Quality Distribution's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov. 6.13 | About: Quality Distribution, (QLTY)

Quality Distribution, Inc. (NASDAQ:QLTY)

Q3 2013 Earnings Conference Call

November 6, 2013 10:00 AM ET

Executives

Robin Cohan - VP, Controller

Gary Enzor - Chairman and CEO

Joe Troy - Chief Financial Officer

Analysts

Ken Hoexter - Bank of America

Jack Atkins - Stephens

Tom Wadewitz - J.P.Morgan

Ryan Cieslak - KeyBanc Capital Markets

Operator

Good day, everyone and welcome to the Quality Distribution Third Quarter 2013 Results Call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Ms. Robin Cohan, VP Controller. Please go ahead ma’am.

Robin Cohan

Thank you, operator, and good morning, everyone. We're delighted to have you joined us today for our third quarter 2013 earnings call. Our speakers today are Gary Enzor, our Chairman and CEO; and Joe Troy, our CFO.

Before I turn the call over to Joe, I'd like to caution all participants that comments made by Quality's employees during this conference call may contain forward-looking statements. Actual results could differ materially from those projected or expected in these forward-looking statements.

Listeners are urged to carefully review and consider the various disclosures made by the company in this conference call and the Risk Factors disclosed in the company’s Annual Report on Form 10-K for the year ended December 31, 2012, as well as other reports filed with the Securities and Exchange Commission.

Copies of the company’s Annual Report on Form 10-K and other SEC reports are available on our website at www.qualitydistribution.com and on the SEC’s website. The company disclaims any obligation to update any forward-looking statements after this conference call.

I also want to remind everyone that we refer to certain non-GAAP measures such as adjusted EPS and adjusted EBITDA that management uses to evaluate the business and to help provide additional measures of earnings and cash flow that may be important to the investment community.

At this time, all participants have been placed in a listen-only mode. The forum will be open for questions following the presentation.

With that, I would now like to turn the call over to our CFO, Joe Troy.

Joe Troy

Thank you, Robin, and good morning everyone. Yesterday we reported quarterly revenues of $236 million in the third quarter which was an increase of 6.5% ex-fuel surcharges versus the same period last year, as each of our segments delivered organic top-line growth. We generated adjusted EPS of $0.20 per diluted share which was inline with our overall expectations, adjusted EPS this quarter excludes $3.8 million of reorganization costs related to our Energy business, $1.2 million of costs related to the partial redemption of our senior notes and $0.5 million of expenses from the Apollo stock offering in August. Adjusted EPS in Q3 was up about $0.03 on a comparable year-over-year basis. This increase resulted from better margins in our Chemical and Intermodal businesses, partially offset by year-over-year declines in our Energy business.

In the third quarter consolidated operating income on an adjusted basis was $11.6 million and adjusted operating margin was 6.5%, with both measures flat versus the prior year period. On a sequential basis adjusted operating margin was also flat as the modest increase in our Chemical business was offset by a slight decline in our Intermodal business.

Before I discuss our segment results, I want to highlight some significant cash flow and debt reduction achievements for this quarter in the first nine months of 2013. Our asset light business model continues to deliver strong free cash flow. Operating cash flow for the third quarter was $20.9 million, which was close to a record at nearly four times the prior year period level. The increase was primarily driven by higher cash from operations as well as the typical working capital contractions during Q3, which tends to be our seasonally strongest cash collection quarter.

On a year-to-date basis, operating cash flow was $39.3 million. In 2013 we have been focused on managing our capital spending, reducing our asset intensity and deploying our free cash flow to reduce debt. Our consolidated net debt position declined by $18.4 million during the third quarter and on a year-to-date basis, debt is down a little over $30 million. And this has been accomplished without a significant improvement in EBITDA.

We have deployed more than 75% of our free cash flow for this substantial debt reduction so far this year, which has enabled us to steadily reduce leverage. At the end of Q3, our net debt to adjusted EBITDA ratio was 4.4 times which is down from 4.9 times at the end of 2012.

