Hello, welcome to the first quarter 2018 Hub Group earnings conference call. My name is Michelle, and I will be your operator for today's conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and during the question and answer session, if you have a question, please press star then one on your touch-tone phone. Please note that today's conference is being recorded. I will now turn the call over to Mr. David Yeager. Sir, you may begin.
Good afternoon, thank you for participating in Hub Group's first quarter earnings call. As we discussed in our fourth quarter earnings release, Hub Group had a very strong finish to 2017. That momentum continued into the first quarter as consolidated revenue grew 23%. Revenue for the Hub segment grew 23% and 19% for the Mode segment. For much of the quarter, both intermodal and truck capacity were tight due to strong demand throughout the country. Many markets that traditionally have surplus capacity in the first quarter had capacity deficits as demand overwhelmed supply. Intermodal volume for Hub Group was up 6%, which is in line with the overall industry. Thus far into April, demand continues to be exceedingly strong with the truckload industry running at full capacity, backed by a strong economy. 80% of Hub's business is either bid or repriced annually.
We have completed the price changes on roughly one-third of our book of business. Price continued to strengthen throughout the quarter. Thus far, we have not found a ceiling for the increases as price inflation continues to gain momentum. To date, our price increases are in the mid-single digits. With that said, on the cost side, we are experiencing driver wage inflation, increased costs with our outsourced draymen, and rail price increases. We remain committed to increasing prices to our customers that will outpace our cost increases in order to secure a reasonable margin that will allow us to continue to invest in the intermodal product. We're also seeing higher operational costs as we continue to see substandard rail service, especially in our eastern network. These challenges not only harm intermodal's competitive position versus truck, but also add unnecessary costs to our operation and reduce our fleet utilization.
On a positive note, since mid-March, we have experienced gradual on-time improvement with our western rail partner. We believe that service will continue to improve in the west for the remainder of the year. In the east, service problems appear to have bottomed out, and we believe that improvements will be seen in the last half of the year. We continue to effectively work with our clients to minimize the impact of these rail service issues by establishing longer transits as benchmarks and communicating and intervening when loads are delayed. Turning to our dedicated acquisition, our pipeline for the dedicated opportunities remain robust. Although we just finished the first quarter, the rewards we have received exceeded our revenue and margin projections for the year. From our vantage point, the acquisition implementation has been successful, and our efforts to cross-sell dedicated services to our clients continues to exceed our expectations.
Lastly, as we have demonstrated, Hub is committed to expanding our current service offerings while entering into new verticals through acquisition. We have several strategic acquisition opportunities in the pipeline that would add value to the Hub network. As always, we remain focused on acquisitions that have a strong management team, are culturally aligned with Hub, are not fixer-uppers, and are immediately accretive. With that, I'll turn the call over to Don to go into more depth about the specifics of our business lines.
Thank you, Dave. Our results clearly reflect that our strategy to become a leading multimodal solutions provider continues to gain traction. Our unwavering commitment to service, execution, along with the standing by our commitments during a capacity-constrained peak, has enabled us to provide our customers multiple options to support their network. Over the years, we have improved our cross-selling capabilities, as Dave mentioned, with the addition of Dedicated, our sales organization has many tools available to support our customers. With that said, all of our service lines grew during the quarter. With bids being approximately one-third complete, we are seeing increased share, strong demand, and improved price. The commitments we made to our customers during peak are now bearing fruit in this year's awards. During the quarter, we further aligned our organization, making internal efficiencies to better support our customers.
These changes will continue to bring value and position us for sustainable growth opportunities. We also have been improving the overall performance of our network by deploying a multimodal pricing and market strategy to our bids. Although this initiative is in the early stages, we are seeing an improvement in balance and yield with targeted customers and markets. We believe that our commitment to stay focused on further implementing our multimodal strategy, coupled with the changing marketplace, puts us in a very favorable position. Truck brokerage grew revenue by 13% in the quarter in a tight capacity market. Our focus remains on targeting multimodal solutions accounts.
In doing so, we can offer our clients a diversified product offering from transactional and surge capabilities to project management and long-term committed capacity. During the quarter, we were able to secure new accounts, provide existing customers project management support, while at the same time growing our transactional business. We believe we will continue to see a challenging marketplace for the remainder of the year. However, we are well-positioned for growth by providing excellent service and integrated value-added services. Logistics top-line growth was 16% as we benefited from the many 2017 onboardings. Despite the strong volume growth, we experienced margin compression due to a tight capacity market and honoring our contractual obligations. Mix was also a factor. During the quarter, we were notified that we will lose four contracts, two due to insourcing of the logistics functions, one to an acquisition, and one as a result of a bankruptcy filing.
Due to these changes, we will see headwinds for most of the year as we look to replace the loss of these accounts by focusing on yield, process improvement, and cost reductions. Our pipeline continues to be strong, and we expect to establish new onboardings in the second half of the year. Our logistics solution is positioned very well in the marketplace, and we will continue to focus on delivering solutions that drive cost improvements for both new and existing customers. Mode continued strong top-line momentum in the first quarter with growth of 19%. Once again, we experienced revenue growth across all service lines, led by logistics, which was up 38%, and truckload, which was up 29%. Our network worked diligently to support our clients in a very challenging capacity-constrained market.
Mode continues to expand its service line offerings to support its customers while providing a leading-edge technology platform and the experience and tenure of its network of agents. I'll turn it over to Terri to provide additional insight.
