UTi Worldwide Management Discusses Q3 2014 Results - Earnings Call Transcript

Dec. 5.13 | About: UTi Worldwide (UTIW)

UTi Worldwide (NASDAQ:UTIW)

Q3 2014 Earnings Call

December 05, 2013 11:00 am ET

Executives

Richard G. Rodick - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance

Eric W. Kirchner - Chief Executive Officer and Director

Edward G. Feitzinger - Executive Vice President of Global Operations

Analysts

William J. Greene - Morgan Stanley, Research Division

Scott H. Group - Wolfe Research, LLC

Jack Atkins - Stephens Inc., Research Division

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

Kelly A. Dougherty - Macquarie Research

Kenton Moorhead - Robert W. Baird & Co. Incorporated, Research Division

Kevin W. Sterling - BB&T Capital Markets, Research Division

Matthew Young - Morningstar Inc., Research Division

David P. Campbell - Thompson, Davis & Company

Operator

Good morning, ladies and gentlemen, and thank you for standing by, and welcome to the UTi 2014 Third Quarter Conference Call. [Operator Instructions] And as a reminder, this call is being recorded, today, December 5, 2013. I would now like to turn the call over to Rick Rodick, Chief Financial Officer. Please go ahead, sir.

Richard G. Rodick

Thank you, operator, and good morning, everyone. Welcome to UTi Worldwide's Fiscal 2014 Third Quarter Results Conference Call. Jeff Misakian has had a death in the family and will be unable to participate on the call today. Our thoughts and prayers are with Jeff and his family at this time. Joining us on the call today is Eric Kirchner, Chief Financial -- Chief Executive Officer; Ed Feitzinger, Executive Vice President, Global Operations, is also here and available to answer questions during the Q&A session.

We've included slides with today's presentation to help illustrate some of the points being made and discussed during the call. These slides can be accessed by visiting our website at www.go2uti.com, and clicking on Investor Relations and then clicking on Webcast and Presentations. Now please turn to Slide #2.

Before we begin the presentation, I'd like to point out that certain statements made in today's call are not historical fact. They may be deemed, therefore, to be forward-looking statements under the Private Litigation Reform Act of 1995. Many important factors may cause the company's actual results to differ materially from those discussed in any forward-looking statements. These risks and uncertainties are described in further detail in the company's filings with the Securities and Exchange Commission. Please refer to these filings for more information regarding the risks and uncertainties that the company faces.

UTi undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Now I'd like to turn the call over to Eric Kirchner. Eric?

Eric W. Kirchner

Thank you, Rick. Good morning, everyone. Please turn to Slide 3. A strong October performance led to us to achieve our best quarterly results of fiscal 2014. Robust freight forwarding volumes and improved contract logistics and distribution activity generated our strongest revenue since the third quarter of last year. Increases from existing clients and some new business wins helped produce volume growth in the abbreviated peak season.

Several factors partially offset the volume growth in the quarter. Pricing continued to be under pressure, and we experienced some declines from other existing contracts. The effects of currency translation also lowered revenue and net revenue.

We continue to make significant progress on our system's deployment. It's exciting to report that our freight forwarding operating system went live in 5 additional countries since our last investor call, including Germany, which is our second largest market by shipments. We're live in 27 countries, representing approximately 50% of our freight forwarding volume. We've also completed the implementation of Oracle Financials for freight forwarding operations in 30 countries. Now please turn to Slide 4.

Freight forwarding revenues grew in the third quarter of fiscal 2014, primarily due to increases in airfreight tonnage and Ocean Freight TEUs. The Asia Pacific region led our growth. Net revenue per kilo and TEU were lower in the third quarter, both on a year-over-year and sequential basis, resulting from the pricing environment.

We continue to experience pressure on our sell rates, while buy rates were volatile throughout the quarter. Contract logistics and distribution delivered their best quarterly results of the year. Adjusted operating income nearly doubled from the second quarter of fiscal 2014 through the third quarter, and the margin percentage was up approximately 40 basis points year-over-year.

We saw increased activity from new business wins and good expense management in the Americas, higher activity in our Africa distribution businesses and improvement in our European and Asia Pacific contract logistics businesses.