Our strong cash flow as well as our aggressive asset rationalization program has also served to enhance borrowing availability under our ABL Facility, which is a key measure of our liquidity. Availability stood at $82.4 million at September 30, representing an increase of $10.2 million from the end of Q2 and $27.2 million from the beginning of the year.

The overall takeaway as we are delivering on our commitment to generate strong free cash flow and deploy the cash to strengthen our balance sheet and we are confident this will continue.

On the asset side, capital expenditures for Q3 were $3.4 million, which was more than offset by $5.4 million of equipment sale proceeds. For the nine month period, capital expenditures net of proceeds from asset sales were $1.2 million, which is down significantly from the $20 million of spend in the comparable prior year and nine month period.

As stated in our release, we expect our net CapEx for all of 2013 to be between $4 million and $6 million as we expect spending to pick up a bit in Q4, primarily as we purchase Chemical equipment to support recently awarded new business.

Looking into 2014, we expect to revert back to a $10 million to $15 million range of expected net spending. Our asset utilization and rationalization program is bearing fruit, as we reposition or divest non-core or sub-optimal assets. For example we are now down to a very manageable level of 110 barrel units in Energy, which has been the primary source of asset sale losses there over the last nine months.

Turning to our segments. Chemical Logistics revenue excluding fuel surcharges rose 4% in Q3 versus last year, primarily due to increased pricing and higher volumes. Chemical shipment continues to be strong in most areas of the country and our driver counts were up nearly 2% over last year due to a continued aggressive focus on recruiting and retention. Operating income and margins at Chemicals are stabilizing as we rapidly put the affiliate conversion issue behind us. The reaffiliation of terminals is now complete and we expect margins from these terminals start picking up beginning in 2014.

At Energy, revenues were $43.1 million up $4.6 million or 11.9% over the prior year quarter driven by organic growth in the Eagle Ford Shale region and the on-boarding of our new affiliate in the Marcellus region. On a sequential basis, revenues were down $2 million or 4.5% versus Q2 primarily due to reduced asset utilization in the Woodford Shale region as well as softer than expected new well development within the Bakken Shale. These declines were offset impart by increases in our Eagle Ford and Marcellus areas.

After adjusting for items noted in our release, operating income at Energy was $2 million in Q3 down $1.3 million from last year’s quarter, but roughly flat versus Q2. Segment results in the third quarter were adversely impacted by lower than expected profitability in the Bakken Shale as higher margin fresh water trucking revenues declined. Additionally our new affiliate in Marcellus continues to grow and perform well and we have swung from an operating loss earlier this year to positive earnings contribution in Q3 in this region, which is a testament to our asset light independent affiliated business model. We are confident, we can replicate this transition in Oklahoma operations as well.

Intermodal segment revenues, excluding fuel surcharges were up $2.5 million, or 8.8% due to increases in trucking revenue as well as strong storage rental and service revenue. Our Newark, New Jersey facility, which is adversely impacted by the hurricane last year continues to expand revenues.

Operating income at Intermodal was up 40% versus last year, which resulted from increased levels of high margin storage and service revenues, profitability enhancement at Newark and the non-recurrence of the steep equipment repair cost which impact in the prior year period.

Sequentially revenues were down a little over 4% as we anticipated as service revenue fell slightly from record levels in Q2. Given the high margins in the service division, margins contracted on a sequential basis, but were still very healthy.

Going forward our focus will remain on creating value by improving operating results, reducing asset intensity generating strong free cash flow and reducing debt.

That concludes my prepared remarks and at this point I’ll turn the call over to Gary.

Gary Enzor

Thanks Joe. As we highlighted the businesses all performed near expectation this quarter, although we did encountered some stronger headwinds and choppier results in Energy. We are roughly five weeks in the Q4 right now and are seeing our typical seasonal slowdown in sequential revenue across our businesses.

On a comparable basis versus last year, Chemicals is running about 2% to 3% higher right now, which is consistent with their trend and Energy is basically even for the last few months. The Intermodal segment is up mid to high single-digits like it has been running all year.

