Good afternoon, and welcome to the Hub Group conference call announcing the acquisition of Estenson Logistics. Dave Yeager, our CEO, will begin the discussion. Following Dave's prepared presentation, there'll be a question-and-answer session. Don Maltby, Chief Operating Officer, Terri Pizzuto, Chief Financial Officer, and Geoff DeMartino, Vice President of Corporate Development, will join us for the question-and-answer session. Any forward-looking statements made during the course of the call or contained in the release represents the company's best good faith judgment as what may happen in the future. Statements that are forward-looking can be identified by the use of words such as believe, expect, anticipate, estimate, project, and variations of these words. Please review the cautionary statements in the release.
In addition, you should refer to the disclosures in the company's Form 10-K and other SEC filings regarding factors that could cause actual results to differ materially from those projected in these forward-looking statements. As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to Dave Yeager. You may begin.
Great. Thank you for joining us today. We are very excited to announce our agreement to acquire Estenson Logistics. We'll be paying approximately $306 million to purchase the business of Estenson. Over the last two years, we have expressed our desire to make an acquisition in the dedicated space. Dedicated trucking is a service that is in demand from many of our customers, particularly the retail and consumer products companies that account for over 70% of our revenue. We conduct an annual survey of our customers, and dedicated trucking consistently ranks at the top of the list as a service line that our customers would like to see Hub offer. Adding dedicated trucking will enable us to offer a more complete multimodal solution, which we believe will resonate with our customer base. Dedicated trucking is an attractive market, benefiting from several positive industry trends.
There will continue to be strong growth among shippers to outsource their non-core function, which we believe will accelerate due to the upcoming changes in regulatory requirements as well as demographic changes in the driver market. Dedicated is a high value-added service that offers opportunities for logistics optimization and the ability to build strong, long-term customer relationships. Over the past several years, we've evaluated a number of opportunities in this space. We are convinced we are purchasing a very strong business with a proven record of excellent service, a safety-oriented culture, impressive growth, and attractive margins. We've long had five key criteria for acquisitions: diversify our service offerings, a good cultural fit, a strong management team, not a fixer-upper, and immediately accretive. Estenson meets all five of these important criteria.
In addition to being a well-respected operator in the space, Estenson has strong cultural alignment with our organization, including the shared emphasis on safety, servicing customers, and operating efficiency while providing opportunities for employees. Estenson has grown to become the 14th largest dedicated contract carrier in North America, with annual revenues of approximately $250 million. The company has a long history of providing superior customer service while receiving numerous awards. Estenson was recently recognized as Home Depot's Dedicated Van Partner of the Year in 2016. The company operates over 1,200 power units and over 5,000 trailers at approximately 120 customer locations. We're also pleased to announce that Estenson's founder and CEO, Tim Estenson, along with the rest of the senior management team, will continue to lead the business.
We are very excited to welcome the company's 1,700 employees to the Hub family. The Estenson business will provide another high-value solution that we'll be able to offer to our clients. We intend to accelerate the growth of the Estenson business with opportunities from Hub Group's diverse customer base. We believe the potential for cross-selling synergies is substantial. For example, we've identified about $2 billion of annual dedicated spend across Hub's 30 top customers. Cross-selling synergies are estimated to start at $8 million in 2018 and ramp up to over $100 million of total incremental revenue in year five. We expect to achieve operating efficiencies as well as benefits from our combined purchasing power on fuel, equipment, tires, and maintenance.
We project operating synergies related to best practices, leveraging our combined spend and network benefits will be approximately $3 million in 2018 and ramp to $6 million in three years. Following the closing of the transaction, the business will operate under the name of Hub Group Dedicated Services. Before we open for questions, I want to review some financial information. The purchase price of approximately $306 million includes approximately $17 million related to recent purchases of tractors and trailers. Excluding this amount, the transaction represents an enterprise value of approximately $289 million or 6.75x 2016 Adjusted EBITDA. $6 million of the consideration is in the form of a two-year earn-out tied to EBITDA targets. The company will be included in Hub Group's results starting in the third quarter of this year.