Turning to Slide 5. Expenses remain inflated due to the ongoing investment in our transformation. We incurred approximately $4 million of implementation and duplicative costs related to the rollout of our new freight forwarding system during the third quarter, and we began amortizing previously capitalized expenses in September. However, because of the progress we've made in our system deployment, we've begun to remove costs from the organization. We removed approximately $30 million in pretax operating expenses on an annualized basis at the end of the third quarter. None of these cost reductions are reflected in our third quarter results.

We anticipate an additional $10 million to $12 million of annualized pretax operating expenses to be removed by the end of our 2014 fiscal year. The remainder of our cost actions and efficiency improvements are expected to be substantially complete by the end of fiscal 2015. These actions position us well to achieve our $75 million to $95 million cumulative pretax annualized savings target.

Please turn to Slide 6. The purpose of this slide is to clarify our targets for the next 2 quarters and the run rate at the end of our next fiscal year. We thought it important to get focused on our go-forward actions. In this slide, we provide estimates on the phasing of these reductions by quarter through our first quarter of fiscal year 2015 and where we believe we'll be at the end of next year.

We've also included the impact of costs associated with the amortization of the new system. By the end of the year, we expect to have in place approximately $85 million in annualized pretax cost savings, which will be offset by approximately $23 million in amortization expense.

Now I ask Rick to cover our financial results in greater detail. Rick?

Richard G. Rodick

Thanks, Eric. Please turn to Slide 7. On a GAAP basis, we reported a net loss attributable to common shareholders of $0.09 per diluted share in the fiscal 2014 third quarter. Excluding adjustments to GAAP results, which I'll discuss in a moment, we reported adjusted net income of $8 million, or $0.08 per diluted share. This compares to adjusted net income of $0.16 per diluted share recorded in the same period last year.

Currency changes continue to have a negative impact on our third quarter results. U.S. dollar was stronger against most currencies, particularly the South African rand. Reported revenues and expenses in the third quarter were negatively impacted by approximately 3 to 4 percentage points. Currency translation also had a negative effect of about 8 percentage points on operating income.

Revenue and net revenue decreased 0.2% and 2.5%, respectively, in the third quarter compared to the same period last year. The decrease in revenue reflects the impact of currency, lower pricing and reduced activity in contract logistics. These factors are partially offset by higher volumes in freight forwarding and broad-based improvement in distribution.

On an organic basis, revenue increased 3.1%, while net revenue rose 1.6% compared to the same period last year. Third quarter adjustments to GAAP results included severance costs of $13 million in the third quarter of fiscal 2014 and $4 million in the third quarter of fiscal 2013.

Severance costs were primarily related to transformation activity. In addition, we incurred $5 million in last year's third quarter for legal judgment relating to a 2006 warehouse fire. We also increased our valuation allowance on deferred tax assets by approximately $3 million in the third quarter of fiscal 2014.

As stated previously, this is pursuant to the accounting rules related to income taxes and does not affect our ability to utilize the operating loss carryforwards once these operations become profitable. We have provided reconciliations of GAAP to non-GAAP results in the tables in today's press release and posted more details on our website. The rest of my remarks will refer to our results, as adjusted, to exclude the impact of severance and the valuation allowances.

Adjusted operating expenses in the third quarter were higher than the same period last year. On an organic basis, adjusted operating expenses increased 4.2%, primarily due to the transformation costs. These costs included approximately $4 million in implementation and duplicative costs during the quarter.

In September, we began amortizing the previously capitalized costs associated with the new system, and we expect this system amortization to be approximately $23 million annually. Our adjusted operating income of $20 million in the third quarter compares to $32 million in the same period last year. The decrease was primarily due to higher operating expenses and currency translation. The increased operating expenses were directly related to transformation costs.

Now please turn to Slide 8. Revenues from freight forwarding segment were up 1.6%, primarily due to higher volumes, partially offset by reduced pricing and the impact of currency. Ocean Freight TEUs increased 10.7% in the quarter compared with the prior year, and airfreight tonnage was up 8.8%. Net revenues in freight forwarding increased 1.1% in the third quarter due to higher volumes and lower buying rates.

Net revenue per kilo declined 8%, while net revenue per TEU fell 4% in the third quarter compared to the same period last year. Adjusted operating profit in freight forwarding declined 24% in the third quarter compared to the same period last year, primarily due to higher operating expenses and currency translation. The increased operating expenses in freight forwarding, as I've said before, reflect investments in our transformation.