We would expect our normal seasonal high single-digit revenue decline to result in reduced earnings on a sequential basis, but expect moderate improvement over adjusted EPS from of Q4 last year. As we prepare to close out 2013 and enter 2014, we will continue pursuing our objective of creating an Energy segment with multiple affiliates moving oil and produced water, which are the more stable and sustainable revenue streams. We envision the business to have base and diversity by operating in about a dozen shales and we are committed to using the asset light independent affiliate model that has worked so well with our Chemical Logistics segments.

Towards this end we have plans in place to convert the rest of our operations in the Woodford shale to an independent affiliate by Q1 of ‘14 and then also evaluating opportunities to affiliate our other company operated terminals outside of the Bakken Shale as soon as possible and no later than the first half of next year.

That would leave us with one large already asset light business in the Bakken, which we will likely ultimately look to convert during 2014 as well. Today, we have affiliates running mostly produced water in the Marcellus Utica moving oil in the Eagle Ford, Woodford and Permian Basins soon to be running the other Woodford business and the startup independent affiliate ready to service customers in the Tuscaloosa Marine Shale.

Our sales in engaged on his behalf and we are currently making plans to enter the Niobrara Shale. I am personally excited to see the progress made by our Energy Logistics sales team and our independent affiliate partners in engaging with customers and finding new business, particularly on the oil with oil producers as well as marketers. This recently formed group has an excellent and has already added double digit MSAs and several oil producers to our customer mix. They come from competitors, oil remarketers and one of our affiliate partners and will be an integral part of our efforts to transform our Energy Logistics business to an asset light model based on stable recurring revenue streams.

As for Chemicals and Intermodal those remain strong high cash generation businesses run by talented and dedicated management teams that are preparing for an additional market demand that will be coming online in the 2016 timeframe created by the tremendous investments by the chemical industry in ethane capacity. We look forward to continued growth with upside in those businesses in the out years. More immediately our Canadian independent affiliate just made a small pack-on acquisition to take advantage of the strong Western Canadian market and we are in the process of expanding with existing affiliates in the two additional chemical operations in the Houston and Midland Texas markets to support recent wins with the key customers.

These are examples of our affiliate model enabling us to leverage growth in a way that does not require us to make significant cash out ways. During the same time horizon, we plan to continue to reduce debt and we will be well positioned to capitalize and the opportunity to significantly reduce our interest cost as our bonds become fully callable in November 14th.

Looking a little further out towards 2015 and beyond, we see a very positive confluence of strengthening less leverage balance sheet with lower debt cost and a chemical upturn driven by low cost energy that should have the company very well position to capitalize on the increased market opportunities that will be forthcoming. And we believe in 2015 and beyond we are very well positioned to deliver increased value for our shareholders.

With that operator, we will open it up for question and answer.

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Ken Hoexter with Bank of America.

Ken Hoexter - Bank of America

Great. Good morning. Gary, maybe just step back a little bit, when you think about the energy at the sales or in the chemical with the plant build out, where do you see more upside and how do you think about your capital deployment when you think about those two sizable opportunities that are coming in the very near-term over the next few years?

Gary Enzor

Yeah Ken, I think there is upside in both, but we would be more focused on the chemical side of the equation and with all the capacity coming on stream in the Houston and Gulf region as I talked about, we're already expanding operations. We've added in the Houston market in the last year. So we've gone from 1 to 3 affiliates. I just said on this release, we're adding another affiliate in the Houston and one out in Midland and we will be adding more in the Gulf. So I think there will be more of a focus on the chemical side of the equation and with energy it will be more about organic growth across the shales as we articulated.

Ken Hoexter - Bank of America

So given I agree just given the size of that market, but why the race to the Niobrara and others when you haven't yet finished converting and the affiliating of the energy business? I mean I guess just how do you step back and know that you are not chasing kind of maybe some of the water business when you first entered that you have found the proper recurring streams. Do you get a handle that you feel like you have done that already?