Thanks, Don. Hello, everyone. I'd like to highlight three points. First, we're excited that operating income grew 35% compared to last year. Second, as we expected, intermodal pricing accelerated as the quarter progressed. Third, Hub Group Dedicated won over $70 million of new business. Let's take a more in-depth look at our performance in the first quarter. Hub Group's first quarter revenue increased 23% to $1.1 billion. Hub Group's diluted earnings per share was $0.48. This is compared to an adjusted first quarter 2017 earnings per share of $0.40 that excludes one-time costs and uses a 25% effective tax rate. That's an impressive 20% increase. I'll talk about details for the quarter, starting with the financial performance of the Hub segment. The Hub segment generated revenue of $832 million, which is a 23% increase compared to last year.
This increase came from combined top-line growth of 14% in intermodal truck brokerage and logistics, $60.4 million of revenue from Hub Group Dedicated, which we purchased on July 1st, 2017. Taking a closer look at our business lines, intermodal revenue was up 14% due to a 6% increase in loads and an increase in fuel revenue and freight rates. Mix was also favorable. Transcon volume was up 13%, Local West volume was up 4%. Local East volume was up 4%. Truck brokerage revenue was up 13%. Fuel price and mix combined were up 14%. Loads were down 1%. Logistics revenue increased 16% due to new customers onboarded last year and an increase in existing business.
Hub's gross margin increased by $18.6 million, or 26%, due to the addition of Hub Group Dedicated, as well as growth in intermodal and truck brokerage gross margin, partially offset by a decline in logistics margin. Gross margin as a percentage of sales was 10.9%, or 30 basis points higher than last year. Intermodal gross margin increased due to price increases, higher volume, and better network balance, which resulted in improved loaded miles. Partially offsetting the margin growth were rail cost increases and drayage cost increases for driver pay and third-party carriers. All of these factors combined drove a 20-basis point improvement in intermodal gross margin as a percentage of sales. Truck brokerage gross margin increased because of more spot business. Spot business was about 22% of total loads this year compared to 12% last year in the first quarter.
Truck brokerage gross margin as a percentage of sales increased 30 basis points because of the increase in this transactional business. Logistics gross margin declined about 17% due to changes in customer mix, higher purchase transportation costs, and headwinds from the Toys "R" Us liquidation. These factors contributed to a 280 basis point decline in logistics gross margin as a percentage of sales. Costs and expenses increased $14 million to $74.2 million in the first quarter. The primary reason for the increase is the addition of Hub Group Dedicated's costs and expenses of $10.7 million and higher bonus and commission expense, partially offset by a decrease in due diligence and severance costs. Hub Group Dedicated startup costs associated with new business were approximately $500,000 and relate to travel, recruiting, sign-on bonuses, driver training and orientation, and additional costs for rental trucks and temporary drivers while we ramp up.
Finally, operating margin for the Hub segment was 1.9%. Now I'll discuss results for our Mode segment. In the first quarter, Mode's revenue was $288 million, which was up 19% from last year due to an increase in revenue in all three service lines. Revenue breaks down as $130 million in intermodal, which was up 6%, $101 million in truck brokerage, which was up 29%, and $57 million in logistics, which was up 38%. Mode's gross margin increased to $2.6 million year-over-year due to an increase in logistics and truck brokerage margin, partially offset by a slight decline in intermodal gross margin. Gross margin as a percentage of sales was 11.3% compared to 12.3% last year, due mostly to a 140 basis point decline in truck brokerage yields resulting from higher purchase transportation costs and an 80 basis point decline in intermodal yields.
Mode's costs and expenses were up $1.2 million compared to last year due to higher agency commissions. Operating margin for Mode increased to 2.4% compared to 2.3% last year. Turning to headcount for Hub Group, we had 2,009 employees excluding drivers at the end of the quarter. That's down 21 people compared to the end of the year. Turning now to the balance sheet and our cash. We ended the quarter with $17.9 million in cash and $284 million in debt, including capitalized leases and $30 million of borrowings on the revolver. Our leverage ratio was 1.5 to one. We spent $22.2 million on capital expenditures this quarter, mostly related to tractors, containers, technology, and trailers. Now I'll discuss what we expect for 2018. We believe that our diluted earnings per share will range from $2.34 to $2.44. We estimate high single-digit to low double-digit revenue growth for the year.
By service line at the Hub segment, we expect 7%-11% revenue growth in intermodal, 2%-6% growth in truck brokerage, and slight growth in logistics revenue. We project dedicated sales for the year will be between $275 million and $285 million. We project startup costs for new dedicated business will range from $1.5 million-$2 million in 2018. We expect consolidated gross margin as a percentage of sales to range from 11.4%-11.9% for the full year. We estimate that gross margin as a percentage of sales will increase as the year progresses, with the fourth quarter being the highest. We revised estimated gross margin as a percentage of sales downward for several reasons.
We believe logistics margins will be lower than we planned because of changes in customer mix, including the loss of Toys "R" Us business and three other customers we will be losing. Mode's yields are also expected to be about 50 basis points lower than we originally projected. Finally, startup costs associated with significant new business will pressure dedicated margins this year. We believe that our quarterly costs and expenses will range from $104 million-$109 million and will be highest in the fourth quarter. We estimate that operating income will increase between 17% and 23% compared to our reported operating income of $96.6 million in 2017. We project that our effective income tax rate will be about 25%. Capital expenditures are expected to range from $190 million-$210 million in 2018.
