Welcome to the XPO Logistics conference call and webcast. My name is Lorraine, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. 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. During this call, the company will be making certain forward-looking statements within the meaning 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.
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. You can find a copy of the company's press release regarding the proposed 3PD acquisitions, which contains additional important information regarding forward-looking statements in the Investors section on the company's website at www.xpologistics.com. I would now like to turn the call over to Mr. Brad Jacobs. Mr. Jacobs, you may begin.
Thank you, operator. Good morning, everybody. Welcome to our call. With me today are John Hardig, our CFO, and Scott Malat, our Chief Strategy Officer. We're also joined by Karl Meyer, the founder and CEO of 3PD. As you saw this morning, we've agreed to acquire 3PD in a deal that we expect to close this quarter, and Karl will come on board to continue to lead the 3PD operations. This is an exciting acquisition for us. It's a major milestone in our strategy, and it accelerates our growth rate. I want to give you some color on the transaction, and then we'll use the bulk of the call to answer your questions. 3PD is the largest non-asset provider of heavy goods last mile logistics in North America. The company uses its network of about 900 contract carriers to facilitate over 4.5 million deliveries a year.
That's about 2 times the number of deliveries as its nearest competitor. So 3PD is the clear leader in this space. We're going to acquire 3PD for approximately $365 million, which is comprised of about $357 million in cash and $8 million in restricted XPO stock. We expect the transaction to be immediately and significantly accretive to our earnings. 3PD is highly valuable to us for a number of reasons. One, the company serves an end market with an extremely high growth rate within our core competency of non-asset logistics. Two, it's a complementary service offering, which strengthens our position as a single source provider, especially for tier one accounts, which are an important focus for us at XPO. Three, 3PD has valuable customer-centric technology that we can use at XPO.
And four, they have a performance-based culture and a long track record of success. So 3PD is a strong strategic fit with XPO. In our base business, we move a lot of freight from factories to distribution centers and stores. 3PD handles the last mile. With 3PD, we're now able to move freight from distribution centers and stores all the way into homes, businesses, and job sites. It's the final mile of the supply chain. It connects the freight to the ultimate end user. 3PD's financial model is also compelling. It's a high-margin, high-cash flow business with solid metrics that are trending upward. Their gross margin is over 30%, their free cash flow conversion is 80%-90%, and their adjusted EBITDA margin is over 10%.
In 2012, they reported 20% year-over-year growth in adjusted EBITDA dollars and 36% EBITDA growth for the first 5 months of 2013 on a year-over-year basis. 3PD's trailing 12 months adjusted EBITDA through June was $36.3 million, which puts the purchase price multiple at 10.1x trailing EBITDA. For the full year of 2013, adjusted EBITDA is projected to be $40 million, which puts the multiple at 9.1x 2013 EBITDA. For 2014, the multiple is 7.6x the EBITDA projection of $48 million. 3PD is a company with tremendous momentum, and our goal is to double its profitability over the next few years. We're going to scale up the business both through organic growth and acquisitions.
3PD operates in an extremely fast-growing area of logistics, and their model is non-asset, which is something we do well. There are two dynamics driving 3PL demand in their space: a trend towards outsourcing the shipment of heavy goods and the expansion of e-commerce retailing, e-tailing. Outsourcing provides retailers with greater cost efficiency and better service than they could achieve by managing white glove deliveries on their own. And e-commerce is the fastest-growing channel for retail purchases, with double-digit growth projected for the foreseeable future. The combination of outsourcing and e-commerce is creating demand for third-party logistics providers with 3PD's specific type of expertise. Many retailers are shifting away from privately owned truck fleets in favor of using third-party providers. At the same time, smaller retailers are using the web as a sales channel to reach beyond their local market area...
These deliveries often require additional white-glove services by the carrier, which creates a premium price structure for existing providers and a significant barrier to entry. Only about 30% of the $12 billion heavy goods home delivery market is currently outsourced to third parties, and we expect that opportunity to grow significantly. Another thing that makes this market attractive to us is that it's highly fragmented. The great majority of the competitors are smaller, regional players. There are numerous potential acquisitions for us in this space. 3PD has advantages of scale versus these competitors in terms of cost efficiencies, productivity, and access to local trucking companies. They've invested over $17 million in their technology to create a competitive advantage in quality assurance and customer satisfaction, and they've used size to their advantage to consistently outpace market growth. 3PD's service offering is a strong strategic fit for XPO.
