RXO, Inc.

Welcome to the RxO Q3 2023 earnings conference call and webcast. My name is Sindhu and I will be your operator for today's call. Please note that this conference is being recorded. During this call, the company will make certain forward-looking statements within the meaning of federal 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 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 as well as in its earnings release. You should refer to a copy of the company's earnings release in the investor relations section on the company's website for additional important information regarding forward-looking statements and disclosures and reconciliations of non-GAAP financial measures that the company uses when discussing its results. I will now turn the call over to Drew Wilkerson. Mr. Wilkerson, you may begin.

Good morning, everyone. Thanks for joining today's earnings call. With me today in Charlotte are Chief Financial Officer Jamie Harris and Chief Strategy Officer Jared Weisfeld. I'm pleased with RxO's performance in the third quarter and what was and continues to be a soft freight market. We've seen this part of the freight cycle before. and know exactly what actions we need to take to fuel our continued growth and set us up for long-term success. In the third quarter, we accelerated our brokerage market share gains while maintaining strong brokerage gross margins. Brokerage volume grew by 18% year over year. For the first time, we've broken out brokerage volume performance between truckload and less than truckload for you. Both grew significantly. Full truckload volume grew by 13% year over year, and less than truckload volume grew by 55% year over year. We service our full truckload customers exceptionally well, and those customers continue to award us LTL freight, which is mostly contractual and highly automated. We expect continued growth in our LTL business. When LTL reaches full scale, It will add a meaningful source of earnings to our business and will be a platform for continued growth. In addition, total volume, quarterly loads per day, and monthly loads per day during the month of September all set new records. All major brokerage verticals grew on a year-over-year basis, and loads per day grew every month as the quarter progressed. The most important driver of that growth was contractual volume. which grew 30% year over year, faster than the 19% year over year growth we achieved last quarter. This result speaks to the significant trust our customers have in us. Securing contractual volume positions us to win even more spot volume and project loads when the market inflects. We expect to grow brokerage volumes again in the fourth quarter on a year over year basis. Jared will walk you through our volume trends in more detail shortly. Our market share gains continue to be profitable. We leverage our cutting-edge AI-enabled technology to improve our buy rates and our sell rates. The year-over-year decline in revenue per load in the third quarter eased when compared to the revenue per load decline we saw in the second quarter. Brokerage gross margin was strong at 15.1% in the quarter. We also saw momentum in our complimentary services. We achieved another quarter of synergy load growth and managed transportation and secured additional new business wins that were on board in 2024. Within Last Mile, we continued to take action to improve our profitability and still expect Last Mile to grow EBITDA year over year for 2023. The strategic pricing actions that we took earlier this year helped contribute to 90 basis points of year-over-year margin expansion for complimentary services. The investments we made in our cutting-edge AI-enabled technology helped fuel our business results. In the third quarter, 97% of our loads were created or covered digitally up from 81% in the third quarter of 2022. The team is executing very well and is growing our core truckload business, expanding and investing in additional services and capitalizing on powerful trends, including nearshoring. Let me give you some more details about how the quarter played out. Early in the third quarter, we experienced a squeeze on gross margin. This is typical for this part of the cycle. We believe July was the low point for brokerage gross profit per load for 2023, and that the third quarter marked the low point for adjusted EBITDA this year. The freight market and RxO's performance improved each month as the third quarter progressed. Many of the industry metrics we look at also improved. The load-to-truck ratio increased from less than 2 to 1 earlier in the year to approximately 3 to 1 at the end of the third quarter. Industry-wide tender rejections also moved higher to approximately 4%, and carrier exits continued, although at a slow pace. We also continue to hear from our retail and e-commerce customers that inventories are in a much better position heading into this year's holiday season. While I'm optimistic about the improvements we're seeing, the industry still faces some challenges, including uncertainty around consumer demand heading into the holidays and the rise in interest rates and increased fuel prices. That brings us to the month of October, where we did see some softening. Many bid activity