We will execute on our strategy, investing approximately $160 million-$170 million for equipment and between $30 million and $40 million for technology. Included in this equipment spend is between $85 million and $95 million for Hub Group Dedicated related to both customer contract renewals and new customer wins. That wraps up the financials. Dave, over to you for closing remarks.
Great. Thank you, Terri. With that, why don't we just open up the phone to questions?
Thank you. We will now begin the question and answer session. If you have a question, please press star one on your touch-tone phone. If you wish to be removed from the queue, you may press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up on the handset first before pressing the numbers. Once again, if you have a question, please press star one on your touch-tone phone. We have the first question in the queue, comes from Scott Group with Wolfe Research. Your line is open.
Hey, thanks. Afternoon, guys.
Hello.
Wanted to ask, first quarter obviously came in a lot better than you guys were expecting, or certainly a lot more than $0.04 better than you were expecting. The guidance only goes up $0.04. I guess, why was the first quarter so much better, and why are you sort of implying that the rest of the year is worse than you originally thought?
Scott, I'll take part of that. Back when we gave our guidance in February, we didn't foresee the Toys "R" Us liquidation or losing three other logistics customers. As I mentioned in my prepared remarks, logistics gross margin was down about 17% in the first quarter. We do expect our logistics margins to be down between 3% and 6% for the whole year, meaning that on a combined basis, gross margin will be up in Q2, three and four. We feel confident about that. On an overall basis, when we look at what we originally provided guidance on back in February, specifically for logistics versus where we are now with losing four customers essentially, that was an impact of about $0.10.
Yeah, Scott, this is Dave. On the positive side, I would say that first and foremost, I think we're comfortable with the higher end of the range. There's no question that there is some headwinds with the logistics. If you look at the intermodal business at this point in time, we have not, as I indicated in my formal remarks, really found a ceiling on price increases. We're a third of the way through. We've been very focused on increasing our overall pricing to our clients ahead of what we feel our costs will be. I think that we'll be able to give you another update after the second quarter when we've got over half of the price increases accomplished. For right now, we're looking at mid-single digits that are continuing to rise from our perspective right now due to demand.
Yeah. With two-thirds of our base will be done by the end of the second quarter-
Right
We'll certainly have visibility. The push has been the price. We've been doing that, also the demand has been strong on the intermodal piece. The headwinds is simply on the logistics side for the first six months of this year.
Did you say how much revenue you're losing on the logistics side?
It's about $130 million.
That starts going forward?
Yeah.
That already started in the first quarter?
Yeah.
Yeah. It started with, obviously, Toys "R" Us, with that bankruptcy.
Right. The rest comes later on.
Right.
Okay. Maybe talking just about rail service, is there any way to think about the operating income impact it may have had in the quarter, and what gives you the confidence in Norfolk starting to get better in the second half of the year? Then, just big picture, we've got really tight truck market, rising truck rates, rising fuel, but bad rail service. What's the customer telling you about intermodal? Do they want to be here despite the service, or they want to be here, but they can't be here because of the service? What's the customer saying?
To answer that last part, what the customer is saying right now is we work with each customer to set the proper level of expectations. In this case, if it's going to be a half a day longer from Chicago to Harrisburg, we're right up front with them. We tell them, we intervene when there's issues. So I think that our on-time performance versus the current service is actually pretty good. We're able to deal with that because we're dealing with realistic benchmarks. I think that particularly in this environment, with the tight truck environment, that the customers really, there is other places to go, but it's much, much more expensive and more costly. As far as why do we think the Norfolk Southern will improve in the second half? We obviously talk to their people on an ongoing basis.
They're doing an awful lot to change the service, but as you know, Scott, there's not just a light switch. You can add locomotives, you add crews, you add chassis, but it takes time. It's gradual, and that's why we're looking towards the second half of the year. We're quite confident that it's going to improve during that period.
How that impacted the numbers, I'll take that part of the question. Our utilization was about four-tenths of a day worse this quarter than it was in the first quarter of last year. For every day of utilization, that's about $6 million annually. The other thing that hurts us is when rail service is unpredictable or inconsistent.
Right.
That makes it more difficult to set appointments at delivery, for example, with our customers, and can make the load planning and improving our empty miles more difficult.
Right. To Terri's point, and to your question, Scott, how are the customers saying, that's exactly it. It's consistency that they want so they can plan. We work with our clients to say, "If the transit's going to change, we have to tell you that up front so you can adjust your TMS accordingly." Consistency has to be there.
Okay, just my last question, why do you think Transcon's so strong? Probably a little bit of a different mix than what others have said. Can you maybe give an update on April intermodal volume?
Yeah. This is Don. Transcon is strong. We were fortunate to have been growing that the last six months or so with some retail accounts, strong retail accounts. With our pricing moving up, we're still continuing to keep that Transcon business and grow it actually. We've grown every region, especially in the East also, up 4% for the quarter.
As far as April, we're up about 5%.
We are. Also contributing to that Transcon volume was some new business that we landed mid last year, growth related to delivering on our commitments during peak season. We believe part of the growth was also conversion freight.
Yep, good point, Terri. Yep.
Okay. Thanks a lot for the time, guys.
The next question in the queue comes from Ben Hartford of Baird. Your line is open.
Thanks. Maybe Don, how confident are you that you'll be able to recoup most, if not all of the revenue lost here in logistics over the next year or two? Is that a reasonable expectation?
Yeah. It's realistic expectation to continue to grow that business. We expect it, though, really to start onboarding new accounts in the second half of the year. It'll be a slow rise up.
