the Norfolk Southern, have responded quickly to mitigate issues, thereby avoiding any significant impact to our network or our customer service levels. Our clients' inventory levels continue to be constrained, while the demand for truckload and intermodal capacity remains strong. As a result of these market forces, going forward, we believe pricing has reached a trough, and the prices will continue to rise as demand is strong and capacity tight. With that, I'll turn it over to Phil to review our business lines.

Thank you, Dave. I would also like to start by thanking our team for their relentless focus on supporting our clients and each other in this dynamic environment. We have participated in a rapidly changing market since the trough in April, and we have continued to provide great service to our customers. We have done this while keeping a strong focus on our costs and continuing to invest in our business to drive long-term growth. For the quarter, intermodal volumes increased 9%, and revenue increased 4% as wins with strategic customers and the strengthening demand environment are driving our growth. Transcon volumes increased 18%, local west was up 17%, and local east volumes declined 3% as we experienced significant tightness in the west coast, leading to an earlier than anticipated peak season. Gross margin as a percentage of sales declined 390 basis points year over year. Our volume growth and improvements in our trucking operations could not offset headwinds from lower prices, rail cost increases, elevated equipment repositioning costs, and increased outsourcing of our drayage to support our volume growth. As the market has tightened, we invested in expanding our fleet, and we have continued to meet our customer commitments while providing a great service product. Strong rail service and continued tightness in inventory levels is positioning us for a strong 2021 bid season. Logistics revenue declined 7%, and gross margin as a percentage of sales declined 100 basis points year over year. We experienced strong growth in K-Stack and have continued to onboard new customer wins, given our excellent value proposition in our outsourced logistics solutions. This was offset by customer losses that were driven by the pandemic, as well as increased supplier costs. We have improved our productivity and continue to have a strong pipeline of onboardings. We anticipate excellent demand for our services will continue to accelerate, given the need of our customers to find more creative solutions to their supply chain challenges. Brokerage volume declined 10%, while revenue increased 10%, and gross margin as a percentage of sales declined 390 basis points year over year. We performed well as we moved into the spot market to support our clients who were experiencing lower primary tender acceptance rates while managing yield on committed business. meeting our customer commitments, and maintaining excellent service. We experienced margin compression as capacity costs increased more quickly than spot volumes early in the quarter. We also had a negative mix impact as LTL and project volumes declined during the quarter. We were seeing strong demand from our clients and are continuing to focus on supporting them during peak season and beyond. Dedicated revenue for the quarter declined 8%, and gross margin as a percentage of sales declined 110 basis points year over year. We have continued to support our clients as their demand surges while shedding unprofitable business and onboarding new customer wins. We are continuing to see improvement in our returns in the business and have a strong pipeline for growth. I will now hand it over to Jeff to discuss our financial performance.

Thank you, Phil, and hello, everyone. We are pleased that our business returned to growth in the third quarter with revenue up 1% led by our intermodal and truck brokerage businesses. As expected, intermodal volumes grew high single digits in the quarter, benefiting from strong demand from our strategic customers. While gross margin as a percent of revenue declined to 11.7%, Q3 gross margin of $108 million was the highest level achieved this year. We continue to exhibit strong cost control, with quarterly costs and expenses equal to 8% of revenue as compared to 10.7% last year. Our non-driver headcount is down by over 10%, due to our efficiency and technology initiatives. We have achieved our 2020 goal of $40 million of run rate savings for our profit improvement initiatives, and we remain committed to operating efficiently. We continue to improve our trucking operations, driving higher utilization while also reducing our operating expenses. Salaries and benefits expense for the quarter was down by over $14 million as compared to the prior year. General and administrative costs declined by over $10 million. Excluding the impact of legal settlement and consulting expense last year, G&A costs declined by approximately $5 million as we reduced our spending in several areas, including travel and professional services. Hub Group's diluted earnings per share for the quarter was 74 cents. This compares to 78 cents of diluted EPS in the third quarter of 2019, which included 19 cents for legal settlements and consulting. Our tax rate for the quarter was 21.5%, as we benefited from a state tax credit and the reversal of a federal tax reserve. For the full year, we expect the tax rate to be around 24.5%, which implies a rate of 26.6% in Q4. Our results continue to demonstrate the resilience of our operating model, as we generated $64 million of EBITDA in the quarter and ended with over $185 million of cash. We continue to have solid liquidity and low levels of net debt. We view our capital structure as an asset, and our priority continues to be reinvestment in the business through capital expenditures and strategic acquisitions. For the fourth quarter, we expect continued high single-digit intermodal volume growth based on customer demand and our recent and upcoming container deliveries. We anticipate revenue will decline sequentially in our non-intermodal business units, due to the impact of business loss earlier in the year, which is not yet being fully offset by our new business wins. We expect gross margin dollars will decline somewhat from Q3 levels due to rising costs in Q4, including for insurance costs in our trucking operation that are not fully offset by our revenue enhancements and our profit improvement initiatives. For the remainder of the year, we expect to spend between $70 and $75 million on capital expenditures to support growth in the business. For the year, we will be purchasing over 3,300 intermodal containers and over 300 tractors to refresh and grow our fleet while continuing to invest in technology. Dave, back to you for closing remarks.