Please turn to Slide 9. Contract logistics and distribution revenues and net revenues decreased 3.8% and 5.5% in the third quarter, respectively, compared to the same period last year. The declines were primarily due to the impact of currency and changes in our portfolio. This was partially offset by increased activity in our distribution's operations.

We did a good job managing cost in our contract logistics and distribution segments. Adjusted operating expenses in the segment were down 5.9% compared to last year's third quarter. As a result, operating profit in contract logistics and distribution was essentially flat on a year-over-year basis.

On an organic basis, adjusted operating profits rose 6% on a year-over-year basis, our first increase in a year. Cash flow from operations was an outflow of $68 million in the first 9 months of fiscal 2014, compared to last year's outflow of $57 million. Working capital decreased $143 million compared to a decline of $160 million in the first 9 months of last year. In the fiscal 2014 third quarter, working capital decreased $62 million compared to a decline of $70 million in the same period last year. Our fourth quarter is historically our strongest free cash flow quarter, and I anticipate improvement in the cash collections in the fourth quarter.

With that, I'll turn the call back to Eric for his closing remarks. Eric?

Eric W. Kirchner

Thanks, Rick. Please turn to Slide 10. The macroeconomic and freight environments will continue to be challenging, which underscores the importance of completing our system deployment as soon as possible. Pricing continues to be under pressure, and we expect this to be the case for the foreseeable future.

So far, the peak season is playing out as we predicted on our last call. The past season tightened certain key markets, leading to significant increases in airfreight buy rates in recent weeks. Like many of our peers, we recovered a portion of these higher rates through pricing adjustments, but we still expect to see some yield compression in the fourth quarter.

Also, many ocean carriers continue to push for higher rates. Their success depends primarily on capacity adjustments, further complicating the unstable nature of the pricing environments. We're very pleased with the progress made under our transformation initiatives.

As I said earlier, we've launched our OneView system in 27 countries, representing about 50% of shipments, including the U.S. and Germany, which are our 2 largest markets. These are major milestones in our comprehensive business process transformation, and it's notable that the U.S. represented the largest and most complex deployment challenge of our entire project.

We have more work ahead of us, but we've already developed a major functionality that's necessary to install the system in all the remaining countries. The sequencing to complete the rollout is paced to accommodate linkages to global customs brokerage systems and the capacity of our deployment teams. We continue to expect approximately 70% of shipments to be on this system at the end of this fiscal year, and to complete the deployment by the middle of fiscal year 2015.

Before I turn the call back over to Rick to direct the Q&A period, I'd like to thank all of our UTi Worldwide employees, who continue to work hard to deliver on our transformation goals. We still have much to do, but I'm very proud of the progress that our team has made. With that, back to Rick. Thank you.

Richard G. Rodick

Thanks, Eric. [Operator Instructions] Operator, may we have the first question, please?

Question-and-Answer Session

Operator

And our first question does come from the line of William Greene with Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

Eric, I think some of the -- in the past, you've talked about getting to some margin targets once you're through this IT transition and kind of the business reinvention. So when we think about getting back there, I assume that you're going to need a little bit of help from macro. Because when you first put these plans in place, macro was a little bit different. Can you give us some sense for what's a realistic margin outlook given the current environment, and how much would be required to get from that point then to your targets?

Eric W. Kirchner

Sure. We have to remain focused on the directly controllable items. So as we talk about this targeted cost savings, we're very focused on that portion. If you look at what builds to the ultimate margin in the business, you've got the costs that produces net revenues, so all the transportation costs that we pay to carriers versus what our sell rates are, and then our OpEx within freight forwarding. So we're very focused on the OpEx portion because there is some fluidity in the margin that will be produced on the basic transportation. So our margin goals, as you have pointed out, assumed flat net revenue when we talked about this back in 2011. And that's not been the case. In fact, net revenue has declined somewhat. And the quality of the net revenue has varied based on margin compression. But we really do continue to believe we'll ultimately hit these margin targets. But the timing is impacted by lower-than-expected net revenue, particularly in airfreight. So I can't give you a great answer for the short term within the freight forwarding business, but we are committed to focus on the cost side and our OpEx to attack the margin target of 20% that we've talked about. On the good news side, our contract logistics and distribution businesses are well on the way to hitting the 10% margin target. And if you look at our results for the last quarter, they showed some pretty good improvement over the prior year, and we're very confident in the contract logistics and distribution target. But it will be a little bit variable and then probably further out for us to hit the 20% margin in the forwarding business.