increased and brokerage volume grew year over year, but the volume growth was at a slower rate in the third quarter. However, Despite the softening in the market, our brokerage gross profit per load remained resilient in October and was roughly flat compared to the month of September with a strong gross margin of 16%. Even though the pace of the recovery is uncertain, we will continue to run the playbook we've talked with you about all year. First and most important, we'll continue to stay close to our customers to ensure we can react quickly to the ever-changing market dynamics. We'll remain focused on the long term and continue to make strategic investments. In the third quarter, we added new team members to fuel continued brokerage growth, introduced new technology to support our customers and our people, and expanded the services we provide to customers. All of these investments increase the stickiness with our customers. And they're an important part of our strategy. So you'll hear both Jamie and Jared talk more about them later in the call. Many of the largest shippers continue to increase their share of wallet with RxO because we have a team that has delivered results for their transportation and logistics departments. Our exceptional service is supported by the best people, the best technology, a broad array of services, and a strong financial position. Our strategy is to invest across all parts of the freight cycle, and that's uncommon in our industry. While investing during the down cycle negatively impacts short-term profitability, it delivers outsized returns when the market improves. This is not the first time we've run this playbook. This was a winning strategy for us during COVID when we invested aggressively in our sales force. We see this down cycle as a similar opportunity to position us for robust growth over the long term. On the cost side, we'll continue to be disciplined. Doing so will provide significant operating leverage for us when the market inflects. Jamie will talk more about the actions we're taking in a few minutes. We believe this playbook will enable us to achieve the long-term target we laid out for you a year ago at our investor day. We anticipate delivering between $475 million and $525 million in EBITDA by the end of 2027. We have a winning strategy, an experienced leadership team, proven technology, and close customer relationships. RxO is in a great position to exit this soft rate cycle even stronger than we entered it. Now, I'll turn it over to Jamie, who will discuss our financial results in more detail. Jamie?

Thank you, Drew, and good morning to everyone. In the third quarter, we generated $1 billion in revenue compared to $1.1 billion in the third quarter of 2022. Gross margin of 17.7% was down 190 basis points year over year, solid performance for this stage of the freight cycle. Our adjusted EBITDA was $26 million in the quarter compared to $66 million in the third quarter of 2022. And our adjusted EBITDA margin was 2.7% down 310 basis points. The declines in these metrics were primarily due to lower freight rates and the moderation of brokerage gross profit for loads. We continued to optimize our cost structure while investing for growth, positioning us well to drive substantial operating marginal average when the cycle inflects. I'll touch on our year-to-date annualized cost savings shortly. Below the line, our interest expense for the quarter was $8 million. Our adjusted effective tax rate of 13% in the quarter was a function of an updated annual forecast of lower taxable income in addition to a small amount of discrete tax items. Our year-to-date adjusted effective tax rate is approximately 19%. Adjusted diluted earnings per share for the quarter was 5 cents, which includes approximately 1 cent of discrete tax benefits. You can find a bridge to adjusted EPS on slide seven of the earnings presentation. Moving to our lines of business. We continue to outperform the brokerage industry. We grew brokerage volume by 18% year-over-year. Brokerage gross margin remained strong at 15.1%, down 390 basis points year-over-year, while only down 30 basis points sequentially. Complementary services gross margin of 20% improved by 90 basis points year-over-year. Our last mile pricing initiatives were the biggest driver. Please turn to slide 8 as we discuss cash flow. Our adjusted pre-cash flow over the trailing six months was impacted by lower profitability levels, increased quick pay adoption by carriers, and timing related to $15 million of certain cash tax outflows, including cash taxes related to prior periods. With respect to quick pay, this service allows our carrier partners to get faster access to their cash payments, increases carrier retention, and generates a strong return on capital for RxO. We have an opportunity to drive increased carrier adoption of QuickPay across our business and we're investing accordingly. While increased QuickPay adoption will be a net use of working capital, it is a good strategic initiative with our carrier base with a good return on investment. QuickPay is a win-win for our carriers and RxO. Normalizing for the increased adoption of QuickPay and cash tax items, our adjusted free cash flow conversion over the trailing