The second half of 2017 will include around $1.3 million of one-time costs related to the transaction. We expect this acquisition to be slightly accretive in 2017. In 2018, we expect Hub Group Dedicated Services will add over $0.20 per share to our EPS. We'll be financing the transaction through a combination of cash, secured equipment notes that will be assumed from Estenson, and borrowings under a new $350 million unsecured credit facility that will become effective as of the closing date. We believe our pro forma debt-to-EBITDA ratio will be slightly under 2x. Once again, we're very excited to enter into this transaction, and I'd like to now turn the call over to the operator for any questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star followed by the number one key on your telephone keypad. If your question has been answered, or if you'd like to remove your line from the queue, you may press the pound key. Again, if you do have a question, please press star, then one at this time. Our first question comes from the line of Kevin Sterling with Seaport Global Securities. Your line is open.
Thank you. Good afternoon, and congratulations on the acquisition.
Thank you, Kevin.
Yes. Dave, if I'm doing my math right, did Estenson generate about $43 million in Adjusted EBITDA in 2016? Am I thinking about that right?
You're thinking about it properly.
Okay, great. And, you're, so you're targeting, I think, $100 million in cross-selling opportunities in year five, starting with $8 million in, in 2018, and you'll stair-step up next couple years. So are you looking at your existing customer base and see who uses Dedicated now and think you have an opportunity to win market share, where they're maybe using other providers? Is that where most of that kind of cross-selling growth will come from? Or are you looking at your customer base like, "Hey, these guys aren't using Dedicated, we should be able to sell them this service," and maybe kind of a cross-selling opportunity there? How should we think about that $100 million? You know, is it mostly going to be market share gains where they're using someone else?
Yeah, Kevin, I think, you know, we have, in fact, surveyed our customers, and with our top 30, as I said in the prepared remarks, it represented about $2 billion in usage of dedicated services. But we do see this as an opportunity to go much deeper, and not just compete with people that are using existing dedicated carriers, but to go much deeper into our customer base. So there, there definitely, we believe, is, an awful lot of upside opportunity with that. I think, you know, one of the major things we want to make sure of is that Estenson is a very, very high-service, high-safety organization.
What we don't want to do is overtax it and grow too quickly, and that's why we're conservative with our 2017, 2018, and 2019 numbers to gradually grow to make sure that we've got the support mechanisms there so that they can grow, yet remain the high-service entity that they've been for so many years.
Okay, great. And, assume when you're targeting this cross-selling, it's obviously a lot's coming from intermodal, but I assume some from your truck brokerage customers as well?
Yeah, our top 30 accounts, as Dave mentioned, overall, which generally our top 30 are multimodal customers. In addition to that, it would be private fleet conversion and business that is not moving dedicated today.
Gotcha, gotcha. And, Dave, did you say, I'm sorry, I may have missed it. Did you say $250 million in annual revenue is what Estenson-
That's correct.
- generated?
Yeah, that's correct, Kevin.
Yep. And last question for me: You know, you talk about not taxing their network and, you know, not putting too much, because obviously, as you know, the driver situation is an issue. Maybe you could share a little color on how Estenson's been able to maybe grow their driver base, and, you know, do you see that being an issue and maybe looking to kind of, like you said, go slow so that you don't tax that network? So maybe touch base a little bit on their driver recruitment and driver retention.
Yes. Their driver recruiting, we, in fact, think that will be very helpful for us with from a HDT perspective as well. They've got an excellent program and a lot of really good people that are running it. They have consistently grown at a 15% compounded annual growth rate. And with many of these dedicated assignments and projects, you do have the, you know, these things can be, in fact, where you have to, they're greenfield operations, and so there is always some degree of expense up front in order to solicit a new account and then actually bring them on board.
So no, they've got some very good resources that are currently with the solicitation of drivers, and again, we'll hope to build upon that with our Hub Group Trucking, our drayage operation, as well as continue to expand it. Their driver turnover is pretty similar to ours. It's in the mid-30% range.
Okay.
Not much better than an over-the-road operator, but of course, there's a lot of benefits, whereby the pay is good, and yet, the drivers are home on a nightly basis.
Yep, of course. Okay, great. Congratulations on this deal. Been waiting for a while to see this. This is really good to see. Congrats once again.
Thanks, Kevin.
Thank you. Again, if you do have a question, please press star then one on your telephone keypad. Our next question comes from the line of Brad Delco with Stephens.
Hi, good evening, and congrats on the deal.
Thank you, Brian.
