XPO, Inc.

Welcome to the XPO third quarter 2023 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 on a listen only mode. Later, we will conduct a question and answer session. If you have a question, please dial star one on your telephone keypad. Please limit yourself to one question when you come up in the queue. If you have additional questions, you're welcome to get back in the queue and we'll take as many as we can. 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 meeting 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 as well as in its earnings release. 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 or on its website. 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 investor section of the company's website. I'll now turn the call over to XPO's Chief Executive Officer, Mario Harrick. Mr. Harrick, you may begin.

Good morning, everyone. Thanks for joining our call. I'm here in Greenwich with Kyle Wismans, our Chief Financial Officer, and Ali Faghri, our Chief Strategy Officer. This morning, we reported financial results that were well above expectations for growth and profitability, despite a soft market for freight transportation. It was a strong third quarter for us company-wide, We grew revenue year-over-year to $2 billion and improved our adjusted EBITDA to $278 million, an increase of 6% year-over-year. Both segments of the business grew adjusted EBITDA in the quarter. Adjusted diluted EPS for the company was $0.88, which was also higher than expected. I want to use my comments this morning to give you a progress report on the four pillars of our plan for LTL 2.0, starting with customer service, where we've made great progress this quarter. Our claims ratio for damages was 0.4%, an improvement from 0.7% in the prior quarter. To put that in context, when we launched LTL 2.0 nearly two years ago, our claims ratio was 1.2%. So we've been steadily making good on our promise to elevate service. Our third quarter claims ratio is our best result ever. And in the month of September, we exited the quarter with the best damage frequency level in our history. Another key service metric is on-time performance. This was eight percentage points better in the quarter. compared with last year. We're very focused on ensuring that our service standards remain high as we grow. In the third quarter, our shipment count was significantly higher as we took more volume into our network, while at the same time, we delivered meaningful service improvements. And we're already taking the next steps forward with our investments in service. This includes enhancing our training programs and loading procedures and equipping our field operations with new service tools. The high caliber straps and airbag systems we're rolling out are generating positive returns in a short period of time. For example, in the service centers with the new airbag systems, we're already seeing a 20% improvement in damage frequency. Our strong commitment to service is critical for our customers. And while we've made significant progress, we can clearly see the runway we have for further improvement. Our top priority is to be the best in class LTL service provider in the coming years. The second pillar of LTL 2.0 is to invest in our network. Our business has historically generated a high return on invested capital. Since the launch of LTL 2.0, we've added 10,000 trailers, 2,000 tractors, and over 500 net new doors. This has allowed us to take on more freight for our customers while maintaining strong network fluidity. More than two-thirds of our 2023 CAPEX is being deployed to increase the capacity of our fleet. Year-to-date, we've added more than 1,000 tractors, which brought down the average tractor age to 5.2 years from 5.9 years at the end of 2022. and we're on track to exceed our production target of 6,000 new traders this year. Year-to-date, we've manufactured over 4,900 traders at our in-house facility in Arkansas. In addition, we expanded our service center doors in the Atlanta and Dallas metro areas in July, and we broke ground on a new facility in Central Florida, which is a key growth market for us. This is consistent with the plan we outlined that we're adding new doors and markets where our investments in capacity can sustain more growth over time. To date, we've added 531 net new doors against a target of 900, and we expect to open the remainder by early 2024, primarily at existing terminals. These targeted expansions are performing well and exceeding our return hurdles. I want to touch on one of the long-term targets we introduced with LTL 2.0, which was for CapEx allocation of 8% to 12% of revenue on average through 2027. Given the recent market dynamics and the opportunity at hand, we're accelerating the pace of that spend. As a result, our CapEx this year will be 12% to 13% of revenue and will likely continue to exceed our target range in the near term. The third pillar of our plan is to accelerate yield growth. In the third quarter, we focused on strengthening our underlying pricing trends, such as contract renewal pricing, and executed a number of other initiatives to align the price we receive with the value we deliver. Yield is our single biggest opportunity for margin improvement, and you saw this impact in our earnings release this morning. We grew yield, excluding fuel, by 6.4% year over year, representing a significant acceleration from the first half of the year. We see a double-digit pricing opportunity that we expect to capture over the coming years through three primary levers. First, as we continue to improve our service, customers are willing to pay a premium price for the value we deliver. We're seeing this with both contract renewals and new business. We also see a significant opportunity to grow our accessorial revenue, including a range of value-added services such as retail store rollouts and grocery consolidations. These are services that our customers are asking for. And lastly, we're focused on growing our local customer base, which is a higher margin business for us. In the third quarter, we achieved double-digit shipment growth in our local sales channel. and we're expanding our log sales force to reflect the scale of this opportunity. So while we had strong yield growth in the quarter, the key point is the momentum it indicates going forward. We're confident that we'll continue to improve our yield in the coming years. The final pillar of LTL 2.0 is cost efficiency, specifically with purchase transportation, variable costs, and overhead. In the third quarter, we reduced our purchase transportation costs by 21% year-over-year by covering more line haul miles in-house, while also paying lower contract rates for the miles we outsourced. We ended the quarter with 21.5% of line haul miles outsourced to third parties, which was a 200 basis points reduction year-over-year. Even though we purchased more transportation on a short-term basis, to cover the recent inflection in volume. Our plan is to accelerate bringing more miles in-house with initiatives tailored to our line haul network. For example, we're in the process of adding more driver teams and sleeper trucks for long-distance hauls. We're targeting a few hundreds of these teams to be in operation by the end of 2024, which will increase the efficiency and flexibility of our service. we're targeting at least a 50% reduction in third-party line haul miles as a percent of total by 2027 compared with 2021. Another margin opportunity we have with variable costs is labor. We managed this effectively in the third quarter. Our headcount and labor hours per day were roughly flat year over year, while our shipment count was up by high single digits. Our ability to realize these productivity gains while also improving our service metrics reflects the strong execution of our operational teams and the strength of our proprietary technology. That touches on the key points of our plan and the progress we made in the third quarter with more to follow. We're generating record service levels, gaining profitable market share, and driving yield higher. These are the critical levers of margin expansion in our LTL business. We're continuing to make strategic investments in our network, and we have the agility to capitalize on changes in market conditions. At the same time, we're becoming more cost-efficient with our operations, so we can translate revenue growth into earnings at a higher rate. We remain solidly on track to deliver on our outlook of at least 600 basis points of adjusted operating ratio improvement through 2027. Before I close, I want to mention that this week marks our one-year anniversary as a standalone LTL provider in North America. I couldn't be more proud of the progress we've made and will continue to make as we work to realize the full potential of XPO. We're well underway in executing on the strategy we initiated at the end of 2021. We're a focused, high-energy, customer-loving organization, and we'll continue to build on our momentum. I want to take this opportunity to thank our thousands of dedicated employees for their world-class support of XPO. We have a phenomenal team driving our strategy to be the best in the industry. Now, I'm going to head the call over to Kyle to discuss the third quarter results. Kyle, over to you.