They match shippers to carriers to move goods at the optimal time and price, and they have strong relationships with large retailers, which are a big growth target for us. Now we'll be able to offer best-in-class, last-mile service to our current retail base. We've already been doing some of this through our freight forwarding division, and in fact, we often use 3PD. By bringing this capability in-house, we'll be able to grow it more aggressively. 3PD's customers are going to benefit from this acquisition as well. They'll have the convenience of truck brokerage, freight forwarding, expedite services, and now last-mile delivery through XPO as a single source. This ties to a key trend in our industry. Many shippers, particularly the larger ones, are consolidating their supply chain partners to use fewer and larger capacity providers that can offer a broad range of services.
So the addition of 3PD represents a major opportunity for us to earn more business from the retail shipper base. 3PD's industry-leading technology is something that we will use at XPO as well. In 2009, 3PD purchased Penchant Software, which is a platform that manages every aspect of the transportation workflow, and they've continued to build that out into a very powerful proprietary tool. One of the areas where 3PD has differentiated its services through technology is with customer experience management. Their software zeros in on each aspect of the delivery, from calling the customer ahead of time, to scheduling the delivery, to automating an effective customer satisfaction scorecard that they use to continuously improve their carrier services. 3PD's technology has a lot to do with their service metrics, which are at the top of the industry.
They have 4 patents pending, all related to their customer-facing technology. Another thing that's very attractive is 3PD's culture. They have a team of about 650 well-trained employees who are compensated on outperforming for customers. Their team is going to fit right in with our culture at XPO. That's important because we believe the real basis for creating dramatic shareholder value is our ability to give the customer a world-class service experience. We're also pleased that the entire senior management team of 3PD has agreed to join XPO and continue to lead the operation. Karl and Randy Meyer are strong leaders who are adept at scaling up the business at an accelerated rate. They've put together a team that has decades of experience in last-mile logistics.
Bud Workman, who will continue to run the daily operations, has over 30 years in the industry, and Will O'Shea will continue to lead sales and marketing with over 20 years in the industry. We're excited to help them build on their track record as part of the XPO family. We're very bullish on this acquisition. As I've said, it's a major milestone, but it's just one part of our plan. There's an enormous amount of growth embedded in our current XPO footprint. You can see it in our organic growth, which was a huge 46% in the first quarter. Our cold starts alone had an annual revenue run rate of about $78 million in March, and they've only been open for an average of 8 months.
Our strategic and national accounts teams are talking to the largest shippers, where our growth and professionalism has gotten a lot of attention. We're going to keep acquiring and opening cold starts to grow our footprint well beyond our 62 current locations. And now we're adding 3PD, which is on fire. We intend to double the size of that business over the next few years. That alone can contribute a quarter or so of our long-term $300 million EBITDA goal. So 3PD is going to be a part of the XPO growth story for a long time. With that, I'd like to open it up for Q&A. We'll have our earnings call coming up in a couple weeks, so to the extent possible, we'd appreciate it if we can use the time this morning to discuss 3PD. Operator?
Thank you. We will now begin the question-and-answer session. If you have a question, please press star then one on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star, then one on your touchtone phone. Standing by for questions. Okay, and our first question comes from Justin Yagerman from Deutsche Bank. Please go ahead.
Hey, guys. Congratulations. Congratulations on the deal. Wanted to get a sense on the purchase accounting here. Recently had a competitor of yours who made a sizable acquisition, and a lot of the accretion didn't show through because of the way the purchase accounting had translated. Wanted to make sure there are no issues with any amortization that's going to mask the profitability of this company as you guys report earnings?
... Yeah, Justin, it's John Hardig. So we're still working on our accounting for the transaction. So, you know, we're gonna be obviously analyzing the value of the intangibles and then amortizing those. You know, I think it's just a little too early to give you exact specifics on that. Although, I'll tell you, we really think about this as an EBITDA driven transaction. And so, you know, from an EBITDA perspective, obviously, that won't have any effect.
Yep. Okay, that, that, that's good. Can you talk a bit about customers are for 3PD and what the customer concentration looks like?
Yeah, this is Karl. The top five customer contracts make up about 29% of the business. Our major customers are retailers, Home Depot, Lowe's, IKEA, manufacturers, Masco, KraftMaid Brands, Merillat. And then the fastest growing part of the business is our targeted service offering for mid and small-sized shippers.