Operator

And our next question does come from the line of Scott Group with Wolfe Research.

Scott H. Group - Wolfe Research, LLC

So I'm hoping -- going back to the Slide 6 with the estimated benefits and costs. Can you help explain a little bit why -- when I look at the -- going from 50% to 70%, to 75% to 85%, the cost savings seemed pretty linear. But then for the final 20%, there's a huge jump in expected savings. Can you maybe give some color on why that is so back-end loaded on the final 20%? And then maybe just along with that, when we think about the run rate of where we're at today and then applying some of these savings, beyond the, call it, the $85 million of savings, are there additional redundancy costs that you think we should also be taking out or is that not the right way to think about it?

Eric W. Kirchner

With respect to the question about the linear nature of the cost reductions, what we expect to see in the first half of the year are continued focus on productivity improvements and working through the deployments with respect to coming to the common branch structure and things that we have talked about with regard to the way the project's working. What we're going to focus on in the second half of the year is really an enhanced view on what we can do with the system and how we reiterate the targets that we set based on productivity in the frontline workforce. So in the second half of the year, when everything's on the system, I think we'll really start to see the opportunities to take advantage of the system functionality and the process changes. Whereas in the first half of the year, we're still going to be dealing with multiple systems and multiple data entry points that will make that cost target a little bit more challenging to achieve in the first half. That's why the second half looks a lot higher. Do you have any other comments on that, Ed?

Edward G. Feitzinger

No, I think that's quite accurate. You were targeting -- basically, the simple way to look at it, the first half is completing the rollout, second half is taking the cost out associated with that.

Scott H. Group - Wolfe Research, LLC

And then in terms of kind of the -- are there redundancies that you're seeing right now relative to -- that we should add on top of the $85 million?

Eric W. Kirchner

The $85 million should be inclusive of taking out these duplicative costs. But, again, keep in mind, we're -- in effect, this is resetting the target from this point going forward, as opposed to other cost actions that we described in the past. So this $85 million target, or this $75 million to $95 million range, we used $85 million to represent the midpoint of that range, is inclusive of actions that only have become effective at the beginning of the fourth quarter. So we took actions in the third, and then to build that cumulatively to the end of FY '15, that's all current actions to take out.

Scott H. Group - Wolfe Research, LLC

So just I'm clear in there, you're saying that the $75 million to $95 million that you're saying is now -- it's higher than what you would have said a year ago because you've done some already, and now there's an incremental $75 million to $95 million. So in essence, you're kind of raising the cost saving target today?

Eric W. Kirchner

Yes.

Operator

And our next question does come from the line of Jack Atkins with Stephens Inc.

Jack Atkins - Stephens Inc., Research Division

I guess, just first, to follow up on Scott's question, I think in the past you've outlined $25 million in costs that you took out, I think it was this time last year. So just kind of help us think about now, when you step back and look at the total amount of savings that you expect, incremental or, I guess, cumulatively, including the $75 million to $95 million today, what's that total amount of cost that you expect to have taken out of your system by the time we get to the end of FY '15?

Eric W. Kirchner

I think the only way to really look at this, and the reason that we've not used the slide deck before, we've not put these targets out in as much specificity before, and the purpose for doing it this time is, basically, to start the clock and start the approach with this information. So we did take out cost. In prior period, we took out the $25 million that we talked about last year at this time. Other costs came back in the business. There were these duplicative costs due to the extension of the deployment process. So the best way to look at this is the clock starts going forward at the first day of Q4. We're detailing the actions that we took in Q3, and then this $75 million to $95 million, that was probably a factor of confusion because it's the same number we've talked about as the overall benefit of the transformation. But these are actions that will come into effect going forward because they weren't obvious in our third quarter results.

Jack Atkins - Stephens Inc., Research Division

Okay. And then could you maybe provide us the month-to-month airfreight and Ocean Freight volumes trends throughout the third quarter, and then what you're seeing in November? And then also, your outlook -- or what you saw in November, and then your outlook for the remainder of peak season?

Edward G. Feitzinger

Sure, Jack. This is Ed. So the -- so if you look at the airfreight side, we had a very strong comparatively August and September with -- in the 10% to 15% range improvement in airfreight volumes that tapered off in October. In Ocean Freight, we went from 7% in August, 13% in September, 11% in October, and then, November looks even better than that. Now keep in mind that on the Ocean Freight side, our numbers are getting more accurate, as we put more countries on OneView. So our TEU count was an estimate in the past for the numbers that we've had, and we have much more specificity because of the way the data is entered into the system going forward. So there is probably an improvement in accuracy in that number as we go forward. So...