Thank you, Mario, and good morning, everyone. I'll take you through our key financial results, balance sheet, and liquidity. Revenue for the total company was $2 billion, up 2% year-over-year and up 3% sequentially from the second quarter. In our LTL segment, revenue was up 2% year-over-year and up 8% sequentially. Excluding fuel, LTL revenue was up 8% year-over-year and up 7% sequentially. Salary, wages, and benefits for LTL were 10% higher in the quarter than a year ago. The increase was primarily related to higher incentive compensation to account for the team's strong third quarter performance, as well as the impact of wage inflation. Our improvements in productivity partially offset these costs. We handled more shipments with lower headcount and fewer labor hours than in the third quarter a year ago. Importantly, it was the third consecutive quarter that shipment count grew at a faster pace than labor hours, and the spread has widened sequentially with each period. In the third quarter, our shipment count per day grew by 8% year over year, while labor hours increased by less than 1%. We were also more cost efficient with purchase transportation through a combination of insourcing and rate negotiation. Our expense for third party carriers was $97 million in the quarter, which was down year over year by 21%. Depreciation expense in the quarter increased by 29%, or $15 million, reflecting our commitment to reinvesting in the business. This remains our top priority for capital allocation. In the third quarter, our CapEx was primarily allocated to purchasing new tractors from the OEMs and manufacturing more trailers in-house. Next, I'll add some detail to adjusted EBITDA, starting with the company as a whole. We generated adjusted EBITDA of $278 million in the quarter. which was up 6% from a year ago, reflecting a year-over-year increase in both North American LTL and the European business. Our adjusted EBITDA margin was 14%, representing a year-over-year improvement of 50 basis points company-wide. And we reduced third quarter corporate expense to $7 million, as we continue to rationalize our corporate cost structure for the standalone business. This was a year-over-year savings of 67%, or $14 million. Looking at just the LTL segment, we grew adjusted EBITDA year-over-year to $241 million. Our revenue growth and cost efficiencies more than offset non-operational headwinds from lower fuel surcharge revenue and pension income. In our European transportation segment, adjusted EBITDA increased to $44 million for the quarter. Company-wide, we reported operating income of $154 million for the quarter, up 11% year over year. Our net income from continuing operations was $86 million in a quarter, representing diluted earnings per share of 72 cents. This compares to income of $92 million and diluted EPS of 79 cents a year ago. The year-over-year decline in third quarter net income was primarily due to an $11 million decrease in pension income and a $6 million increase in interest expense this year. We also had $8 million of transaction and integration costs related to the RxO spinoff, and another $1 million of restructuring charges across our segments. These costs stepped down materially from the first half of the year. On an adjusted basis, our EPS for the quarter was $0.88, which is down 7% from a year ago, also reflecting the impact of lower pension income and higher interest expense. And lastly, we generated $236 million cash flow from continuing operations in the quarter and deployed $133 million of net CapEx. Moving to the balance sheet, we ended the quarter with $355 million of cash on hand. Combined with available capacity under committed borrowing facilities This gave us $944 million of liquidity. We had no borrowings outstanding under our ABL facility at quarter end. And our net debt leverage was 2.2 times trailing 12 months adjusted EBITDA. Our capital structure gives us the financial flexibility to execute on the significant growth opportunities we have at XPO. Before I wrap up, I want to highlight some updates to our full year 2023 planning assumptions. We now expect that gross CapEx will be in the range of $675 to $725 million this year, given the opportunities we have to invest in network capacity to drive long-term growth. We're also projecting interest expense of $170 to $175 million pension income of $15 to $20 million, and an effective tax rate of 23 to 24%. Our assumption for diluted share count remains unchanged at 118 million shares for the full year. Now, I'll turn it over to Ali, who will cover our operating results.