Got it. And I would assume that the higher margin customers are those small and mid-sized customers?
Yeah, the margin on the small and mid-sized customers is higher than the large retailers.
Can you give us a sense of the breakdown of the different value-added service, or the top value-added services that you guys supply when you're, you know, providing these services to your customers?
Sure. So from a model standpoint, we operate just like XPO. You know, passionate people, a leading technology platform linking shippers and carriers. The area we focused on in last mile is really last mile larger than parcel, product that has a service requirement. So we're largest appliance installer in North America, with leading positions in electronics, furniture, and retail building material.
All right. That's, that's helpful. And just two questions for the XPO guys. One, how competitive was the bid for 3PD? And two, the cost of debt on the new facility that you guys are using on the financing end.
I'll take the first part, and I'll pass along the question about the debt. You know, it was a process. Morgan Stanley led the process, and one of the things about processes is it's not transparent, it's opaque, so we don't know how competitive it was. We focused on what the business was worth to us and pitched not just the amount of money, but being able to be part of the XPO growth story for the management. And I thought everyone got along really well, and it was a good attraction mutually, and we got a deal done that we think is a reasonable price.
When you're paying 9x current year EBITDA for a company that's growing 36% on the EBITDA line, so far year to date this year, I think that's pretty good.
Justin, on the financing, so we have a first and second lien term debt structure. It's $140 million of first lien. It's a 6-year facility at a rate of LIBOR plus 500, and the second lien is a $55 million facility. It's a 6.5-year facility at LIBOR plus 900.
Great. All right, thanks for the time, guys. Appreciate it.
Thank you, Justin.
Thank you. Our next question comes from William Greene from Morgan Stanley. Please go ahead.
Yeah. Hi there, good morning.
Good morning.
Brad, you put out some targets on acquisitions, and I think what you had left to do was, correct me if I'm wrong, but I think about $200 million-$250 million or so left, and this is obviously bigger than that. Does that sort of suggest you feel kind of comfortable where we are on a run rate basis, or you want to sort of up those sort of targets?
I think, you know, it's so hard to predict with acquisitions. It's lumpy, and sometimes it's feast, sometimes it's famine. We have a lot in the pipeline, so I mean, there's a lot of things we're looking at and of different shapes and sizes. So I think the base case scenario is we probably will do more acquisitions between now and the end of the year.
Okay. And then you'd also talked about becoming EBITDA positive. This will obviously do that, I suspect. So, can you talk about how you sort of see the trajectory toward your long-term margin goals? Has this accelerated it? How do you think about that?
Yeah. On the first part of the question, yes, we still feel comfortable with being EBITDA positive in the fourth quarter. We thought that was an important milestone for the company to achieve, and, and we're on target to achieve it. In terms of long-term margins, this business has about twice the EBITDA margin percentage as regular truck brokerage. So it will increase our margin a bit. But over the long term, we're going to grow much bigger in truck brokerage than in last mile, so it's not going to dramatically increase our margins.
Yeah. When we think about sort of pickup and delivery kind of businesses, we often think of those as having a lot of handling costs. But can you sort of go through a little bit about how you've been able to achieve this kind of margin in what appears to be a business that's actually quite difficult?
Yeah. Well, there's really two components about this, Karl. There's really two components of the business. One is dedicated contracts, and the other is transactional. In the dedicated contracts, we're able to engineer the solution, typically an RFP, to generate our rating. And for 3PD, our differentiator is really technology and our scale. So that allows us to drive margin in that business. In the transactional business, it's tariff-based pricing on an order-per-order basis. And, you know, with over 2,000 units on the road every day, in every part of the U.S., we're able to scale and drive margin in that piece of business as well.
All right. Then just last question, Karl. You talked a little bit about what you saw as one of the, some of the attributes of XPO that helped kind of make this a good fit from your perspective. Can you talk a little bit about your motivation to sell? Was it sort of size, you'd reached a size where you needed more financing, or what was sort of the motivation here?
I think we had an equity partner prior, who'd been in the investment for a while, and we were looking for a stronger
... platform to be a part of, whether it was strategic or private equity, for some of our, some of our vision of the future, and XPO matched up nicely. I think we have tremendous opportunity in this space to acquire, to grow through acquisitions, both in our core business, but also businesses that add services in the last mile. I think, I think different types of installs, more commercial types of business. And our space is very fragmented. So, you know, $12 billion in revenue and three, you know, in the space, and $325 million revenue that, that is 3PD being the largest player, there's tremendous opportunity in a very fragmented market to, to grow through acquisition. The other piece is in, you know, is sales force. We have 6 salespeople at 3PD, historically.