Jack Atkins - Stephens Inc., Research Division

Got you. And the November airfreight tonnage, Ed?

Edward G. Feitzinger

The November airfreight looks about the same as last year, last year's November.

Operator

And our next question does come from the line of David Ross with Stifel.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

Could you give us some commentary around lane strength in those airfreight and Ocean Freight volume wins? Where did you gain the most share? On what lanes were they, both in air and in ocean?

Edward G. Feitzinger

So the air side is outbound Asia Pacific. So it was a little bit of intra-Asia Pacific, a lot of outbound to North America to Europe. On the ocean side, a significant improvement in Asia to Africa, and a combination of European exports and Asia to Europe.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

On the outbound Asia, was that more Asia-Europe, more Asia-U.S.?

Edward G. Feitzinger

About an equal mix of both.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then at the South Africa rollout, you mentioned that Germany and the U.S. are now in the new system. Is South Africa going to be one of the ones that's going to be on by the end of January?

Eric W. Kirchner

That is where we are right now in the deployment schedule. So we -- I think the 2 remaining countries that are going to really have impact are going to be South Africa and China. It's not that the rest aren't important and it's not -- I think the best way to think about our greatest opportunities to start realizing the cost savings are when everything's on the system. But if not for the holidays, we would probably be going into China and South Africa sooner. But you've got Chinese New Year that's going to impact the end of January. And we're in the holiday season. But we're ready to go in terms of deployment, and we expect to have them on, probably at the end of January.

Operator

[Operator Instructions] And our next question does come from the line of Kelly Dougherty with Macquarie.

Kelly A. Dougherty - Macquarie Research

I appreciate the additional insight on the gross cost savings. But can you help us think about what a net number would be? You talk about a $23 million amortization. Is there anything else that we should think about netting against that $75 million to $95 million over the next several quarters?

Richard G. Rodick

Not this time. I mean, the amortizations, it's the $23 million, it's about $5 million a quarter growing to about $6 million a quarter. The other thing that you would probably look at and include is severance, which will be -- we recorded $13 million this quarter, $15 million to $20 million annually -- next year for FY '15. Those will be the only other costs.

Kelly A. Dougherty - Macquarie Research

And then that, as you go into fiscal '16, you really have kind of a run rate of $75 million to $95 million just minus the $23 million.

Richard G. Rodick

Correct.

Kelly A. Dougherty - Macquarie Research

That's the best way to think about it?

Richard G. Rodick

Correct. So, yes, we exit FY '15 at the targeted or the midpoint of $85 million of savings. And we get the full impact of those savings in FY '16.

Kelly A. Dougherty - Macquarie Research

Okay. And then just quick on the $23 million. I think you've previously been talking about $20 million in amortization. And I think on the last call, you had said, we want to get 8 to 10 additional countries on. By this call, it looked like there were 5. Is there anything we should think about with things getting a little bit slower during this past quarter, or costs increasing that increase that amortization number at all a bit, and how you think about catching up to get to that 70% by the end of the year?

Eric W. Kirchner

Sure. To go back, let me add something also to the -- to your earlier question. The way we need to think about these costs is run rate by the end of. So, as an example, when you look at the cost actions that we showed for the third quarter, a lot of them came -- became effective at the very end of the third quarter, therefore, they're not reflected in the numbers. And we would anticipate some cost actions that would run close to the end of next year to get to that $85 million number. So it's not as if those things start or are front-loaded when you consider what our OpEx or our basic cost run rates will be. When you look...

Kelly A. Dougherty - Macquarie Research

Sure. That would be kind of a number we should think about for fiscal '16, right?