Thank you, Kyle. I'll start with the operating results for our LTL segment. In the third quarter, we had a year-over-year increase in shipment count of 7.8%, led by 13% growth in our local sales channel. As a result, our tonnage per day increased by 3.1%. This more than offset the impact of macro conditions, which continue to put pressure on our industry. Our weight per shipment declined 4.3% in the quarter compared with a year ago, which was slightly better than in the second quarter. There are two key drivers behind the solid growth we reported. First, we're continuing to gain market share because of the significant service improvements we're making in the network. And second, when Yellow exited the LTL market, we were well positioned to onboard incremental freight, given that we've been investing in expanding our network since 2021. We also demonstrated that we have the operational discipline to take on more volume while at the same time continuing to improve our service levels. On a monthly basis, our July tonnage per day was up 4.2% year over year. August was up 3.3% and September was up 2.2%. Looking just at shipments per day, July was up 8.8% year-over-year, August was up 8.3%, and September was up 6.6%. Our shipment count increased sequentially by more than 1,000 shipments per day every month of the quarter from July to September. On a two-year stack basis, monthly tonnage and shipment count also improved each month throughout the third quarter. With October almost complete, our preliminary tonnage per day is up approximately 2.5% year-over-year, and shipment count is up 6%. On a sequential basis from September, October tonnage and shipment counts are down 2.5%, with both outperforming seasonality. Looking at yield in the third quarter, we grew yield excluding fuel by 6.4% year-over-year, which is an acceleration from the second quarter. On a sequential basis, we increased yield ex-fuel quarter-over-quarter, outperforming typical seasonality by 290 basis points. And importantly, we accelerated yield growth as the quarter progressed, supported by our strong customer relationships and pricing initiatives. Our underlying pricing trends also strengthened, with contract renewal pricing up 9% in the quarter compared with a year ago. We expect year-over-year yield growth, ex-fuel, to further accelerate in the fourth quarter, and we're excited about the long-term impact that our yield initiatives will have on profitability. Turning to margin performance, our third quarter adjusted operating ratio was 86.2%, which was 60 basis points higher than a year ago. On a sequential basis, we improved adjusted OR by 140 basis points compared with the second quarter. This outperformed seasonality by 370 basis points. Moving to our European business, we delivered another solid financial quarter with adjusted EBITDA growth of 2% compared with a year ago. This was supported by strong pricing, which outpaced inflation, as well as cost discipline. While macro conditions in Europe remain soft overall, our sales pipeline is robust, and the team continues to execute well, especially in the UK, where we drove positive organic growth in the quarter. I'll close with the drivers behind our momentum, including the strong outperformance of our third quarter operating ratio. First, we continued to make significant improvements in service across the board and delivered record results. We also accelerated yield growth in the quarter and will accelerate it again in the current quarter. We expect our robust yield performance to continue into 2024. And we operated far more productively by leveraging our technology and effectively managing our labor costs. In summary, our strategy is working. XPO in North America is stronger as a standalone LTL company with focused execution, and our results will continue to reflect that. Now, we'll take your questions. Operator, please open the line for Q&A.

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question today, please press star 1 on your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. So that we may address questions for as many participants as possible, we ask that you please ask only one question and one follow-up. If you have additional questions, you may re-queue and time permitting those questions will be addressed. Thank you. And our first question today is from the line of Chris Weatherby with Citigroup. Please proceed with your questions.

Hey, thanks. Good morning, guys. Maybe first if we could start on operating ratio and how you might think about the opportunity as you move through the fourth quarter and then maybe bigger picture for next year. So I guess Could you help us a little bit with what you view as normal seasonality and what you think maybe you could do relative to normal seasonality in 4Q?

Hey, Chris, this is Mario. Starting with the fourth quarter, we can give you some colors like we usually do on tonnage, yield, and ultimately what OR would do, and then give an outlook for 2024. On the tonnage side, following our market share gains in the third quarter, we expect to be in line with seasonality in the fourth quarter. which implies Q4 tonnage being up low single digit on a year-on-year basis. Now, for us on the tonnage side, normal seasonality Q3 to Q4 is a 4% sequential decline. October was better than seasonality, but this was also driven by a small increase in volume earlier in the month, given a cyber attack at another LTL carrier. And we'll give another update on November tonnage in early December. On the yield front, as we gain traction in our initiatives, yield growth improved through the third quarter, and we do expect Q4 yield ex-fueled to accelerate versus Q3, and on a year-on-year basis to be in the high single-digit range improvement. And ultimately, for OR in the fourth quarter, we typically see, seasonally, we see a deterioration of OR of 310 basis points from Q3 to Q4, and we expect to outperform that seasonality by somewhere in the 100 basis point range. So on a year-on-year basis, this implies an improvement of roughly around 200 basis points in OR, and the magnitude of the outperformance will depend on what the tonnage environment does in the back half of the quarter. As you know, Q4 is usually a tough quarter to predict with the holidays. Now, for 2024, we do expect a strong year. The biggest swing factor will be the macro and what the macro does through the course of 2024. But as I said, we have a lot of company-specific initiatives. As we have mentioned in our opening remarks, our service product continues to improve, hitting company records. Our yield is accelerating here in the fourth quarter, and we expect a strong year for yield in 2024. And we expect to continue to make great progress driving cost efficiencies, including line haul insourcing and accelerating that, and productivity improvements in labor as well. So from an OR perspective for 2024, we do expect a strong year, but we'll see where the macro take us here over the quarter to come.