Gary Enzor

Yeah. I think we understand the markets much better. We now have the right assets and the right business model, which is basically our logistics business model. So again, when we go into the Niobrara, we're not going to go in there asset heavy, we're going to go in there with an affiliate partner and have very limited investments and just take advantage of the fact that we know this market very well now and we have the right equipment for it and we understand how to play in it and we want sustainable revenue streams and that's a good shale.

Ken Hoexter - Bank of America

Wonderful. I appreciate the thoughts.

Gary Enzor

Thanks Ken.

Operator

Thank you. We'll go next to Jack Atkins with Stephens.

Jack Atkins - Stephens

Good morning guys. Thanks for the…

Gary Enzor

Hey Jack.

Jack Atkins - Stephens

Gary just to kind of go back to the discussion on the energy logistics business for a minute. I know you guys of course and we all know that that you share challenges there over the course of the last couple of years. But you've also done a lot of work to get that business on the right track. So I guess when you think about the prospects for that business it sounds like you like where you’re headed today versus where you were 6 to 12 months ago. But could you maybe sort of expand on the opportunity for margin expansion not just the revenue growth, but when you look at the opportunity to maybe convert that revenue to bottom-line results?

Gary Enzor

Yeah. I think the shortest answer Jack is as you end up in a dozen shales with $20 million or $30 million of revenue per shale and you end up with an affiliate business model then you get affiliate margins, which typically we have a 15% coupon and we own trailers. So that translates to roughly a 15% to 20% EBITDA margin across $250 million to $350 million of revenue over, the target would be over 24 month or so window.

Jack Atkins - Stephens

Okay, great. That’s great to hear. And then as far as the Chemical Logistics business you did have a nice uptick in margins there sequentially. Could you maybe talk about the, as you look out over the next couple of quarters, do you feel like you’ve hit the lower water mark in terms of margins now that you've got the underperforming chemical affiliates, chemical terminals re-affiliated?

Gary Enzor

I'll let Joe take that one.

Joe Troy

Yeah. I think Jack where we are is we're seeing really, as I said in my prepared comments, really good stabilization in margin in chemicals. But the uptick probably doesn’t come until 2014 we're still in that transition phase and we’ll also be sequentially coming down in Q4. So let’s put Q4 aside and say as we get into Q1 and Q2 of 2014 that’s when we would expect the uptick in margins coming from these affiliated terminals. And we would expect to continue to see growth in that business. And what we would be looking for is a good conversion of those incremental revenues into improvements in margin.

Jack Atkins - Stephens

Okay, great. And then Gary you mentioned, I think you have mentioned in your prepared comments that there has been some recent business wins on the chemical side. I know you don’t want to talk about specific customers, but can you talk about the initiatives you guys have in place to sort to grow business there beyond just adding drivers?

Gary Enzor

Yeah. I think some of the significant business opportunities have come through recent bids. And now that we've been through getting the model stabilize as we went through some of the affiliate conversions last year, as Randy Strutz who runs our chemical business says this is the strongest he has ever seen with all the players in this business. So we are able to be quite competitive in bids and these were couple of the major chemical shippers and we were able to take decent shares.

Jack Atkins - Stephens

Okay. That's great. And then last question, the housekeeping item. The equity issuance cost Joe, were those in the chemical segment as far as were they shut up on the P&L or were they somewhere else?

Joe Troy

In the chemical.

Jack Atkins - Stephens

Okay. That's great. Thank you.

Gary Enzor

Thanks Jack.

Operator

Thank you. We’ll go next to Tom Wadewitz with J.P. Morgan.

Tom Wadewitz - J.P.Morgan

Yeah. Good morning. I wanted to see if you could talk a little bit about the driver, it sounds like you did better and grew the driver count in Chemical Logistics. I wanted to see if you could talk about the hours of service impact on your business and as you ramp up some of this new business that you want in the chemical side, how much of a constraint to your volume and revenue growth in 2014 is the driver market?