Eric W. Kirchner

Yes. So when you talk about the point of schedule and where we are with the rollout, the number of countries is important because all the countries have to get on the system, obviously. But the percentage of transactions in the system is a bigger driver of how we're viewing the progress of the rollout. So we did go into fewer countries than we had initially anticipated in this quarter. But the U.S. implementation was the most complex. And we wanted to make sure that we had everything right before we went into additional countries. So if you look at the U.S., that involved our largest number of branches, it involved a new freight forwarding operating system, a new finance system with Oracle Financials, a new customs brokerage system, and all the associated linkages of those systems and business process changes. So it was the most challenging and complex rollout that we had, and we wanted to make sure we had that right before we went into a lot of additional countries. I wouldn't characterize that we fell behind or that, that would have been amiss, that we went to 5 versus 8 to 10 countries because we now have our 2 largest countries on the system. And we expect to get the next 2 largest countries on the system at the end of the fiscal year. So we're about 50% today. Just the addition of China and South Africa, and it's well on the way to that 70% number. And we'll add some other countries to get there. So I think that we've made excellent progress. The fact that we've got more -- or half of our transactions in this system today and it's functioning and working and we're seeing the benefits that we expected in terms of how that system performs, I think we're doing a great job with that.

Kelly A. Dougherty - Macquarie Research

No, that's helpful. And then just a quick follow-up on that, though. The $23 million versus $20 million in amortization, were there maybe some additional costs as you got the U.S. and some of these other bigger countries on there, that we should think about maybe a higher CapEx spend that led to higher amortization or anything like that?

Richard G. Rodick

Yes, Kelly, I'll give you a little more on that. The -- when we were -- we've done some additional development. We've spent about $7 million this quarter. So inception to-date, we've spent about $155 million, $156 million. We're winding that down. We think we'll be in the $160 million to $170 million range. So in case we're at the higher end of that range, I've given a little higher guidance to $23 million. It will be in the $22 million to $23 million range.

Operator

And our next question does come from the line of Ben Hartford with Robert W. Baird.

Kenton Moorhead - Robert W. Baird & Co. Incorporated, Research Division

This is Kenton on for Ben. I wanted to maybe talk a little about some of your efforts in terms of managing the net working capital. And then maybe as a follow-up to that, as you're basically 2 to 3 quarters away from finishing the rollout, how do you guys start to prioritize some of this free cash flow that you guys are going to be generating?

Richard G. Rodick

Okay. So you mentioned net working capital, talking about where we are now and what we see in the upcoming? Okay.

Kenton Moorhead - Robert W. Baird & Co. Incorporated, Research Division

Yes, in terms of managing just the amount of net working capital that you guys -- you're laying out. Because it looks like, obviously, this is a higher net working capital quarter. But it looks like -- I remember a few quarters ago, you talked about when you came in, that this was something that you were going to kind of focus in on?

Richard G. Rodick

Yes, definitely. We've increased focus. A couple of things. Number one, the -- this is always our weakest cash flow quarter because it's normally, our highest revenue. We had actually have record -- our highest revenues, I shouldn't say record, highest revenues of the year this quarter. So with that, there's increased demands, higher volumes, higher payments to our higher -- charges with carriers and things. And so, what we normally see is that it ramps up a bit. There's a use of working capital in the third quarter, and then fourth quarter improves dramatically. There is -- there has been an excellent focus on it. I will tell you, in the last few quarters, in each of our regions, we've seen the older debts be paid down. And what we're seeing is higher current billings. So while it doesn't show up in improved working capital, our aging is improving. So I think you'll see that improvement in the fourth quarter continue to improve. And we've been investing in the business with the system and such.

Kenton Moorhead - Robert W. Baird & Co. Incorporated, Research Division

Yes, and then the other part of that was, as you get through that system, and you've got basically 2 to 3 quarters more in terms of the rollout if you're getting towards mid-fiscal '15. What -- where is the focus turn in terms of uses for free cash flow?

Richard G. Rodick

Well, we'll reevaluate at that time. But number one, we want to pay down debt. We'll look at investing in the business. Because our investment in the business, the last couple of years, has been in the transformation, and those costs wind down. So we'll be looking to invest in the business. And then we'll consider other options returning dollars, cash to the shareholders and such. But right now, it will be pay down debt, invest in the business and then consider other options.

Kenton Moorhead - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then maybe just a follow-up on that. Is there like targeted debt leverage ratio that you guys would sort of lean towards?

Richard G. Rodick

I'd like to be under 3 to 1 debt-to-EBITDA.

Operator

And our next question does come from the line of Kevin Sterling with BB&T Capital Markets.

Kevin W. Sterling - BB&T Capital Markets, Research Division

In Europe, x severance charges, it looks like it took a leg down this quarter. I was wondering what's going on there, was there anything in there may have been one-time in nature? And then when do you expect Europe to become profitable again? How should we think about that?