That's very helpful. I appreciate all that color. And just one follow-up on 2024. As you think about sort of the longer-term operating ratio targets that you guys laid out through 2027, Given what you've seen with the post-yellow world, the pricing opportunity, and some of the significant improvements you're making around the service side, is it reasonable to assume or can you give us a sense of what the cadence of that overall OR improvement might look like? Is it front-end loaded? Is it back-end loaded? Any kind of thoughts about how that cadence should present itself, particularly given what we're seeing in the market currently?

First, on the number itself, we've always said it's at least 600 basis points by 2027. But we're not stopping at 600, and we're not stopping at 2027. And I think the cadence of improvement, based on what we're seeing short-term, it's fair to assume we can get there faster. But obviously, as we execute, we're going to keep on posting these numbers and going from there. And it will depend a bit, obviously, short-term on what the macro does in 2024. But we expect, obviously, a strong outlook going from here.

Our next question comes from the line of Scott Group with Wolf Research. Please proceed with your questions.

Hey, thanks. Good morning, guys. I want to dig into the pricing opportunity a little bit. So I think you said contract renewal is up 9%. Is that a number that you view as sustainable over the next few quarters? Help us think about, I don't know if you guys announced a GRI or what you're planning on the GRI, and then maybe touch on the assessorial value-added opportunity. Are we seeing any of that benefit yet, or is that still all incremental?

Hey, Scott. It's Kyle. So if you think about the contract renewal rates, you said 9% is what we're seeing in Q3. And relative to GRI, just one clarification, too, is that the contract renewals will impact most of the business. So we'll go through an annual cycle increase. So we expect those to be in the high single-digit range. And then when you think about the GRI for us, you know, we're going to go through our annual process, and we'll follow our normal timeline. So we communicate to customers here in the fourth quarter and then go live with increases in Q1. And then I think your second question was on accessorial, Scott. You know, accessorials are one of many yield initiatives we're excited about. Currently, that accessorial is about 10% of our revenue. Worked hard to get closer to 15%. That's a combination of offerings we have today as well as some new service offerings. And then in Q2, we did begin rolling out new tools. That helped us really capture more location-based and time-based accessorials. We started seeing an impact from that in Q3. We also have a team that's working on growing our premium service offerings. So those should help us really drive that high single-digit impact in Q4, as well as positive yield in 2024.

Okay, thanks. And then you guys are talking a lot about the claims, seeing some nice improvement. Is there any way to help us think about what does lower claims actually mean for the model? Does it mean lower costs? Does it mean lower better price, and how quickly do we see any sort of benefit of lower claims showing up in the model?

Thanks, Scott. This is Mario. When you look at claims, it's one of our core areas of focus as a company is improving service for the customers. And in our industry, whenever we provide better service and we keep on that trajectory, and eventually our goal is to be the best in class and to get to a 0.1% claims ratio, customers are willing to pay a higher premium for the value that we would offer there. So what you would see is an impact on pricing, and we already are seeing that here in the third quarter. As Kyle just mentioned, our contract renewals are up to 9%, and most of that was driven by these improvements in service. And to keep in mind, Scott, also when we started LTL 2.0, our damage claims were at 1.2%, and we've been able to take this here in the third quarter to accompany best through a multitude of initiatives, all the way from incentive comp to local incentive comp programs for, we call the gladiator, to incentivize our supervisors to load with quality, to rolling out new technology and how we rate our traders, and moving forward, the combination of airbags that we're launching in all service centers, higher quality straps, and improvements across the board, all of these would lead to an even higher premium on price over time. So that's what we see the impact on the medium to long term of that continued improvement in service. There is a benefit on the P&L. Obviously, I would claim dollars amount would go down, but that's small in comparison when you look at it versus the improvements in pricing we can pick up over the quarters and years to come.

Our next question is from the line of Ken Hexter with Bank of America. Please proceed with your questions.

Great. Good morning, Marion and team. Just talk about the accelerating yields. Yet you only target about 100 basis points to outperform seasonality when you just did 370 basis points. Maybe you can kind of delve into the why we should not or what the opportunity is to see better versus why you think it maybe takes a step back from outperforming seasonality versus what you just posted.

Sure, Ken. This is Ali. So we do expect to outperform seasonality by 100 basis points. That's going to be primarily driven by our stronger yield growth. Just keep in mind we are coming off nearly 400 basis points of outperformance versus seasonality in the third quarter. So we're delivering 100 basis points on top of that 400 that we delivered in the third quarter. I'd also point out that on a year-over-year basis, that 100 basis points of outperformance versus seasonality would imply 200 basis points of year-over-year OR improvement and about 20% EBITDA growth in our LTL segment ex-real estate. There are also a few short-term impacts to consider from the investments we're making. As we continue to invest in incremental capacity that comes with higher depreciation, that was about 120 basis points year-over-year headwind to OR in the third quarter. We would expect a similar impact in Q4. We're also investing in growing our local sales force. And overall, we do expect these investments to generate strong returns for us over the medium to long term, but they will have a modest cost impact over the next few quarters. So we feel comfortable with the roughly 100 basis points of outperformance versus seasonality for OR. It is still very early in a dynamic environment, and ultimately that magnitude of outperformance is going to depend on how tonnage progresses through the rest of this quarter.