XPO's got 850. So the ability to integrate our rate tariffs into the XPO platform increases our, our selling infrastructure tremendously, and we, and we think that's a big part of our growth with small and mid-sized shippers.
That makes sense. Okay, that's great. Thank you for the time.
Thank you. And our next question comes from Kevin Sterling from BB&T Capital Markets. Please go ahead.
Good morning, gentlemen. Congratulations on the deal.
Good morning, Kevin.
Brad, it sounds like this acquisition of 3PD, it sounds like it allows you to get deeper into your existing accounts, to existing customer base, and possibly add new customers. Is, is that a, primary motivation for doing this deal?
It's one of the main ones. The large retailers are a big target growth avenue for us in our strategic accounts group. And 3PD literally has great relationships with all the top retailers in the United States. So getting a introduction and an endorsement and a foot in the door will accelerate what would have happened anyways as we grow our market share and improve our abilities to those large retailers. But having 3PD as our partner, number one, gives us more credibility, and number two, allows us to offer something that's differentiated from other truck brokers, providers, or even asset-based truck broker truck company, trucking companies who can't deliver on the final mile. So having that full service for the whole supply chain is a leg up.
Right. Okay. Thank you. And, you know, it sounds like, just to listen to your commentary there, it's while there may be some customer overlap, may not be quite as much as we think, and it—this could open up a, maybe a new Rolodex of potential customers. Is that the right way to think about it, too?
Yeah, both ways. They have a better and deeper relationships that go back long, long time with the largest retailers in the United States. We have a few of those, but they have all of them. We have a bunch of relationships with small and medium-sized retailers that they haven't been focusing on yet, so there's some good synergy there in that respect.
Okay. And then, then lastly, maybe this question is for Karl, too. It sounds like 3PD is primarily Southeast, regionally located, but, you know, the largest player in the industry. Maybe there are some gaps with regionally that you may have had holes. Now, by partnering with XPO, are there opportunities to maybe to fill in some of those regional holes and really become a, a national player in a $12 billion industry?
Yeah, so we are a national player. We operate in over 500 markets in U.S. and Canada. Of our 650, you know, associates, close to 500 of them are geographically positioned across 29 offices across the U.S. So we've got the U.S. and Canada covered. I think our opportunity with XPO is integrating the service offerings to sell complete solutions. And from the 3PD side, it's leveraging the sales force that has existed at XPO to drive last mile volume.
Okay, great. Well, that's all I had this morning. Thanks so much for your time, gentlemen.
Thanks, Kevin.
Thank you. Our next question comes from David Tamberrino from Stifel. Please go ahead.
Good morning, gentlemen.
Morning, David.
Just a quick high-level question in terms of strategic focus, going forward. You know, beginning of the story, you kind of had four pillars. You had your truck brokerage, your freight forwarding, expedited and intermodal, and then kind of intermodal kind of backed away a little bit, and we were focusing on, truck brokers and really rolling up that space. You know, how does the strategy change going forward, and are brokers unwilling to sell at this point?
Oh, no. There's plenty of truck brokerage backlog in our acquisition pipeline, and that's going to be the major focus of our acquisitions going forward and the major portion of our organic growth as well. But we haven't abandoned intermodal. I mean, we're doing intermodal. We formed relationships with two of the largest rails, and we're on their system, and we're selling intermodal, and we're doing that now. We're also growing LTL, because that's a service that all of our truckload customers have. Expedite is still a big part of our business, and it's going to continue to be a big part of our business. Freight forwarding, we're growing, slow and steadily, but we're growing. And you know, we're a small player in a very, very large market there. And now we've got the last mile.
So the last mile... All these services are complementary. They're not diverse from each other. They're all part of the same puzzle. And we will stick to our knitting, primarily truck brokerage at the core, but the rest of these services will complement them and differentiate ourselves to, to the shippers. Operator, who's the next question from?
One moment. Once again, if you have a question, please press star then one on your touch tone phone. Once again, that's star then one on your touch tone phone if you have a question. We're standing by for questions.
Okay, operator, if there's no more questions, then we appreciate everyone's time this morning, and sorry for the technical difficulties, and we'll be in touch with you soon. Have a great day.
Thank you. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.