Great. Thank you, Jeff. Despite the fact that the pandemic remains with us, we are encouraged by the strong freight economy that is being driven by demand for capacity, creating a positive pricing environment. We expect this strong demand to continue through the end of the year and into 2021. And with that, we'll open the line to any questions.

Thank you. We will now begin the question and answer session. If you have a question, please press star then 1 on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then 1 on your touchtone phone. And we do have our first question from Justin Long from Stevens.

Thanks and good afternoon. So maybe to start with intermodal, I was wondering if you could provide some color on how you're expecting to reprice your business in terms of just the quarterly cadence going forward, going into this next bid season. And then any initial thoughts around contractual rate increases for this bid season as well?

Sure. Yeah, this is Phil. Happy to do that. I would start with, you know, I think it's a little early to make a call on exactly where bid season will be going. We're repricing about 5% of our business here in the fourth quarter, and we'll reprice about 45%. in the first quarter of next year. So we'll have a whole lot more detail to provide, I think, on our Q4 call. However, I think given the backdrop, you know, with very strong demand, low inventory levels, tight truckload and intermodal capacity, Class A truck orders are staying at replacement levels, and I think we've done a very nice job of servicing our customers. I think all of that paints a backdrop where we'll be in a position to improve pricing and also continue to grow as an organization. So feeling very strongly that it will be a positive pricing year, just don't know the magnitude of that at this point.

Okay, thanks. And in terms of headcount, could you provide an update on what headcount was in the third quarter? Just curious what type of year-over-year change we saw there. And as you think about revenue starting to come back here sequentially, and hopefully that continues into next year, how sustainable are the headcount reductions that you've recently made?

Sure, yeah. So, September 30th, we were at about 1,850. That was down about 11% year over year. We do have a pretty rigorous process for Any headcount ads, we're looking to drive efficiency in the organization, so as revenue returns, we're going to hold the line to the extent we can on headcount and manage through efficiency metrics.

This is Phil. The only thing I'd add is that there are a few strategic areas we want to continue to invest in, being our maintenance network, where we think there's a cost reduction opportunity by the addition of headcounts. as well as continuing to develop our inside sales organization in the brokerage to help us drive volume and margin growth there.

Okay, Jeff, and I know you said in the fourth quarter, gross margin dollars should be down sequentially, but because of what's happening with headcount, and it sounds like you're focused on holding the line there, do you think that operating income will be down sequentially or can it be flat to up with some of the cost reductions um it should yeah we should be able to leverage some of those costs um a q3 number is a pretty good run rate on the cost and expense side okay great i'll leave it at that i appreciate the time thank you thanks then we do have our next question from scott group from wolf research

Hey, thanks, afternoon, guys. So when I think about fourth quarter, when there's typically a good peak, like it feels like we're having and there's some peak season pricing opportunities, we typically see fourth quarter net revenue higher and some years meaningfully higher than third quarter. Why is it not the case this year?

Yeah, sure. Thanks for the question. I think, you know, sequentially this year we do have some cost headwinds coming in in certain areas. You know, our drayage spend is one. We're working to mitigate that with our tractor ads this year. But we do think there's some sequential cost pressure. We also have a rising insurance cost that may be not, you know, not seasonally that we may not have had to that extent in the past if you're comparing us to prior years. Those would be the two big drivers.