Great. Thanks for the clarification there, Ali. That's great stuff and great detail on the progress so far. So congratulations on a great quarter. Can you talk a bit about your thoughts on, I guess, two things, one on the yellow line, I guess you have 294 service centers. How are you thinking about positioning into this? Are there different locations you may want to expand on? How do you think that process goes? Do you think it brings more than needed capacity into the sector, and does that impact the ability to get pricing? And then on that pricing, can you talk about how much have you already renewed versus what is still to come?

Yeah, sure, Ken. This is Mario. On the yellow service centers, It is an opportunity for us to potentially accelerate our capacity growth. We are participating in the process and we'll see how things play out over the next few months. Now, our focus from a physical network capacity perspective has been to grow the network and markets where we see higher demand from our customers over time. And we don't look at these things for the next couple of years, but we look at it over the next 10 plus years in terms of where the freight markets will have more demand in them over time as well. So as I mentioned earlier, we've opened up so far more than 500 net new doors. Here in the quarter, we expanded two service centers in the Atlanta and Dallas metro areas, and we just broke it out in a service center in central Florida. and we're going to continue executing on that plan. Again, these yellow service centers, we'll see where the process rolls out, and it will help us accelerate that plan over the years to come. Now, in terms of capacity coming back into the network, it's tough to estimate what percent of these service centers will be back in the hands of LTL carriers. We estimate it to be roughly around 50%, but it will depend on other uses for the land or these locations for other industrial-type applications. Now for the service centers that will come back into LTL, it will take time. Keep in mind that a lot of these service centers to go backwards, the process has to play out. And then a lot of these service centers to get back into operations, they take time to get up to the different standards of the different carriers. That could be, we estimate it to be in the year plus range for them to get back into the industry. And they will get back into the hands of more premium priced operators. So you would have a rising tide for pricing across the entire industry. And the last thing I'll say also, Ken, that capacity went out at a time where shipment count in our industry is down, the underlying demand is down 10% across all the different carriers. So whenever the macro tightens again, you won't have enough capacity in LTL to handle all of that trade. I'll turn it over to Kyle to discuss yield.

Yeah, from the renewal standpoint, Ken, the cadence for contract renewals is pretty level across the year. We have a disproportionately slightly higher amount in Q4. that will cycle through here in the quarter. But it's fairly even across the year.

Our next question is from the line of Fadi Shamoon with BMO Capital Markets. Please proceed with your question.

Okay, thank you. Good morning, Mario and team. Just a question on yield. You mentioned double-digit pricing opportunity in coming years from service, accessorial, and local customer base, like When you look at this kind of past quarter, third quarter, where are you having more success? It sounds like you're getting some decent penetration in the local customer base side. What's the kind of areas where you're seeing a greater contribution to the yield? Is it assessorial local customer base or is it fairly spread across the three kind of levers of pricing?

So, Fadi, when you look at the three of them, the biggest impact in the third quarter was the improvement of service. Because when you look at our claims ratio hitting 0.4%, customers seeing the trend of improvement and those relationships with our customers keep on improving over time as well. This is where we're seeing the most amount of success, that these contract renewals are coming in, and customers understand that we are investing in the network, we're investing in people, and to be able to support and service them the right way, and that's leading to higher yield and price gains. On the accessorial side, we're still early innings, and we believe these over-the-quarters to come as we launch the premium services we mentioned, and as we sell them to existing customers and new customers, we see that's going to happen again over the quarters and years to come to bridge that accessorial gap. On the local side, we're making a lot of progress. I mean, here in the third quarter, we increased our shipment count in the local channel by 13% on a year-on-year basis. However, this channel is more impacted by the softer macro, so the weight per shipment is still significantly down in the local channel. So although we're making progress on it, we're still not seeing the impact on yield. But as we start seeing tonnage in that channel improve because we're gaining market share, you would see that becoming a tailwind for yield over the quarters and years to come as well.

Thank you.

Our next questions are in the line of Tom Ladovitz with UBS. Please proceed with your questions.

Yeah, good morning and congratulations on the strong progress on the OR and service and pricing, all those things that I think are really positive. I wanted to see, Mario, if you could comment a little bit on the kind of underlying trend in freight and how you kind of weave that in. It seems like the I guess the monthly tonnage numbers are, I don't know if it's kind of stabilizing or how you want to view it, but they're a little bit lighter maybe at the end of the quarter. So I don't know if you think the underlying freight market is stable or if you could offer some trends, some thoughts on that. And also, how do you think about that change in weight per shipment looking forward? Does that become more neutral? or should we think about that even into 24, that that's maybe a bit of a continuing reduction in weight per shipment?