Okay. To completely fill that bucket, is it two years out, or is it too big of a hole to really estimate at this point?
The $130 million would be
Yeah
year, one side of the year from the second half of this year.
I guess, Terri, as we think about some of the headwinds here, you talked about the gross margin relative to your initial base, but some of those fall-off, startup costs fall-off, Mode's yields probably reverse if and when gross margins normalize. The loss of business, you fill that bucket. You still expand gross margin sequentially. The probability that it continues to rise in 2019, I assume is high in terms of gross margin %. Is that a fair assumption as well?
Right. Because the startup cost, for example, at Hub Group Dedicated would abate pretty much in the fourth quarter for the over $70 million of new business that we're bringing on annualized. All that will not be in this year, but we'll certainly ramp it all up this year. You're correct, as we begin to fill that, as Don said, that logistics pipeline.
with new business, that will help. Finally, Mode Transportation, which just 50 basis points lower than what we originally projected, and that was primarily due to intermodal with Mode Transportation. They just didn't have as much margin growth as we did.
We did. Right.
as the Hub segment did in intermodal.
Right.
We have to turn around too, as they reprice that business.
Yeah. As we reprice the intermodal, as I said, we're one-third of the way through on bids through the second and third quarter. Those margins, as we onboard that business, will increase.
From a higher-level perspective, the mix of the business has changed and is changing. Gross margins are inflecting from the trough. Here's 2017, a trough and gross margin trough, and overall EBIT margins. Hopefully, fingers crossed, investors will have their opinion on when the cycle ends. As you think about the profile of this business with Dedicated growing, with some of the acquisitions in the pipeline, with the focus on getting to reinvestable levels sustainably on the intermodal side, what are reasonable kind of peak gross margin and EBIT margin targets in the business as it's presently constructed? You don't need to give a specific number if you don't want to, but just trying to get a sense for what is a reasonable ceiling on both fronts as presently constructed.
Yeah. We'd love 4% operating margin. That's where we used to be. For the Hub segment, it was 1.9% this quarter. For the Mode segment, it was 2.4%. We think we can get back to those levels with a couple of strong pricing cycles in intermodal. As Dave mentioned, we haven't hit a ceiling yet, so we hope to get part of the way there this year, then further along in 2019. This year, if you remember from our discussion back in February, we have the headwind of more bonus this year, a lot more bonus than we had last year. That certainly drives operating margin down, but we won't have that headwind next year. It'll be in the numbers already.
To answer your question specifically, four is the ideal operating margin we'd hope to get to in a couple of years, maybe by the end of next year. Gross margins, because Dedicated is a higher gross margin business than our other business lines, and truck brokerage is second biggest, and we've had significant growth in our truck brokerage business over the last couple of years. We're confident we'll be able to grow that as well. Maybe gross margins get back closer to the 13% range.
In the next business-
Okay.
Right. We said this bid cycle next year's bid cycle-
Right.
Right
against that. We're being very focused on being opportunistic here on increasing prices. We're very focused within the spot market with our truck brokerage, which is a real sweet spot right now. Again, we're not going to lose that focus. I think the entire market is looking after what was an abysmal late 2016 and 2017. I think everybody's looking that we need to be able to earn our cost of capital. That's going to be our focus, and it does, as I said, appear as though that's the industry's focus as well.
The acquisitions that we're looking at would all improve our operating margin and our gross margins as well.
Right.
Sure. Okay, great. That's very helpful. Thank you.
The next question in the queue comes from Justin Long with Stephens. Your line is open.
Thanks. Good afternoon.
Good afternoon, Justin.
Hey, just wanted to clarify first on the guidance, Terri. I think you said the impact from the lost logistics customers was $0.10. Is the right way to think about it that the kind of fundamental outlook for the business actually improved by about $0.14 if you strip out those losses?
Yes. Exactly right.
Okay. Thinking about the cadence of earnings over the remainder of the year, I think last quarter you gave a little bit of guidance for the first quarter. Could you help us think about the ramp in 2Q in the back half or at least what's baked into the guidance?
Well, I'll talk to operating income perhaps and how that trends. Maybe that'd be easier. Operating income on an adjusted basis was up the same as our adjusted EPS when you normalize for taxes at our 25% effective tax rate and add back the one-time cost. If we look at Q2, operating income could be up a similar amount, maybe a little bit less. In Q3, operating income ramps up more than Q1 and Q2, and this is all on a consolidated basis. Because we have such a tough comp in the fourth quarter, maybe operating income is about flat in the fourth quarter.
Okay. That's very helpful. Going back to the question on service, Terri, you mentioned you saw a degradation of about four tenths year-over-year. What was that utilization number in the first quarter, and how are you expecting that utilization number to progress the rest of the year?
It was 15.8 days compared to 15.4 days last year, Justin. We expect utilization to be about 0.2 tenths of a day worse than last year overall. For the whole year. We're assuming rail service is similar for the rest of the year to what it is now.
Yeah, I do think that we are seeing some improvement in the West. Justin, we really do expect that the NS will be improving in the last half of the year. I think that our estimates are conservative. We definitely, again, want to establish the proper expectations with our clients, we'll change for the better, hopefully those expectations as the year goes on.
Okay, great. I guess lastly, I wanted to ask about intermodal pricing. You've made the comment that you're not finding the ceiling yet. Could you talk about where you exited the quarter and maybe what you're seeing in April in terms of intermodal pricing? You talked about mid-single-digit increases on average, I'm just curious if you're more in that high single-digit increase level or maybe something better as it stands today.