Yeah, I think the other pieces that I would highlight is we did take rail cost increase in September. That wasn't fully baked into the third quarter results. And obviously with pricing, that was somewhat challenging. So we are doing, I think, a much better job of reducing our repositioning costs as the quarter is coming on to continue to support our volume growth opportunity but reduce expense. And then as Jeff mentioned, we have outsourced more of our trade. We are anticipating the growth is going to continue to be very strong, but given that insurance and the tax rate change, I think as well, obviously that's not a gross margin impact, but an impact as well. So those are really the main factors that are at play.

How much are, can you just, can you quantify those headwinds? I'm still just struggling a little bit because when I look at like 17 and 18 good peaks, we had $20 million uplift in net revenue. And maybe it's something different. Are you not doing peak season surcharges? Are the rail costs doing something different this time around?

Yeah, I think the difference might be the Q3 numbers are probably higher going in this year than they were in the past just because the market tightness started earlier. So there's probably not as much of a sequential improvement that you may have seen in earlier years.

Yeah, given the strength in import volumes, it was certainly a quicker peak than I think we would have anticipated, and we locked in a lot of those peak plans really before those volumes increased. So it is somewhat of a lower surcharge than we have typically been able to garner, but at the same time, it's a contractual commitment. On the spot side, when we are getting spot volumes, obviously we're able to garner very strong incremental surcharges to help cover that cost. But I think the other side of it is that we do have that increased cost of repositioning offsetting some of those returns on the surcharge.

Okay. And then just last question. Can you just talk about your visibility on rail cost increases for next year? And just do you think you've given up, I think, two points, give or take, of of gross margin this year. Can you get that back next year, or does it take a couple years to get that back?

Thank you. Hi, Scott. This is Dave. As far as the two points, I do think that during this upcoming bid season, particularly providing if demand remains very strong, which we anticipate it will, then yes, we can get that back very quickly. So I think that that can be accomplished within the next year.

Yeah, I think going into bid season, we see a really good opportunity. The discussions that we're having with our customers are the, you know, given the transition they've seen in truckload capacity and rates, they want to lock in capacity and ensure that their supply chains are going to stay fluid next year. And that's a really good setup for intermodal and for intermodal pricing. I think the other good sign is that we are seeing shorter haul, more local east volume, start to transition back to intermodal, which generates a higher gross margin percentage and higher margin per load day for us because we're able to spin the assets in a more balanced manner and reduce our repositioning costs. So we feel as though there is both an operational and balanced yield opportunity as well as in our prices.

And to answer your first question, too, as far as the visibility with rail price increases, we have very clear visibility on that for next year.

Okay, great. Thank you, guys. Thank you.

And our next question comes from David Ross from Seifel.

Yes, good afternoon, gentlemen. I want to start, Jeff, a little couple nits on the CapEx side. Yeah. That CapEx number you gave, $70 million, $75 million, is that for the fourth quarter or for the full year?

That is for the fourth quarter. So we spent about $55 million year-to-date. We gave guidance on the second half when we announced Q2 earnings. And just based on the timing of the deliveries of containers and tractors, most of that ended up into Q4. We didn't spend much in Q3.

And any thoughts yet on 2021 directionally where that should go?

We're working on budgeting right now, so we'll have more to say when we announce Q4.

All right. And then for Dave and Phil, maybe just what have you learned about the business through the last seven months with all the ups and downs? Are there any things you've found out that surprised you and maybe helped ultimately coming out of this to run meaner and meaner?

You know, that's a very interesting question because I've never seen the types of fluctuations that we've experienced this year before in my career. I do think that some of the things I did learn is the resiliency and that you have to be very nimble and be able to react quickly to these types of changes. I mean, a pandemic is rather extreme. But certainly, we have been able to adjust very quickly with our leaner staff to price changes, whether it be from April when we were down significantly overall to where September we're up substantially. So I think that with the restructuring of the company, with the smaller headcount, but with very capable managers and people working at the company that we've been able to sustain ourselves pretty well during a very unusual time. I think it's a testament to the team.