Thanks, Tom. I'll start by first covering the demand side, and Ali can walk through the cadence in the quarter as well, because our comps are not similar to the other carriers in the back half of this year compared to last year, so there are a few things we can drill into it with more details. But if you take a step back on the customer demand side, it is a fluid environment, and it's hard to call what the macro will do when we look at the demand environment. More recently, the underlying environment has been bouncing along the bottom since the month of April of this year, so it's been softer demand overall for LTLs. Now, in terms of outlook, we do survey our customers on a quarterly basis, our top customers. And here in the last survey last week, for the fourth quarter, our customers were more balanced. So some customers were seeing some strength in demand, while others were seeing softer in demand. But generally, it was balanced in terms of where we were earlier in the year. Heading into 2024, we are hearing more optimism from customers about demand picking up. But, again, it's not a big number, but it's still there is more customers that expect a demand pickup versus customers that expect more softness or flat. Now, when you look at some of the indices we look at, about two-thirds of our customers are industrial companies, and the ISM manufacturing index is a good proxy. It did pick up a bit to 49 last month. It's still under 50, but it did pick up a bit. And same thing on the retail side. We saw retail sales accelerate to 0.7% month over month in September. And that was also slightly better than expected. So we're seeing things remain soft, slightly improving, with a bit more optimism going into the first half of next year. But it's still very tough to call the macro at this point. There's a lot of cross signals here.

Good morning, Tom. This is Ali. In terms of the cadence through the quarter, as Mario mentioned, we did have tougher compares in the second half of the year last year as our market share gains were accelerating. So if you look at it on a two-year stack basis, our shipment counts and tonnage both accelerated throughout the third quarter. and that two-year acceleration continued into the month of October. Also, if you look at it just on a shipment count basis, we saw our shipment counts improve by more than 1,000 shipments each month of the third quarter from July to September. And then as we moved into October, as we noted, October outperformed seasonality relative to the month of September.

One quick follow-up. Do you have any thoughts you can offer on line haul miles and kind of where you're going in terms of making further gains. You've improved that quite a bit with the insourcing. Just wondering how you think about the opportunity as going forward. Do you improve a lot from that? I think you said like 21.5% outsourced.

Thanks. For the third quarter, we were outsourced 21.5% where we insourced roughly 200 basis points on a year-on-year basis. Now, keep in mind, Tom, we did invest on a sequential basis, Q2 to Q3. We did get a bit more third-party line haul miles given the inflection in volume. But moving forward, we expect to move quickly on insourcing. As I mentioned earlier, we are excited about a program we're launching called the RoadFlex operation. It's a program where we have teams of drivers in sleeper cab trucks that move freight across longer halls, and this will enable us to move faster on the insourcing process. We do expect to insource at least 50% of the miles by 2027, but given this new program we're launching, we expect to accelerate that over the quarters and years to come here.

Thank you. The next question comes from the line of Ravi Shankar with Morgan Stanley. Pleased to see you with your question.

Thanks, everyone. So good traction with the service improvements. I'm just trying to get an understanding of what percentage of the fruit on this tree are low-hanging versus higher up. I'm just trying to get a sense of whether we can expect this traction of improvement to continue in the coming quarters, or does it get incrementally a little bit harder from here?

So, Ravi, from our perspective, our top priority, one of the top priorities is to improve service and continue to improve service for customers. And our goal is to be best in class and get to a 0.1% claims ratio over time. Now, we've made tremendous progress. You look from end of 2021 through Q3 of this year, we went from 1.2% damage claims ratio down to 0.4%. However, the improvement from here won't be linear, and it will take time. It's not something where every quarter we're going to post a 0.3% improvement from a 0.7% to a 0.4%. Now, we have rolled out multiple new initiatives heading into 2024 with Dave coming on board and the operating team are implementing a number of initiatives, including higher quality straps, new airbag systems that we are launching across all of our service centers. And, Ravi, I'll tell you here, from the first couple of service centers we've launched, We've seen an incremental reduction of more than 20% of damages just with these new tools and programs that we launched that we're very excited about. And we're also enhancing our training programs and how we load trailers, taking it to the next level as well. And I mentioned earlier line haul insourcing. That's another measure of service improvement because today when we use a third-party carrier, They typically have 53-feet trailers that don't have the bars in them. We call it the safe stack system to separate freight from effectively having two decks of freight. But we have that in our equipment. So as we make progress on insourcing third-party line haul, we will continue to see these improvements in service as well as we roll these things out. But, again, the progress is fantastic. September was a company record in damage frequency, so how many damage do we cause versus the shipments that we move. And October got even better than the month of September. So great trajectory ahead. But again, it won't be linear over the quarters in years to come.

Guys, very helpful, Mario. Maybe as a follow-up on the same topic, you said earlier that better service begets better pricing and better share. What does that conversion process look like? How does that take? Is that kind of immediate? Is that one contract cycle? Does that take a couple of years? Again, just trying to figure out what the longer-term trajectory of this improvement looks like.

Hey, Robbie, it's Kyle. So when you think about it, we're going to go through all of our, again, about 20% of our customers are using a standard tariff. Really, that will get impacted by the GRI. The other 80% will go through contract renegotiations. That cycle is fairly consistent, meaning we cover the same number of contracts almost every quarter. The fourth quarter is slightly higher, but we'll see that improvement basically progress through the next several quarters to capture a lot of the service improvements that we're seeing right now in the network.

Our next question is from the line of Jason Seidel with TD Cowen. Please proceed with your questions.

Thank you, operator Mario and team. Good morning, guys. Congrats on the progress in the LTL 2.0. I wanted to focus a little bit on your cost per shipment. How should we think about the increases in the cost per shipment or the decreases as we roll into 2024, especially around you rolling out that airbag system throughout the rest of the network?