So, just wanted to see if you could touch on the, you know, customer diversification of the business and, you know, kind of what it looks like by industry vertical?
Do you want to go over?
Sure. The industry verticals are, retail and consumer products are the big ones. And combined, those are about 72%, so very similar to us.
Then the top 10 customers are about 91% of sales.
Okay, that's helpful. Thank you. And then maybe, is there any detail you could give just on the margin profile of the business and, you know, how it compares to your margins today on a consolidated basis, and then maybe the ROIC profile of the business as well?
Sure. In terms of operating margin, they're between a 6%-7% operating margin, so better than ours. And it's, they've grown, like, as Dave said, 15%, you know, CAGR over the last five years, ex-fuel. We think that the next five years will grow at a 19% CAGR, so that is faster than the Hub segment growth as well. But because of the cross-selling opportunities, we hope to realize that. And in terms of the ROIC, it kind of depends on how you look at it. You know, initially, maybe it's -- and if you look at it based on DCF, we think it's pretty good. If you look at it, you know, just as of today, it's more like it would bring our ROIC down by about 3%.
Okay. That's, that's really helpful. And then lastly, just on the EBITDA, you're assuming the EBITDA contribution you're assuming in 2017, are you assuming... I mean, could you just provide maybe how much growth you're assuming off of their 2016 base?
Yeah. It's about top line growth would be about 12.8%, and EBITDA growth would be. EBITDA margin would be about 15.7%, is what we're anticipating.
Of course, we'll have that acquisition we're expecting for the second half of 2017.
Yep.
That's helpful. I'll leave it at that, and congrats again.
Thank you.
Thank you.
Thank you. Our next question comes from the line of Bascome Majors from Susquehanna.
Yeah, thanks for taking my question here. So just want to take a step back. You know, you guys have been very deliberate on the acquisition strategy, and you mentioned, you know, passing on some dedicated businesses before over the last two years. I'm just curious, you know, what are the one or two things that made this be the one for you guys?
I would say that first and foremost was company culture. Very much aligned. As we got to know the management team and the founders, I think what we found really saw in them was very much it reflected, it reflected a lot of our values in all candor. And I mean, if you look at their focus on safety, if you look at a focus on customer service, if you look at their candidly their focus on profitability, they're very focused on it, and they but they value first and foremost safety and customers.
That was the biggest attraction. I also really liked their scale. This is a $250 million in revenue, is solid. They're fourteenth in the country in dedicated services, and it's something that we just felt as though we could build upon with their management team, because it's a very, very strong management team.
Understood. Maybe, Terri, could you tell us, you know, you gave us an EBITDA number and kind of what you're expecting that to grow. What's the capital budget look like for this company? You know, how does it look like on a free cash flow basis?
A free cash flow basis, you know, we are investing back in the business, so it's negative. But we think that's the right thing to do, and because we have so many opportunities. And in terms of the CapEx going forward, we think for the second half of this year, it'll be about $16 million. Next year, maybe $57 million-$60 million. In 2019, between $70 million and $72 million, and then in 2020, close to $110 million.
Okay. That's mostly growth investments in tractors and trailers?
Yeah. That's exactly.
Yep.
Okay. And lastly, you know, you mentioned Adjusted EBITDA and an accretion, I believe you said $0.20 in 2018. Can you just help us understand what adjustments? I mean, is that fully burdened for things like deal amortization, or, you know, can you just walk us through kind of the adjustments you're making and get into that?
Yeah, we're doing pro forma financial statements for it, so it's got the amortization associated with intangibles in there, it's got the depreciation in there, it's got the interest expense in there on our, hopefully, new revolver that we'll put into place upon closing. And, it's got in there the upfront, the amortization of the upfront fees associated with the new credit facility as well.
Okay. Just to be... I'm sorry. Go ahead.
It's fully loaded, too.
Okay. So, that $0.20 number was fully loaded for everything deal related?
Yep.
All right. That's all I have. I'll turn it over. Thank you.
Thanks, Bascome. Thank you.
Thank you. That concludes our question and answer session for today. I would like to turn the conference back over to Dave Yeager for any closing remarks.
Great. Well, we'd like to thank you for joining us on such short notice. And, as always, if you have any further questions, please do not hesitate to give us a call. So thank you for participating today.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.