Edward G. Feitzinger

So our European business, we have some new management in there now. We've restructured the organization there to drive some improvement. We've seen underlying improvement in our contract logistics business there that's taken sort of a while to come around, but we're seeing improving margins in our business there. And we do have a heavy presence, as we've talked about at other calls, in Spain and Portugal. And that's weighed heavily on us. That economy appears to be stabilizing. So it's a combination of the stabilization of the macro. And then, frankly, us doing a better job at managing the business there. I'm quite confident in the team that we have there now. We're showing some near-term results to improve that. And I think you'll -- I expect us to see a continued improvement in the European business results on the top and the bottom line as we go forward.

Operator

And our next question does come from the line of Matt Young with Morningstar.

Matthew Young - Morningstar Inc., Research Division

Just a quick follow-up on the European contract logistics business. Are you guys largely done shedding low-margin accounts there?

Edward G. Feitzinger

Yes.

Matthew Young - Morningstar Inc., Research Division

Okay. So there's not much more to go. Another question on the sales initiatives. I know in the past, you guys have said that market share gains have come more from the Ocean Freight than airfreight. But it looks like you got some more traction on the airfreight side this quarter. Is that -- would you attribute that to some of your sales initiatives targeting airfreight more so than in the past? Do you think that's a good opportunity for you guys?

Eric W. Kirchner

I wouldn't characterize it as an outcome of a different targeting strategy. So a lot of what we see in terms of the cyclicality of the business relates to our existing client base. We are excited about new business wins. I wouldn't go out on a ledge to say that a lot of new business wins are going to carry forward and produce the same kind of numbers that we saw in this quarter because it really relates to the macro environment more than anything else. So our existing customer base had a lot more activity, specifically around automotive and around fashion and retail, I guess, is the best segment to describe it as. We did win the business. But it's not due to a change in sales focus. Our sales people are targeted on providing the right solution to the clients. So it more relates to the addition of new nameplates, new clients, and then expanded opportunities with existing clients and how their business is flowing based on the markets that they operate in.

Operator

And our next question comes does come from the line of David Campbell with Thompson, Davis & Company.

David P. Campbell - Thompson, Davis & Company

Regarding my question, I just want to clarify the -- your freight comments. You said August and September, traffic tonnage was up 10%. And then in November -- and up about 10% in October, and then November was no growth. Is that correct?

Edward G. Feitzinger

Yes. So if you look at the aggregate for the third quarter, it's about 9%. And then, so far, again, November is just 1 month. It's relatively flat. Now we did have a peak surcharge in that time period as well coming outbound from certain locations in Asia Pacific. And there is some shedding of lower-margin accounts outbound from Europe in that as well. So there's a mix. I don't know that I would take that number for November and extrapolate that out to the whole industry at this point.

Operator

[Operator Instructions] And our next question is a follow-up question from the line of William Greene with Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

Eric, I'm curious if you could just touch a little bit on your latest thinking about this debate that goes on and on about -- kind of it touches both air and ocean, but more air, about the cyclical versus structural trends. And I think there's a sense that both are affecting, and particularly the airfreight market now. But as we've heard from some folks, there are some structural issues there. So can you just touch on your latest thinking there?

Eric W. Kirchner

Sure. We have to strike a balance between having our heads down and executing on this transformation and then getting ready to move into the next iteration of our company strategy. So we've been doing a lot of thinking around this issue. The expectation would be that the shift from air to ocean will continue. Air is always going to be necessary for certain commodities and types of products. But if you look at what we've seen even in the current environment, one of our key providers ceased operations in the last quarter and caused us to, obviously, have declining capacity elsewhere. I think it's a tough time, especially for freighter operators in the air business. You're seeing this huge shift to more cargo moving in belly capacity. You're seeing the growth and the emergence of the carriers in the Middle East. So a lot of things are moving around within the air space, no pun intended, itself. And then you just look at the average cost and -- the easy way to look at it is at least 10x more expensive to go air versus ocean. And it seems logical that that trend is going to continue. You've got excess capacity in the ocean business and more liners coming on with regularity, increasing the capacity. So I think ocean is where our focus or thinking is going into the future and not at the expense of airfreight, but just because we see the market moving that way. The other factor that we're trying to integrate into our thinking is near-shoring and whether or not we have to still have more focus on within region movements, and we believe we do. So I think that's going to -- I do believe it will continue. And we're integrating that thinking into this next generation of our strategy as a big focus area.