This is Kyle. So when you think about cost per shipment, let me start a little bit with Q3 and then some of the costs we saw that were slightly higher in the quarter. So from a cost per shipment standpoint, overall, we're down about 2%. There's progress made in a lot of areas. Mario's talked about the insurance and claims. That was down almost 35% in the quarter. We also saw a drop in fuel. There's a couple areas where we saw kind of higher transitory costs in the third quarter. That's going to include some of the purchase transportation expense. So we were about 10 million sequentially, and that's reflecting the effort needed really to make sure we can service the additional shipments in the network. We'd expect, as we continue to ramp up the line haul insourcing, for that to come down both in Q4 and into 24.

So overall, you would expect cost per shipment to trend down into 24? Just wanted to clarify that.

No, I think we're expecting more cost productivity into Q4 and into 24.

Okay, fair enough. And then as a follow-up, I know we haven't really brought it up because it hasn't been a focus, but maybe a little bit of an update on Europe. And then as we roll into the new year, do you think the M&A market might be favorable enough to bring that back up again?

Well, Jason, our long-term plan remains to be a pure play North American LTL carrier. But in the meantime, our European business continues to perform really well. When you look at the European economy, it's been softer here over the last couple of quarters, but the team was able to deliver great results, growing EBITDA on a year-on-year basis and just fighting on all cylinders. We're onboarding more customers. We're getting more cost-efficient in our European business, and the team's performing well. But long-term, our goal continues to be a pure-play North American LTL company.

Thank you. The next question is from the line of Brian Ostenbeck with JP Morgan. Please proceed with your questions.

Hey, good morning. Thanks for taking the question. Just wanted to see if you could comment, Mario, on capacity available in the network. What's actually the limitation of the bottleneck? Now, I know last quarter you talked about needing to add some more. You talked about the doors you're adding, the new service center you broke ground on. Where does that stand, and how do you see the limitations at this point, you running up into any... conditions that need a little bit more capital expenditure, especially when you're boosting that up here in the fourth quarter. It looks like a pretty big increase to get to that mid-year target, midpoint of the target rather you just raised.

In the third quarter, we had high teen success capacity in our network from a physical perspective, so in terms of how many doors we have. But as you know, this is not evenly distributed across our network. In some markets, we are bumping against capacity limits, but in many, many markets, We have available capacity from a doors perspective. And our service center expansion plan does contemplate those markets where we see that higher demand from customers, where we've got to expand physical capacity. But we will run rating in the high teens. Our goal is to be in the 20% to 25% range is where we would like to be on a longer-term basis. Now, in terms of rolling stock capacity, We have had tremendous progress since the beginning of LTL 2.0. We've added more than 10,000 new traders over the last year and a half, two years. We've added 2,000 tractors to our fleet, and this is enabling us to be able to take on more customers but also run more efficiently. You see it here in the third quarter. We were able to handle 8% more shipments while gaining productivity. I mean, our headcount was down on a year-on-year basis, and our labor hours were up slightly versus an 8% increase in shipments. and equipment help us manage that. And on the people side, we're staffed for current volumes, but we do have headroom as well. And if the demand continues to increase, we can staff up for that. The current labor markets are much easier to hire into. We have our driver schools as well, so we feel good from a people perspective. But generally, if you take a step back, we feel great from a capacity perspective, and we continue to invest in the network, and we're well-positioned to capitalize on any upswings in freight.

Okay, great. So as a quick follow-up, maybe you can, looking longer term, you've been able to sort of bridge the different buckets, you know, performance and productivity of pricing, yield, SSROs, all the things we're talking about here in terms of starting to narrow the gap with some of your peers. Just wanted to see if you could lay out some of the thoughts in terms of where those pieces are going to come from and if you're able to quantify them in some of those buckets like SSROs, yields, productivity, et cetera. Thanks.

Thank you. The biggest component is going to come from yield. As I mentioned in my prepared remarks, we see a double-digit incremental yield opportunity over the coming years through the three main levers I mentioned, which is one is around service and continuing to get this higher price from customers who understand we're investing in the network and investing in the business. That's roughly half the yield opportunity to bridge the gap. And the other half is we expect for accessorials to go from roughly 10% of revenue to the 15 plus percent of revenue range based on the premium services we are implementing. And what I like about this program, these are services that our customers are asking for. So we're taking care of the customer and we're making a higher yield and a higher margin. And then finally, on the local channel side, by growing our local sales force, and here so far this year we've increased our sales team account by 10% to 15% so far, and our goal is to get to more than 30% increase in overall sales headcount by end of next year, and that's enabling us to gain market share in that local channel that would also help bridge the gap. But the lion's share of the opportunity does come from price. The second category is around insourcing third-party line haul, and we are accelerating that with our Roadflex team and our new program for team drivers, and we would get higher service and lower costs. which is also really good, then we're going to continue to improve efficiency as well. So when you combine all of these things, again, yield is number one by a long shot, but then all the other areas will help making sure that we are running more efficiently as well.

Our next question is from the line of Stephanie Moore with Jefferies. Please share your questions.

Hi, good morning. Thank you. Thank you. I guess you touched on a little bit of this just in this previous question, but maybe just to double-click on it a little bit more, could you talk a little bit about kind of the labor additions that you've had to make just given the disruption from the, you know, post-yellow bankruptcy, you know, where you think you kind of are positioned today, you know, adequately staffed, what areas where you have added, maybe you noted a little bit on the sales force, and then kind of your view as we go through 2024 kind of incremental hiring needs. Thanks.