Gary Enzor

Yeah. I think based on our length of [haul] we haven’t had substantial impact from the HOS change, although we did say we probably had some flex in the system to pick up the current incremental opportunities, but we’ll hit a ceiling with that going forward. I think we are like everybody else if I look at the three business segments versus the same period last year, chemicals was up 2% in driver count which is roughly 48 to 50, energy was up 20% in driver count was fairly easy to attract drivers and -- was up roughly 10% in driver count. So we’ve been successful at recruiting, but it’s not any easier here than anywhere else. It’s a lot of hard work and the [gating] factor and a lot of the revenue is getting the drivers on board.

Tom Wadewitz - J.P.Morgan

So if you had new business wins that drove greater than 2% growth in volume you would find ways to handle that. So it’s not, I mean I guess you would necessarily want to say that that driver issue is constraint on revenue growth next year or should we consider that as being something that hold back which you can handle?

Gary Enzor

Yeah. I mean we’ve said this year Tom that driver of growth was a constraint on revenue that we could handle more if we had more drivers. So again our view is in the volume arena probably 2% to 4% next year based on how we grow drivers. If we add 6% drivers we could probably grow 6%. So it’s still a factor.

Tom Wadewitz - J.P.Morgan

Okay. And then one more quick one, on the Bakken what’s the timing to kind of stabilize that business in terms of the mix and the drilling activity and so forth?

Gary Enzor

I think that’s still working in at least the first half of 2014.

Tom Wadewitz - J.P.Morgan

Okay, great. Thanks for the time.

Gary Enzor

Alright. Thanks Tom.

Operator

(Operator Instructions). We will go next to [Ellison Lander] with Credit Suisse.

Unidentified Analyst

I just wanted to follow up on Tom’s question regarding drivers, but specifically you know what you guys are seeing in terms of wage inflation for the new drivers and maybe relative to the repositioning drivers. And then on the retention side, what tact that you guys have been using that seem to be successful there or unsuccessful I guess?

Gary Enzor

Yeah, on the wage inflation side, our business model in the Chemical segment and the Boasso segment and really a lot of energy is heavy on our operator mix. So they tend to get their percentage, typical percentage is 62% to 65% in the Chemical space and higher in the Energy space. And so there isn’t necessarily wage inflation on that percentage, it just get move with the revenue. So as you are increasing the rate of revenue, they get their increases.

In general, the rest of the drivers in our fleet are company drivers that work for our independent affiliate partners and they set the rates for those drivers in each of the markets. So we are not as -- we don’t manage that cost, they do, but I would say a lot of them would also tend to use a percentage for a company driver and so again their salary would fluctuate as we increase revenues.

Unidentified Analyst

Okay, got it. So that like a specific year-over-year 3% increases, something like that. Okay, and then maybe just switching gears a little bit and talking about your reorganized ops in Oklahoma. What do you see in terms of run rate margin profile in Oklahoma and then I guess also you expanded operations in the Permian and North Dakota?

Gary Enzor

Yeah, I'd say [Ellison] in Oklahoma, the fourth quarter I wouldn't expect to look dramatically different, hopefully some level of contraction in expense there in Q4. But assuming that we convert that business to affiliate model in the first quarter, second quarter and next year, you will start to see that margins start to pick up. But what we tend to do in this affiliate conversions is provide some level of concessions on our revenue share upfront and let them grow into the operations and manage it and then we start climbing into more appropriate levels of revenue share.

So, don't expect much I would say in the initial part of the conversion, very similar to what happened in our Marcellus conversion where for the first couple of quarters we still had some residual costs and still running some operating losses and then by the third quarter or after that affiliation we had earnings contribution. And I would expect something similar out of that location.

Unidentified Analyst

Okay. That is fantastic. Thank you so much.

Operator

(Operator Instructions). We'll go next to Ryan Cieslak from KeyBanc.

Ryan Cieslak - KeyBanc Capital Markets

I guess firs off I just wanted to get a sense on the new chemical business, Gary that you mentioned, I know you talked about a little bit about that's going to bring out some new affiliates there. But how should that rate up I guess near term? Is that something you think you'll start to see more of a benefit into the early part of next year? I'm just trying to get sort of the sequential trend from that business and any impact in chemical.