In our brokerage, the productivity was up 24% in the quarter on a year-over-year basis. In logistics, it was double digits. Our driver productivity improved by 6% on a year-over-year basis. So, The fact that our folks are able to continue to deliver those sorts of results given all the fluctuations is a real testament to their work ethic. So we're very proud of what they've accomplished. But I think it positions us really well with our customers because we were able to step up and support them. And I think our customers see that value in deepening their partnerships with a company like ours because of that.

And last question on the DRAGE side, you mentioned it's a little bit, out of kilter in terms of increased third-party dray. What's the percentage now of in-house versus third-party, and where do you want that to be?

Yeah, we were at 54% during the quarter. That's down four percentage points on a year-over-year basis. And that's actually with a lower driver count in our drayage operations. We had earlier in the year gone through and identified that we had opportunities to bring on higher-performing drivers into our fleet, and we've been able to reduce the driver count, get more productivity out of that. So we're actually doing more volume with fewer drivers. So we are going to focus on getting to a long-term, that 80% goal, but invest in the fleet. We think to get to around and continue to grow to get around 60%. So that'll be the target that we'll have in our CapEx plan as we look ahead. Excellent. Thank you.

And we have our next question from Todd Fowler from KeyBank.

Great. Thanks and good evening. Dave, I just wanted to follow up on your comments and the prepared remarks about rail service. You know, it sounds like that you didn't experience any significant issues here in the quarter, but I just wanted to Make sure that was the case and have you expand on that a little bit. And then as you think about, you know, intermodal and the competitiveness versus truck, I mean, are you seeing anything from a service standpoint that given how tight the truck market is, you know, would prohibit more share coming to the intermodal market in a really constrained, you know, truck market? Just kind of what you're seeing from a service standpoint and customer interest at this point.

Sure. Thanks for the question, Todd. Yes, rail service, I mean, any time sequentially that you have the type of growth that we've experienced, you will have some amount of issues, but our rail partners have been able to remediate those very, very quickly so that we really have not negatively impacted our clients or our overall service. So the service has been good. I think that the major thing that our clients always want is consistency of service, whether it's A three-day transit or a four-day transit, that's the most critical issue for them. And so, you know, there's always going to be issues when you have that type of sequential increase, but how quickly you can, in fact, solve them and fix them is the key. And the railroads, our partners, the Union Pacific and Norfolk Southern, have been very nimble and able to accomplish those goals very quickly. Okay, good, great.

And then just to follow up, Jeff, on the operating expenses, the $74 million for the total for the third quarter, is that a good run rate for the fourth quarter? And as we get into 21, are there anything that we need to think about as far as costs coming back, if it's incentive compensation or anything that would change that significantly from the run rate where you're at right now?

Sure, yeah. So for Q3, the number is, I'd say it's a good run rate number to use. There was nothing... kind of to call out that would be unusual in that number in the quarter. And then to your point, we, you know, with the current trend this year, we've not been, you know, we don't expect to pay incentive compensation. We will budget, you know, typically we budget for that next year, any year, so we'll have that as a headwind.

And just, Jeff, what's kind of a ballpark number that you would think? I mean, not looking for maybe, but what would be a range that we should think about that could be coming back in 21?

Probably $5 million per quarter. Is there a number to think about? Okay, good.

All right, thanks for the help tonight.

And our next question comes from Basco Majors from Siskelahana.

Yeah, 2016 was the last time that you bought back stock in size, and looking at the price back then, it's 10 or 15 bucks higher today than it was, but your stock's trading at the same P multiple as it was back then. And it's actually a lot cheaper on free cashflow. Um, I mean the balance sheet, you talked about low leverage. It looks like you'll end the year under a half turn that debt to EBITDA and you know, you'll probably generate hundreds of millions of dollars in free cashflow over the next two years. So, so why not ramp up the buyback now?

Sure. Yeah, no, this is Jeff. Um, Our priority for reinvestment is always to invest in the business through either capital expenditures or acquisitions. We have been able to fund most of the CapEx through pretty attractively rated interest rate debt. We have been and continue to look for acquisitions. It's been about almost two years since we made the last acquisition of KSTAC. I'll tell you, we've been looking ever since. We've been active and anticipate doing something in the short term here, so that will continue to be a priority when it comes to the way we use our capital. But having said that, we do evaluate exactly the points you raised. We discuss with our board every quarter on return of capital to the shareholders, but at this point, the priority continues to be to grow and reinvest in the business.