It really does vary a lot by customer as far as the amount of the increase. We are in the mid-single digits right now. We're hoping that we can continue to increase that and rise. Again, a lot of it is very account specific, where some may be in the 15% range and some may be in a lower range. It's sequentially, we have been able to consistently January was better than December, with February better than January. Again, where we may end up this quarter, I'm not quite sure. It's going to be interesting, we're pressing to find that ceiling.
Right.
What we're seeing too with the price is also growth. You've got twofold. One is how we're pricing to the market and how we're pricing to our network. We talked a little bit about that on one of my comments, is we're really looking at how we can try to reduce our empty repositioning costs and look at our network to grow. We're seeing that, as to Dave's point, as these bids come in, we're closely looking at the opportunities, closely looking at the lanes that we're bidding on, then trying to take that price up, which has been very effective so far.
Okay, great. I'll leave it at that. Thank you so much for the time.
Thanks, Justin.
The next question in the queue comes from Thomas Wadewitz from UBS.
Good afternoon. Dave, I wanted to ask you a bit about growth in intermodal and the cycle, and also how you think about container adds. Maybe first off, could you just refresh on what you're doing with your container fleet this year? Is it basically flat, or you have some net adds in the system this year?
We do have some net adds.
We do. We're increasing our container count by about 7%. At the end of the year, we had about 34,500 containers. We expect to have around 37,000 containers by the end of 2018, which means we'll get 4,000 new containers in. You remember that we had about 1,300 manufactured last year that we didn't bring over yet, which we are in the process of bringing over. We'll be returning about 1,500 of those leased containers for a net add of 2,500. The reason that we, if you remember from our last call, we did up that by about 500 containers to have those containers, that capacity available for our customers when they need it. With transits as they are, and with the demand that we've had, we thought it was prudent to increase the order by 500.
Yeah. Net-net, when you consider the service, we're probably at about flat versus 2017 on the fleet.
When you consider the service.
Right, when you consider the service.
Okay. The turns being down, your effective capacity is essentially flat today, or year-end it would be flat?
By year, I would say more by the later third quarter it would be flat.
Okay. I guess the other question is really, as shippers see such a dramatic step-up in their rates, maybe they can't do as much more on intermodal as they would like to, rail service constraints, maybe you don't get a lot more containers in. There are probably some drayage constraints for some people. Do you think that, looking back at prior cycles, that this sets up to be a really powerful year potentially, or when you look forward a bit, and rails have made some investments, you got some more containers in, that you could set up for a pretty strong conversion year in 2019, or maybe you see some of that come in later this year. Is that a reasonable way to think about the potential setup for the cycle?
I guess, I suppose fuel is hard to predict where it's going, there has been somewhat of a move up in fuel, I suppose the last several months. How might you think about that?
Well, I would say, first and foremost, I do think that there's no question that our customers are not particularly happy with the increase in costs that are occurring. I think at the same point in time, if you look at the entire industry and what we've gone through the last 18 months, that it shouldn't be unexpected. We, like them, need to return our cost of capital for our shareholders. That's first and foremost. I do think that right now, since the economy is so strong and we've burned off so much inventory, that demand is going to continue to be very strong. I would suggest your one observation there, Tom, with potentially the drayage capacity, I think that that could be one issue. Not so much for us and some others, but for the asset base guys.
I do think it definitely it's a constrained market. There's not a lot of new drivers that are entering the drayage industry. That potentially could be a factor that would keep a damper on how much growth overall intermodal may have. Although we feel as though we like where we're positioned on that. From a fuel perspective, no question when fuel rises, intermodal becomes even more attractive than it is today. It does seem as though that's an ongoing trend right now. And you or I choosing or picking whether it's going up or down in the next six months is-
Right
Probably doesn't make much sense. As it does rise, it certainly, intermodal already is extremely attractive. Increases in fuel just makes it more so.
Yeah. Right now, the divide between truck and intermodal is anywhere from 24%-30%. That spread is nice, and that will continue to spread higher once the fuel keeps going up.
I guess just to ask a little bit more on that, is it reasonable to think there might be some pent-up demand for intermodal that, rail constraints and maybe container limitations, so forth, you can't take as much volume as shippers might want to move from truck to intermodal? Or is that being a little bit too optimistic in the way we think about pent-up demand and volume looking forward a couple of quarters?
It's interesting you ask that. In the first quarter, we actually had constrained markets in traditionally non-constrained, except in this environment. We do look for, and we're beginning our peak planning already, a very strong peak. We obviously, we're very committed to our clients on making sure that we live up to our commitments.
I would suggest that probably you are correct that when we get later into the quarter end, the second quarter end, and into the late third quarter, there will be a lot more opportunity than capacity.
Yep. Okay, just one more related question. Have you experienced drayage as a significant constraint, or you have more outsourced dray than some of the other big players. Has that been an issue for you, or have you been able to get the drayage capacity that you need?
We have been able to get the drayage capacity we need. Our spend is about $230 million roughly.
Yep
without outsourced drayage. We work very closely with our outsourced draymen. We try not to be transactionally focused, but we try to work with them the same way that we want our clients to work with us.
Yeah.
That has allowed us, I think, to build some very strong relationships that we have been able to, in fact, get the capacity that's required.
Absolutely. Yep.
Right. Okay, great. Thank you for the time.
Thanks, Todd.
The next question in the queue comes from Todd Fowler with KeyBank. Your line is open.