Gary Enzor

Yeah, I would say the early part of next year and I would also say I still mix it into our aggregate view of 2% to 4% volume growth. Again if we have more drivers, we can have higher revenue growth, but I would mix it into the whole picture, so that we don’t start counting excess drivers.

Ryan Cieslak - KeyBanc Capital Markets

Okay. And then into 2014 and I am not looking for specific guidance, but on Chemicals it seems like certainly there is a lot of healthy underlying demand within that business and I just wanted to get your view Gary, do you view ‘14 sort of pivotal year for you guys, can you continue to bring on affiliates, is that going to be part of the story for Chemical into next year?

Gary Enzor

Yeah, I think the ethane investments are really going to drive further out in ‘14 more likely ‘15, ‘16 timeframe, so we're making sure we're well positioned for that. But the two terminals that we're adding in Houston and Midland should be source of the growth, tuck-on acquisition that our affiliate made in Western Canada should be a source of growth and we believe we can continue to find opportunities like that in the Chemical space and then we want to be very well positioned for the incremental volume that we expect to come year and half after ’14, in late ‘15, ‘16 timeframe.

Ryan Cieslak - KeyBanc Capital Markets

Okay. And then switching to Energy, your comments about the margin profile there or in the next 24 months or so, you’re getting to that maybe 15% to 20% EBITDA margin, what gets you there I guess and then is that a gradual process in terms of just having the affiliate the business and overcoming some of these equipment headwinds? Is that something you can see at least maybe a mid to high single-digit type EBITDA margin in the early part of next year. I’m just trying to get a sense of the cadence to get to that level maybe into ‘14?

Gary Enzor

Yeah. And again I said to get that level is really a two-year horizon. I mean we talked about a lot of conversions that we’re working through in ’14. And by the time you get to that level, $250 million to $350 million of revenue year or 24 months out and typically it will look like the energy space. If we own and rent trailers, you have the opportunity to earn 20%, but you do have some fixed cost, it would probably reduce that number and if we’re not renting trailers, then you are flowing about 15%, but again you have insurance and some other variable items that would reduce that number.

So when you take that from an EBITDA margin to an operating margin number, it’s probably more like 10 to 15 and 15 to 20 when you get it all the way to the operating margin level.

Joe Troy

And I would say Ryan, we’re going to find it that it will be not a very smooth upward situation only because like Gary said, we’re going to be going through transitions, those transitions can’t be a little bit choppy and then they will smooth out again exactly what happen really with our Marcellus operations.

So don’t be looking for big step functions or smoothness in that and might be a little bit up and down along the way, but we’re already seeing some benefits from the actions that we take in whether it’s on cost reduction, asset, rationalization, improving the affiliates that we already have in transitioning to new affiliates. So all those strings turn into a bucket, give us a positive outlook.

Ryan Cieslak - KeyBanc Capital Markets

Okay. And then just lastly a couple of housekeeping items, Joe within the Energy segment in the P&L there, it looked like there was $1.6 million of other expense and I am just trying to get a better sense of what exactly that was in the quarter, is that part of the reorganization cost or is that something separate?

Joe Troy

No, it’s part of the reorganization cost, a lot of that is the asset sale losses from sales of equipment.

Ryan Cieslak - KeyBanc Capital Markets

Okay. And then lastly just any sense of good placeholder for interest expense going into next quarter and maybe the early part of next year, obviously understanding there is opportunities to continue to reduce debt but just trying to get a sense of good placeholder for interest expense going forward?

Joe Troy

Yeah, somewhere in $7.3 million, 7.4 somewhere in that range on a quarterly basis, now depends on overall levels of debt reduction. So I would say that that’s probably good for the next couple of quarters until we hit our next opportunity to regain some bonds in July of next year.

Ryan Cieslak - KeyBanc Capital Markets

Okay, thanks, guys.

Operator

I would now like to turn the call back over to Gary Enzor, Chairman and CEO for any additional or closing remarks.

Gary Enzor

We would just like to thank everybody for participating in our Q3 earnings call and we’ll talk to you next quarter. Thank you.

Operator

That does conclude today’s conference. Thank you for your participation.

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