So it sounds like If things go well, you would expect to have a decent size acquisition sometime before the end of next year.

Yeah, certainly the pipeline would suggest that that's the case, yes.

Thank you.

You're welcome.

And our next question comes from Brian Ossenbeck from J.P. Morgan.

Hey, good evening. Thanks for taking the question. Just going back to the rail side of things for a second. On the conference call last week, your main rail partner in the West mentioned going end-to-end with one point of contact for the customers. They weren't talking about going retail, but they did make it a point to say that there needs to be a better visibility and coordination throughout the supply chain end-to-end for shippers. So what can you add on to that? How far along is that process? Is it too early to see some any benefits? And I guess, you know, bottom line, what does it really mean that's happening here? Hi, Brian.

This is Dave. You know, I would suggest to you that Hub is very fortunate that we have very strong relationships with both the Union Pacific and the Norfolk Southern. And, in fact, I would say that these relationships have never been stronger. And a major reason for that, the strength of that relationship, is that We work very diligently on bringing value to the rails, in fact, probably as much as we focus on bringing value to our clients. So, you know, we invest our capital, hundreds of millions of dollars in containers and tractors and technology. We're exclusive to these rails. And so as a result of that, the networks that we build are, in fact, very complementary to to either the Union Pacific and or the Norfolk Southern. So we work with them very closely from a operations perspective in as much as we always target ourselves to get loads off the ramps the quickest of any IMC at every single terminal on these railroads. And we also never bring an empty back to the ramp thereby what that allows is for a relatively reducing the dwell time and also allowing their ranch to be very fluid. So we feel as though the value that we bring to them, in addition to being a large, low-cost-to-serve customer, puts us in very good shape with both our rail partners, and that as long as we bring value to both our customers and our rails, we believe we have a very strong seat at the table.

Okay. I guess maybe more generally, what can you add about trying to put more visibility through the supply chain when it comes to shipping? Because if we are trying to convert off of the highway, then shippers would really want one point of contact. And then they don't want to deal with any more touch points than they have to or any more than they would with trucks. So do you see anything on the horizon in that regard?

I think to a large extent we've worked diligently on that and invested in a lot of technology to just do that, enhance the visibility. As an example, I think we're still the only intermodal fleet that is 100% GPS tracking. So that the whole thing with visibility, where the blind spot was, was not on the rail because they have good systems. You can identify exactly where containers and shipments are. It was at either end of the drag cycle. With our technology, we know not only where the container is on any given moment, we know if it has freight in it because we have a sonar type device which will check to see if there's any freight in the box, as well as we know when the doors are open. So we offer that visibility to our clients so that they can see at any point in time where the container is. We can push that notice to them. They can go on an app that allows them to look at it and to determine when it's going to be delivered. So the visibility is something that we have right now and that we work with our rail partners on very consistently.

Yeah, and I would just add there continue to be opportunities to improve the experience and the handoffs that we have between our rail partners to create a more fluid operation. We work very closely with them on that, but it could be anything from making sure that the highest priority shipments are always getting loaded even though it might be last minute, improving our driver cycle times through the terminals. You know, those are things that reduce costs, that improve the intermodal product, that on top of our great technology, you know, are going to make us even more competitive, I think, to continue to compete with truck. And we're working very close with our partners on continuing to make it a truck competitive or better than truck product.

Wonderful. Okay, one quick one then on logistics. Can you just give us an update on KSTAC? We saw, I guess, the return of OTIF not too long ago. I imagine that's probably pretty good for that business, but you already mentioned trying to meet the customers where they need it and where you can find capacity. So maybe just an update on KSTAC, the growth opportunities, and how that change back to OTIF or the tightening of OTIF should benefit that business in the coming quarters.

Yeah, the tightening of OTIF is certainly a tailwind for that business. I think the service sensitivity is extremely important, and there just continues to be a proliferation of SKUs in different retailers that is going to drive growth. We've done a nice job of growing with a significant number of retailers and continuing to diversify the business. It continues to grow at a double-digit rate. And although we are seeing some short-term margin challenges with some increased costs, we are working diligently to get that improved. So, we think there's a great growth opportunity ahead. We are continuing to position the product, I think, extremely well and also tying it into – all the solutions that we bring to our larger customers, which is going to thrive even further scale outside of the typical smaller consumer product, small to mid-sized consumer product customer that they've had traditionally. And we've seen really great success in cross-selling to our existing client base. So continue to be very pleased with how the acquisition has gone and what we have ahead of us.