Great. Good evening. Terri, in the guidance right now as it stands, the $234-$244, did you share what the volume assumptions are for the Hub segment? I think previously it was 3%-5%, I wasn't sure if that was updated. Same thing for the pricing. I think previously it had been mid-single digits, and it sounds like that's what you're talking to right now. Do you give any more color on volume and pricing expectations in the guidance as it stands?
Sure. Our Intermodal Hub segment volume guidance is now we raised it to between 3% and 6% instead of between 3% and 5%, because we're seeing the demand and confident we can execute. On the pricing, we're assuming mid-single digits. As Dave said, we'll have more visibility to that as we complete the rest of our bids, but that's what we went with in our guidance.
Okay. I think that this was covered a little bit, but just on the mid-single digit pricing, I think that some of your peers that have reported have been speaking to more high single digits and that pricing in the intermodal market, I think you had these comments as well, is approximating more in the truck market, which seems to be higher than the mid-single digit level. Can you maybe help clarify a little bit? Again, I think you talked to this a little bit, but just so we understand, the volume growth seems good in the quarter, but the pricing is a little bit below what we're hearing from some of the peers. Is that more of the focus on the network and targeting the volumes? How do we think about maybe some of the industry comments versus your comments on pricing?
Todd, this is Dave. We certainly are very focused on what fits our network, what's going to create better balance, reduce empty miles. I would suggest to you, as I had said in some of the remarks here, is that sequentially, we have seen increases in pricing. We're only a third of the way through. I would not discount the fact that we could end up in the high single digits. Again, we're only a third of the way through our bid process and repricing process. Certainly, all signals are very positive at this point that we can continue to increase that percentage. Yeah.
Okay. I think I understand where you're coming from there. I wanted to ask on the dedicated business that you're winning, can you speak to where that's coming from? Is that private fleets being converted? Is that existing dedicated that you've won from somebody else? I know that you've quantified the startup costs, at least that you're expecting in the back half of the year, but we've also been seeing, with the driver market where it is right now, some additional costs in recruiting and retaining drivers. I was just hoping to get to the extent that you can provide some confidence that you can onboard that amount of business and have the capacity to do that at the margins you're expecting.
Yeah, Todd, we're really excited about the new business that totals about $75 million annually. Dedicated, and the two most significant wins that represent about 70% of the business are private fleet conversion, and then business from an existing Hub customer.
Okay.
They're pretty huge wins for the Hub Group Dedicated compared to their historical wins. We are adding drivers, and we believe we're well-positioned to be successful. The startup costs, you're right, we're about half a million dollars in first quarter. We project that there'll be $1.5 million to $2 million for the whole year, and that would include the travel, the recruiting, the sign-on bonuses, the driver training and orientation, and then the fact that in some cases, we have to rent tractors and drivers as we ramp up.
Right. Yeah, I'll just point to that, Todd, is we want to make sure we deliver the value to our customers. We do not want to sacrifice service and safety to support them. We were conservative in our approach in how we would onboard Dedicated. It's far exceeding our expectations, and that's a good thing. We also want to be very cognizant, though, as we add business, we want we do it right.
Okay, good. Yeah, this is helpful too, just I think in the context of what you've got in your expectations for your guidance on a couple of these areas. Just lastly, I think the comment was made about the acquisition market, and I was curious if you could speak to maybe how close or how far away you might be from doing something. I know that obviously the timing of that can be very lumpy. Just give us a reminder, I know some of the general criteria, but some of the areas that you're still focused on that could be helpful. Thanks.
Sure. We do have several that are in the pipeline that were kind of in the final stages, if you will. Not actually signed, but we've gone through several stages in the cycle as far as where they may stand with the acquisition. We've made some progress there. We feel as though we're close. We're hoping that we will have one, possibly two more acquisitions this year.
Okay.
The pipeline is very full. Jeff's doing a great job in identifying them and then making sure that we're competitive where it's appropriate, where strategically it makes sense for us. As always, we're looking at businesses that will help us to diversify, and also those that may be complementary within the IMC business. The drayage business can be attractive, particularly in this market of constrained drivers. We're looking at truck brokerage in particular. We do have a desire to build scale, but we also have a desire to build technology that'll make us more productive. I would say that those are the two primary areas that we're looking at right now. As always, logistics opportunities, transportation management, that may take us into verticals that we are not in, would also be very attractive.
Okay, interesting. Thanks for the time tonight.
Thanks, Todd.
Thank you, Todd.
The next question in the queue comes from Brian Ossenbeck from JPMorgan.
Hey, good evening. Thanks for taking my question. Just a quick clarification on pricing. Are the trends you're seeing inclusive of accessorials? I know recently we've been talking about that as a trend this year versus perhaps in prior years, we were trying to go back and hit those with contract renewals, especially as the equipment perhaps isn't being as used efficiently as you might like. Maybe if you can give us a little comment on that, please.
Yeah, absolutely. This is Don. We certainly are going after the accessorial contracts in a way that brings back negative to positive. Part of our agreements with our customers as we look at them is not only the price of the transaction for the move, but also the accessorial agreement that we have in place. We've been actively changing those agreements over the last four months, five months, and we're going to continue to do that. It's bearing fruit.
It's part of the cost, I think the beauty of it is when we do approach a customer that has a negative accessorial agreement, we give them the option of an increase X plus if you want to keep that accessorial agreement in place because they're real costs, or an X, which is a smaller number if they change the accessorial agreement. Because that's something that is under their control. That way they can actually direct how large of an increase they take or don't take.