Sure, Stephanie. This is Ali. So if you look at the third quarter, our headcount was down slightly on a year-over-year basis, and that's relative to shipment counts up high single digits. So we did a great job managing headcount relative to the volumes in the network. Also, if you look at it at a labor hours perspective, labor hours were up less than 1% year-over-year, again, versus shipment counts up 8% year-over-year. And more importantly, that spread between labor hours and shipment counts accelerated through the year from low single digits in the first quarter to high single digits in the third quarter. Now, as we think about the fourth quarter, we would expect total headcount and labor hours for 4Q to be roughly the same as the third quarter on both a quarter-over-quarter and year-over-year basis. We've done a really good job, again, of managing productivity in the third quarter. We expect that to continue into 4Q and then into 2024 as well. So we are staffed for current volumes and we have some headroom. If demand does increase, we want to make sure we're staffed for that as well. I think the positive side is the labor market is looser than it has been in recent years. So we're confident in our ability to flex up labor as needed. And we're going to continue to manage headcount effectively relative to the volumes we're moving through the network.

Got it. Thank you. And then just the follow-up, can you talk a little bit about, you know, as you think about, you know, kind of going into 2024, your thoughts in terms of incentive compensation, if maybe you're looking to align metrics both at the top and then all the way down to the terminal level with kind of new targets. Any changes in philosophy there as you kind of prepare for 2024? Thanks, Stephanie.

This is Mario. So this last year and the one prior in 2022 as well, we did change our incentive comp structure. It used to be only based on EBITDA growth on a year-on-year basis, but we had a good portion of the incentive comp plan switched to also focus on quality and on-time service. And that was part of the reason why we were able to drive meaningful improvement in both of these categories here through the course of the year since we started LTL 2.0. Now, if you look moving forward, We are contemplating a change to switch from having EBITDA as being the compensation driver, and this is for field operations at the service center level and at the regional level, to using OR expansion as being the key metric for profits improvement for the compensation program. We're still early in anxiety. There's still a few months here before we start 2024, but that's one change we are contemplating for next year.

Thank you. The next questions are in the line of Scott Schneeberger with Oppenheimer. Please proceed with your questions.

Thanks. Good morning. Mario, I was hoping you could touch on CapEx. You mentioned it's going to be above your long-term guidance range here in the end of the year for this year. And it sounds, I infer that it was going to be elevated again next year in the way you positioned it. Just kind of curious if that's your anticipation of And is it predominantly tractors, trailers, new doors? Just if you could kind of hone in a little bit on where the excess spending will be. And curious if you're spending anything in Europe because that is picking up. I know that that's an asset that may not be with you forever, but it's just curious if that's an area where you're having to increase capex as well. Thanks.

It's got it, Kyle. So as we mentioned earlier, this year we think we're going to be in that 12% to 13% range. And if you think about the investments we made in the last 18 months, that includes over 2,000 tractors and 10,000 trailers. That's really helped enable the share gains in recent disruption. So if you think about more specifically what we're investing in right now to put us above that 12% range, really two things I can point to. One, we're going to produce more trailers at our Searcy facility. Initially in the year, we were thinking 6,000. We're now going to produce more, about 7,000 trailers. And the second thing is something we mentioned earlier on the call, our sleeper cab initiative. So we're going to bring about 100 tractors in the network to do that. For us, it's going to do a couple things. It'll help us accelerate line haul insourcing. There's obviously a service benefit and a cost benefit there. But both of these efforts are really pull-forwards of capacity investments for us. And if you think about the investments we make in total, in general, we expect very high returns from our LTL investments, upwards of 30%. So we think this is the right place for us to be investing in the company.

Great, thanks. Appreciate that, James. Great, thanks. Oh, go ahead, guys.

Yeah, I was going to say, the only thing to touch on from your question was Europe. So Europe's about 10% of our gross capex in general. That's been about pretty consistent for the business and will remain there.

All right. Thanks, Kyle. I appreciate that. Yeah, for my follow-up real quick, just you mentioned at the top of the call the 8 percentage points of on-time improvement year over year. That sounds impressive. I'm sure that goes into helping you interact for your sales folks. on new business wins. Just curious if you could put that a little bit more into perspective. How is that? Is that trending? Is that something that, you know, now that you've seen, you know, the first month of the fourth quarter, is that something that you're going to continue to see trending very well here through the end of the year?

Yeah, absolutely. When you look at all of our service metrics here in the month of October, we've seen a step up from where we were in the third quarter as well. I mentioned earlier, for example, I mean, on time continues to do really well, and our network fluidity has been in a long, long while, which is great to see, and our customers appreciate that. And similarly, on the damages side, in terms of damage frequency, we've seen a further improvement. September was a company record dating back to 1996, And October was even better than September.

Thank you. We've reached the end of the question and answer session. I'll now turn the call over to Mario Herring for closing remarks.

Thank you, Operator, and thank you all for joining us today. As you saw from what we reported this morning, we're in a strong position as we begin our second year as a standalone LTF business in North America. Our solid momentum is driven by continued execution of of our LTL 2.0 plan, and it spans our entire business from revenue, earnings, and yield growth to significant service improvements, operating efficiencies, and market share gains. We're still in the early innings here, and there's a lot more we'll achieve. Look forward to speaking with you all on our next call. Thank you.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.