Okay. Thanks for the time today. Thank you.

And as a reminder, if you do have a question, please press star then 1 on your touch-tone phone. Once again, that is star 1 on your touch-tone phone. And we do have our next question from Tom Wadewoods from VS. Yeah, good afternoon.

I think it's pretty notable if I look at the volume performance in intermodal. that you're up at 9% and you're two big intermodal competitors. JB Hunt and Snyder are down around 2% for the quarter. So I just wondered if you could offer some thoughts on what some of the key drivers of that are. You know, they both ride in the BN, you ride in the UP. Obviously price could be a factor, but what do you think, what do you think between those two things? I mean, do you think there is a, significant outperformance of how UP is running and that that's some advantage that maybe can continue to accrue for you? Or is it kind of a, you know, more of a factor on how aggressive you were with rates? So just some thoughts on that competitive dynamic.

Yeah, I think it's a combination. Our combined service with the UP is very strong and we continue to improve on it. As I was just mentioning, you know, the operational side, partnership that we've developed with them to create a more seamless service is fantastic. So I certainly think that service product and the flexibility that we've had is differentiating. The other piece is certainly during bid season, we were able to get some wins with strategic customers of ours that drove growth. And also during the initial fallout from the truckload market, we were very aligned with some of our larger customers to support them during that. Given the container ads that we also made, I think that has been a big differentiation where we have had capacity coming into the West Coast, not only in our empty repositionings, but in our import of new containers. And that has helped us significantly in supporting the demand in that portion of the market. So they both set up a very nice picture, though, for us to be in a position where we can discuss with our clients the support we were able to provide during, you know, really a dislocation in the market. So I think it sets us up very well going forward.

Would you expect to add meaningfully more containers next year as well?

Yes, we are anticipating continuing to grow the fleet. As Jeff mentioned, we are in our budgeting process. We don't have a specific count, but we will be looking at our our forecasts and working with our customers to understand their needs and requirements based on what we know. The conversion of truckload freight back to intermodal should be very high and sets us up with a opportunity. We want to be balanced in our approach to grow above market, but also continue to improve our pricing.

Great. Just one other follow-up. I think you were asked a little bit about M&A. you know, it seems that there are a pretty good number of, uh, transports out there, uh, you know, looking to at least interested in doing M&A. I mean, there is, there is, you know, one that announced the, uh, special dividend today, which seemed to be at least an indication that, uh, partial indication that maybe it's just tough to find the right companies to buy. Um, what are your thoughts on what's going on in the M&A market? Is, uh, are sellers just looking for too high of a price? Um, Is it kind of COVID-related, or what do you think it is that's maybe, you know, a number of people looking but not necessarily a lot happening with actual deals?

Yeah, on that front, you know, we haven't seen a lot of companies kind of actively launching sale processes. We've been active on searching and, frankly, knocking on doors that, the acquisitions we've been engaged in diligence on have been, you know, those types of situations where we've found a company that we either have worked with in the past or has a really high-quality reputation, and we knock on the door and kind of kick things off that way. So I don't know if the other companies you're referring to just aren't seeing opportunities or not looking in the right places, but we've had some good success in our, you know, I think, maturing along in the phase of diligence on some of these opportunities, and we're hopeful to get something done in the short term here.

Okay. Yeah, great. Thanks for the time.

Thanks, Tom. Thanks, Tom.

And we do have our next question from Jason Seidel from Cohen & Company.

Thank you, Operator Ray. Gentlemen, I hope everything is well. I wanted to ask about the dedicated side. Obviously, you got hit by some higher costs on the insurance and repair side. Dedicated, obviously, is a lot different than sort of over-the-road, one-way truckload. How long is it going to take for you to sort of get those expenses back through pricing?