Okay. That's helpful. I guess if I heard you correctly, the way to interpret the pricing, it's what they just, that you're looking at now, that would be excluding accessorial. If shippers decide to make the choice or not, that would be reflected in those rates?
Yeah. It's not like all of our customers have negative accessorial
No
Those that do, we're addressing upfront right now.
Yep.
It's a cost.
Right. Okay. The other question I have is just on, just refresh us on the technology investments, the pace of spend, and when you might start to see some of that leverage from rolling out I believe it's the Oracle TMS system. Anything else you have in the works right now?
Yeah. This quarter, Brian, we've spent the majority of our time working on finalizing our quote-to-cash design, which will create the foundation within our new financial system that will go live in the first half of 2019. In addition, we continue to configure capabilities in OTM to facilitate the asset portions of our business. That's what really we've been working on.
Right. We've also been working on implementation within the Unyson Logistics product. I feel good that it's making excellent progress right now and is very focused with our outside consultants.
All right. [As well as a quick ones, maybe] i f you could just comment on the insourcing contracts in logistics. I think it's typically we think of this as environment as where outsourcing would be more of the trend. I know a lot of factors can drive insourcing, M&A on the customer side or incumbents or anything along those lines. In a tight market, I would expect more outsourcing than in. Maybe if you could give some context here on that.
Sure. In one of the accounts that the contract change was an acquisition, so that contract's being absorbed internally. The other two, to our point, were brought in because they had a TMS and they wanted to be able to use their own tools to handle it. Was a surprise on, I'd say one of them. The others, I understand. Yeah, you're right. That's that balance of a customer of how much it costs to insource versus outsource it. To this day, still some customers fight it. They want to insource their own. They realize quickly that they can't get the IT resources to support it.
Okay. Is that included in the $130 million, or was that just the one large customer?
The $130 million includes the loss of the four contracts.
Okay. All right. Well, thanks a lot for your time.
Thank you.
The next question in the queue comes from Bascome Majors from Susquehanna Financial.
Yeah, thanks for taking my question here. Just to follow up on the M&A line of questioning. The one or two deals that you may get done this year, or hopefully will get done this year, can we think about that moving the needle? Are we talking pennies of EPS here on a run rate basis if these things go through? Just trying to size that up as we think about the cadence into 2019.
We're in the latter stages of the process with these, but we're still a bit off and we're trying to. Nothing is finalized with the numbers, trying to give an accretion number at this point would be difficult. We obviously, one of our major focuses is that it's initially accretive-
Yeah
to earnings. Bascome, that would be hard to do right now because we're not at that point where we can finalize the purchase price and the costs. We're getting closer, we don't have it ironed out yet.
Maybe just to directionally size things up, could you put a bracket around dedicated investment value so we can think about the size of what may be coming on?
That's hard to do too, because we're just not far along enough yet. On a combined basis, it would be less than we paid for Dedicated.
Understood. That's helpful. Just lastly, maybe put a finer point on the first question of the call and just trying to reconcile the seasonality. It looks like what you've guided to for the full year is fairly normal seasonality with where the first quarter went off. Yet most trucking and intermodal related businesses are guiding pretty significant or seasonal plus acceleration in the second half of the year. If I could interpret the earlier comments, it sounds like you're suggesting that logistics loss is a headwind that kept maybe a more material guide up from happening and potential tailwind would be rail pricing accelerating as you hope, but aren't willing to guide that it is. Is that a fair assessment of how you see the puts and takes in the second half of the year, or is there anything you'd like to add to that?
Yeah, I think that's pretty fair. As we had said, number one, we're comfortable with the top end of the range. Secondarily, we do feel as though unless something dramatic happens within the economy, that all indications are that the pricing increases will continue to accelerate through the year. Again, we are, by our nature, very conservative. We're only a third of the way through the bid cycle. So I think that that approach, we're not being cautious with trying to find what the ceiling is from a price increase. I think as we give you guidance, we want to make sure that it's something that we can live up to.
Understood. Thanks for the time this afternoon.
The next question in the queue comes from Diane Huang from Morgan Stanley.
Great. Thanks for squeezing me in here. My first question is, there have been some fears that the TL market will weaken from here. From your perspective, how much of your intermodal pricing and load outlook for the second half is dependent on the TL market? Have you seen any impact from ELDs, and what are your expectations of ELD impact in the second half?
As far as our dependency on the truckload market, of course, it does get on the shorter lengths of haul more competitive when in fact there's an excess number of trucks. I would be shocked if that occurs in the second half of this year or even the first half of next year. I think it's the demographics with truck drivers aging. It's people that are in fact leaving the industry at this point in time. Partially with the impact of ELDs. It's hard to really quantify how large it is because there is still some exemptions on agricultural goods, that type of thing. I do believe once those become effective, that we're going to continue to see an impact of ELDs in shrinking the overall truckload capacity.
I think that intermodal is very well positioned to continue to grow at the existing pace through this year and certainly into the first half of next year.
As we said before, we mentioned it with a third of our bids, we're seeing growth, incremental growth on top of what we had. Price is coming up and growth is happening on the intermodal side.
Got it. It sounds like you think the impact from ELDs will be more gradual over the next six or 12 months rather than an immediate impact following April 1st.
Yes, absolutely.
Okay. A quick question for Terri. Last quarter, I think you guys called out about $6 million-$7 million of one-time-ish costs that would be in the first quarter. Just wondering if you can quantify if you had any of those costs in 1Q. When I look at 1Q's costs, excluding transportation, it was much lower than the guidance of $104 million-$109 million.