six-month period was approximately 45%, which we are pleased with at this point in the trade cycle. We remain comfortable with an annual adjusted cash conversion rate between 40 and 60% of adjusted EBITDA over the long term across market cycles. As we mentioned last quarter, accelerated growth as the cycle turns will result in a use of working capital. We continue to anticipate to use approximately 7 to 9% of each incremental revenue dollar. This can impact short-term cash conversion depending on the pace of recovery. Let's move on to our cash balance. We've also included a six-month cash bridge on slide eight. We ended the quarter with $104 million of cash on the balance sheet. The largest headwinds to cash in the six-month period were restructuring and spend-related cash outflows in the amount of $12 million. We continued to expect restructuring and spend-related charges to decline significantly in 2024. We also continued to settle RSU tax withholding obligations in cash to minimize solution, which was an outflow of $5 million in the period. Let's now discuss cash on a three-month view. As you'll recall, in second quarter, we collected approximately $15 million of receivables earlier than we expected. But considering these earlier collections, the normalized starting cash balance for the third quarter was approximately $109 million. In addition to the use of working capital for quick pay, we used cash of approximately $3 million for restructuring and approximately $3 million for RSU tax withholdings. Turning to cost, We took out additional costs in the quarter and achieved annualized run rate savings of approximately $3 million. We've now achieved year-to-date annualized run rate savings of approximately $31 million with associated restructuring charges of $12 million, a strong return. While the savings have been masked by the current freight cycle dynamics and the reduction in brokerage gross profit for load, they will create significant operating leverage when the cycle turns. We now expect lower restructuring and spend-related costs relative to our prior estimate. Specifically, we expect 2023 restructuring and spend-related costs of approximately $30 to $32 million compared to $35 million previously. Additionally, we now anticipate cash outflows associated with these restructuring and spend-related actions of approximately $25 million, $5 million lower than our prior estimate. As you can see on slide nine, our balance sheet remains healthy with net leverage at a quarter end at approximately 2.1 times trailing 12 months adjusted EBITDA. This is higher than the 1.6 times last quarter due to our cycling or prior year EBITDA. While our leverage is above our long-term target of one to two times, our liquidity position remained robust with $604 million of available liquidity at the end of the quarter. We will again cycle through a tough comparison in the fourth quarter and expect net leverage to move higher at year end. I'd also like to review our capital structure. In early November, we exercised the accordion feature under our existing revolving credit agreement that increased total revolver commitments from $500 to $600 million. We simultaneously repaid all outstanding obligations under our term loan credit agreement. Pro forma, these actions will yield annual interest savings of more than $1 million. Gross debt will decrease, and our net debt and liquidity positions remain unchanged. We've maintained the same liquidity with more flexibility at a lower cost. As you'd expect, at the end of the fourth quarter, you will initially see a lower cash balance as a result of the prepayment. Our customers want to work with strong partners that can perform and invest across all market cycles. And these actions highlight our financial and balance sheet strength. You can find our updated 2023 modeling assumptions on slide 15 of the deck. Capital expenditures are expected to be between $60 and $65 million. This includes $10 to $12 million of strategic investments in real estate to position us for additional growth in our brokerage business. This is down slightly from our prior estimate of $15 million due to some changes in project timing. Depreciation and amortization is expected to be approximately $70 million at the low end of our prior range. Stock-based compensation expense is expected to be between $20 and $22 million. Interest expense is expected to be between $32 and $33 million, which is slightly lower than our prior estimates. This is pro forma for the capital structure optimization and includes the fourth quarter benefit associated with the net interest expense savings I mentioned earlier. We continue to expect a full year 2023 adjusted effective tax rate of approximately 25%. You should also model an average diluted share count of approximately 120 million shares. This does not include any impact associated with potential share repurchases. Overall, given the current state of the freight cycle, we're pleased with our execution. We have a strong balance sheet, we're operating well, investing strategically while remaining disciplined on cost, and positioning RxO for the cycle inflection. Now, I'd like to turn it over to Chief Strategy Officer Jared Weisfeld, who will talk more about our outlook.