Yes, what I would tell you is that I think we're still middle innings in the evolution of that business. We've put in much better cost disciplines, and although we saw some gross margin compression, we're – improving our returns in that business. We are continuing to get through the tail end of shedding of unprofitable business and bringing on some nice new wins there and implementing technology. You know, I think the opportunity that's out there is going to be to convert one-way truckload or higher-cost private fleets over to a dedicated configuration, and that is what is really driving our pipeline right now. As we look at renewals, I think given what is being stated about the truckload market and what we're seeing with wage inflation and insurance costs, there is going to need to continue to be discussions, and we're going to need to execute on rate increases. to offset those challenges. And our customers are very understanding of that and see those same challenges. If we're not able to have a competitive wage and recruit drivers, we're not able to provide the service levels that our customers desire and that we demand of ourselves. So it's a very open dialogue. It's very collaborative. And I think we'll see ourselves being able to continue to grow that business at a healthy profile going forward given the baseline that we've set, but still opportunities that are out there.

Okay. I appreciate the color of that. And I guess I want to hop to brokerage really quickly. You know, your percentage of contractual business declined, and I'm assuming that's just because the amount of contract business, excuse me, transactional business is out in the marketplace. How should we look at in terms of repricing in the brokerage business? Like what percentage do you guys get to reprice in 4Q and what percentage of those contracts get to reprice in 1Q?

Yeah, I'd say it's a similar breakdown to our intermodal business where you'll see about 50% repriced through the first quarter of the year. So, you know, obviously we've seen some contractual cost compression. We've seen inflation of our purchase transportation costs. We're working very diligently to offset that. But given, obviously, the market changes anticipated that we would see that, I do think we'll be able to do a much better job in managing that through the latter portion of this year and into next year. So the contractual volumes, though, should be relatively in line and really match our our intermodal business, and there's going to be an opportunity to reprice at a higher level, I think probably even a higher percentage potentially than intermodal, just given what we're seeing and hearing from our clients at this point in time. The only other piece that has been a little bit of an impact, and I know I addressed it in my prepared remarks, is our project volumes, which just given the dislocation of inventory at this point has gone down significantly. That's typically a high margin profile for us. Based on the discussions we've had with our large customers, we anticipate that's going to come back in 2021 and should be a nice tailwind for us, as will our LTL volume growth be as well. So we're seeing positive signs in brokerage and I think very well positioned given the productivity enhancements we've made to that business.

Fair enough. Gentlemen, I appreciate the time, as always. Thank you.

And our next question comes from John Chappell from Evercore.

Thank you. Good afternoon, guys. Phil, Jeff mentioned in the 4Q outlook that revenue will decline sequentially in the non-intermodal categories from customer losses early in the year. That's exactly what you guys said for 3Q relative to 2Q, yet in every category it was up sequentially and pretty meaningfully in logistics and brokerage. So how much of that 3Q to 2Q trend was kind of macro? The market just moved really aggressively in the last two months of the quarter versus your available capacity, some market share wins, customers that you brought online. And if it's the latter, how come that wouldn't be repeatable then as we look at 4Q versus 3Q?

Yeah, the Q3 numbers actually did, frankly, surprise us. The revenue did beat our internal forecast. A lot of that was, frankly, the biggest piece was in brokerage, where we had some higher revenue dollar spot business opportunities. I'd say just generally the market surprised us on the other business lines. Logistics and brokerage were up, again, better than we expected, not to the same degree that brokerage was. But we do think, you know, there is going to be a little bit of softness. There's some seasonality in the business as well that will impact revenue in Q4 as well.

And we did not recognize the full impact of some of the losses from some of those non-essential retail clients that, unfortunately, were heavily impacted by COVID in the third quarter. We will recognize that in the fourth quarter. However, I would say we're working hard every day to keep bringing on new wins. We are bringing on new wins in logistics and are going to continue to do that. They'll have a better margin profile than the business that we lost, a much better margin profile. And in brokerage, we have a team every day that is focusing on supporting our customers. And if demand holds, there's certainly opportunities for us to expand our top line and net revenue. So we're not certainly going to say, hey, we're throwing in the towel and not going to push ourselves to be better from third quarter to fourth quarter, but just trying to give you our best view of what that might be given what we know at this point.