Oh, yeah. The $6.1 million you're referring to was one-time cost in 2017. Is that what you're talking about on the $6.1 million of costs, one-time cost? You're right that our guidance was higher on our cost and expenses than what they came in at. That was for a couple different reasons. Number one, we expected our headcount to be down, or excuse me, up, and it's actually down 21 people, as I mentioned. Number two, Mode agency commissions were down about $1 million from what we projected because gross margin was also down from what we originally projected in the first quarter. Number three, our IT spend was about $1 million less than we projected in the first quarter.
Okay. Yep. I was referring to, yep, the bonuses, the restricted stock, and the IT spend, but it sounds like those changed.
Yep.
Okay, great. Thank you very much.
Thank you.
Thanks, Diane.
The next question in the queue comes from Matt Brooklier from Buckingham Research.
Hey, thanks. Good afternoon. Ed, another driver question. In terms of market tightness, is there a difference between the dedicated driver market and the drayage driver market, or are they equally as tight right now?
They certainly are both very tight. We do think that it's obviously when you take over a fleet from another carrier, it's a lot simpler because you have an automatic driver base that obviously likes the business, likes the way it's operated. We have actually, we were kind of staying level set, if you will, with our intermodal drayage drivers. We have changed our recruiting, we've added recruiters, we have actually, the last several weeks, are showing very positive signs of adding on to the intermodal driver fleet. No question that the dedicated is ongoing, we're thinking that the total for this year, that we'll add and need a total of about 400 drivers for both Hub Group Dedicated as well as Hub Group Trucking. When we think that those are very achievable.
Okay. Can you talk to driver wages, where those are trending in the quarter, where you think they're going to land for the year? A couple of your competitors have talked to driver wage increases that kind of commensurate with the pricing that they're getting right now. Would be curious to hear your opinion on the topic.
Yes. We did increase our driver wages in February. We've also changed some of the structure of how we pay drivers, particularly within intermodal, to make it more attractive. I would agree that by the end of this year, they're very likely, depending upon the geographic region, may be additional increases that we'll be taking with increasing our driver wages. It's really on a region-by-region basis that we look at it. There's no question one of the key assets is certainly the driver at this point in time.
Okay, just switching gears, you mentioned there's some end markets, some industries that you're not currently in. What are some of those markets that potentially you'd like to get some exposure to? I'm assuming you would potentially do that through M&A.
Yeah, Matt, I think we're actually looking more towards adding on, if you will, with the existing business lines. When I talk about with Unyson, with looking for a transportation management solutions company that may offer different verticals, as an example, we're not very big in the refrigerated space. We're not very big in the industrial space within logistics. Those would be adding value to us because as we look at it, we do like the business that we're in, and we want to be very deep in those businesses. With intermodal, we're the second largest player. With truck brokerage, we want more depth.
Yep.
With logistics, we want more depth. The same with Dedicated, and we'll grow that organically. That's what I was referring to, was actually looking at different business verticals to expand into with some of our existing products.
Okay, that's helpful. What about final mile?
We've looked at it. We've talked about it. I think it's our belief that those that have large infrastructures that would be costly to rebuild are better positioned to do that than us. That could change, but we have not found an acquisition target that in fact we think would put us solidly enough in that space that it would be defensible longer term.
Okay, that makes sense. That's all I got. Thank you.
Thank you.
Thanks, Ed.
Okay, once again, if you have a question, please press star one on your telephone keypad. The next question in the queue comes from David Ross with Stifel. Your line is open.
Thank you. I'm not going to take up too much time, appreciate you squeezing me in. Truck brokerage, you mentioned it's a hot market right now. How do you guys find capacity? You're a decent-sized broker. You're not only competing against all the other brokers for truckers, you're competing against all the shippers for truckers. What has allowed you to find your customers freight and keep carriers or increase the carrier base?
Well, this is Don. We've always been different in the brokerage space with regards to how we went to market. We generally have around 150-250 carriers that are really the go-to folks that service our business. We've got 35,000 carriers that are under contract with us. At the end of the day, what we've been able to do is leverage that relationship with those carriers to drive performance. The other part of it, we're on the truck brokerage side is to leverage a greater amount of carriers on the transactional business, which as you know, is the spot side of the business, which has been growing rapidly for us. As we try to grow more and more into that space to get more and more load boards when capacity gets tight, we got to lean on our carrier base.
We've been loyal to our carriers since we've had brokerage, and we've been able to develop those relationships. We look at brokerage again in three stools. One is transactional, one is contract, and one is projects. When we're selling to a customer, we're selling those three products to them.
Just real quick on Dedicated. It's a fairly new business line for you all, but you look like you're having success in it so far. What do you view as a target margin for that business, or target operating ratio to allow for the good, safe product that you want to provide to your customers?
Well, as Dave and Don both mentioned, we're going to carefully ramp up on this new business and make sure we do it right and carefully. In the long run, we target operating ratios in Dedicated similar to what our competitors have, which would be mid to high single digits.
Yep. Okay. Thank you.
Thank you. That's right.
Okay, there are no further questions in the queue at this time. I'll turn the call back over to Mr. Yeager for final remarks.
Okay, great. Well, thank you for joining us for our first quarter earnings call today. As always, if there's any questions, further questions that you'd like to ask Don, Terri, or I, please do not hesitate to call us. Have a good night.
Ladies and gentlemen, this concludes today's teleconference. You may disconnect your phone lines at this time. Enjoy your evening.