Okay. Thanks for that. And I did want to ask as my follow-up about the customers, like the non-essentials that have been shut down recently, Two weeks ago, this might have been a different conversation, but it does seem like, broadly speaking, things are opening up again. How much of your customer base that was shut down for a period of time has come back? And I guess, how's your capacity, ability to take some of that on, especially as you balance some of the new customers you brought on? And this can span intermodal to logistics to brokerages across the entire business.

Sure. So I would say with Intermodal, we have really focused on supporting our strategic customers who supported us during challenging times in COVID. And we have brought on some new clients that we think are strategically important for us longer term and industry verticals that we would like to crack into, but have mainly focused on supporting our core group of clients. Brokerage, I would say, as well, we have stuck to our commitments and continue to support our customers on the contract side, despite some of the cost compression that we've seen there. And we've been rewarded for that in the past and plan to see that again. We also are able to participate in the spot opportunities that are much higher yield, although that doesn't completely offset just given the dislocation in the market. And then, you know, and In logistics, we have become much more productive and improved our onboarding process significantly, so we are able to scale our business, slot in new onboardings much more effectively. They aren't as high of revenue dollars, but the growth and operating margins of those new business wins are very strong. We're, you know, continuing to focus on scaling the business, using what we have to continue to provide a great service, and the investments that we've made in technology are really helping us continue to do that. As I mentioned, our productivity in brokerages is a fantastic result, a 20-plus percent improvement there. year-over-year basis. So we feel good about our ability to continue to scale and add new customers, but, you know, we're trying to be selective on who we work with as well, just given some of the impact that we had from those nonessential retailers who, unfortunately, you know, weren't able to make it through given their financial position. So we are scrutinizing the financials of our customers. We want to continue to partner with the winners, and that will be our focus going forward.

Great. That makes sense. Thanks, Phil. Thanks, Jeff. Thank you.

And as a reminder, if you do have a question, please press star, then one on your touchtone phone. And we do have our next question from Todd Fowler from KeyBank. Todd, your line is open.

Sorry about that. Can you guys hear me? Yes, we can. Okay, good. Thanks for taking the follow-up. I guess I just wanted to follow up a little bit on the question about the brokerage growth here in the quarter. Traditionally, I don't think about you as having a large transactional brokerage presence, so it sounds like that a lot of the increase in volume was helping out some existing customers. Is that some business that you can convert to being more sticky business into the future? So how do you think about kind of the sustainability of some of the the transactional volume that you saw here on the brokerage side this quarter? That's exactly right.

Yeah, it's not only on a lane basis seeing spot transactions that are continually coming across to convert to a contracted carrier and to a contract win for Hub. But it's also, you know, we in the past had a difficult time cross-selling our brokerage given the service that we were providing. I think we have completely improved our service product. We are, you know, and especially in the spot market and in our contractual business, and that sets us up to have that dialogue and grow on an ongoing basis, as well as get the opportunities on the spot board to continue to grow as well. So we're anticipating that the support we're giving those strategic customers is going to lead to larger wins during their RFP events, as well as continued opportunities to participate in the spot board and then convert that business over to contractual business as well. So hopefully we're working to create really a strong cycle there with these customers where they see us as a strong brokerage option that can support their needs.

Okay, that helps. That sounds good. And then just the last one for me, Yeah, I think in the past you've talked about the ability to hit 5% operating margins, which you've done on a quarterly basis. As you think about the progress that you've had on the cost takeout here and then the repricing of some of the businesses you get into 2021, is that something that's achievable maybe in the back half of next year? Are there some other things that you need to see to get to that margin target that you've talked about in the past?

Yeah, that does continue to be our longer-term target. I think we're going to need a stronger pricing cycle to get there, so I'm not optimistic at the end of next year. We may be at that run rate, but it's probably going to be beyond that.

Okay, so not just – maybe not something you pick up on one bid season, maybe another bid season after that.

I don't think so. We've certainly been focused on taking out operating costs, but – Gross margin driven by price is a very powerful lever in our business.

Yeah, understood. Okay, thanks for the time tonight. Thanks, Todd.

And we have no further questions at this time. I will now turn the call over to Dave Yeager for closing remarks.

Well, thank you for joining us for our third quarter earnings call. As always, Jeff, Phil, and I are available for any additional questions that you may have. So, again, thank you and have a good evening.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. We may now disconnect.