William J. Greene - Morgan Stanley, Research Division

That's very helpful. Do you have capabilities for things like intra-North America? Or is that an area you would need to build out?

Eric W. Kirchner

No, we do. In fact, Ed reminds me a lot, especially with his background, that we don't talk enough about our contract logistics and distribution businesses. Though our distribution businesses within the U.S. really give us some great opportunities to take advantage of movements within North America, we're bolstering our presence on the border between the U.S. and Mexico. And I think we're better positioned than some pure international forwarders because of the investments that we made in these distribution capabilities in the mid-2000s. So I think we're in pretty good shape there.

William J. Greene - Morgan Stanley, Research Division

Okay. And then just one last question. One thing you didn't mention in the structural changes, just the opening or the expansion of the Panama Canal, does that have any impact on your business, or is it just a non-event?

Eric W. Kirchner

We have not seen any real impact at this point. And the other thing that's interesting is, even now, some of these new ships that are coming online, are too big to fit through that space. So it will be interesting to see how that dynamic plays out. But we've not seen a lot of impact yet. We're obviously watching it very closely, but we have not seen impact currently.

Operator

And our next question is another follow-up from the line of Scott Group with Wolfe Research.

Scott H. Group - Wolfe Research, LLC

So maybe, Rick, can you give us some color insight on how we should think about the corporate expense line going forward, just on a quarterly run rate?

Richard G. Rodick

Yes. Right now, we're anticipating flat, no real increase. The only thing that would be in there is severance, but on an adjusted basis, we would take that out. So right now, you should assume it should be flat.

Scott H. Group - Wolfe Research, LLC

And as the cost savings kick in, does some of that show up in corporate or is that more of the segment operating level?

Richard G. Rodick

Mostly the segment operating level. There will be some in corporate, but the lion's share is in the segment level.

Scott H. Group - Wolfe Research, LLC

Okay. And then just maybe going back to my earlier question, Eric. Just bigger picture here, maybe give some -- I want to understand a little bit better kind of the -- when you talk about kind of resetting the dial or the cost savings start now. So you've been talking for a few quarters now that you've been getting cost savings. We don't see it in the numbers yet. So maybe kind of why are you resetting the dial now? I think that's what you said. And then, 2, what changes so we'll see the cost savings going forward, but why we didn't see them previously? I guess I'm just struggling to understand that.

Eric W. Kirchner

Well, as I had mentioned, we took out the cost that we committed to, about $25 million, around this time last year. In the intervening time, we had other costs come into the business. So we did have to process certain merit increases or rate increases around the globe where we have contractual obligations, and other costs associated with this transformation persisted longer than we expected. So we -- if the rollout was completed and we've mentioned that we're about 6 months short of where we wanted to be at this time, then a number of the costs associated with that would have come out. But they stayed in the business. So if you look at an example. We have finance -- country-level finance operations in 59 countries. And we're migrating to finance operations in 3 shared service centers. So because we have not -- you have to staff the shared service centers in advance of the work coming in, but if the work hasn't been transferred in, that work still has to be done in the field. So that's an example of the duplicative or the carrying kind of costs that we would have expected to be out by the end of the year. So I think the real purpose in resetting the target is to really wipe clean the discussions about these past programs and focus on what we're going to do going forward. Because it isn't obvious in the numbers. We did take the actions, but it is what it is, and we're going to focus on these cost actions going forward and execute on those.

Operator

And our next question does come from the line of David Ross with Stifel.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

Yes. The gateway consolidation you guys were doing in airfreight, is that largely finished and it's just layering on the new system in all these countries? Or are you still working in parallel to kind of improve the gateway efficiency?

Edward G. Feitzinger

So in terms of the -- so, basically, yes, we're finished with it. Obviously, we're going to continue to do some work to tune it and improve it. But the -- all the gateways are in, they're operating effectively, you're seeing that in some of the aerial numbers. And so, we're satisfied with the progress we've made to-date. And we fully expect to continue to tune that and improve that going forward as a part of our long-term strategy.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

And then you talked about yields, in general, being pressured in the freight forwarding side, both on air and ocean. Would you say that, going forward, kind of absent the peak season, that air should be more pressured than ocean, ocean should be more pressured than air? Is one expected to be more volatile than the other?

Edward G. Feitzinger

That's a really good question. It's very trade-lane specific. I would say that right now, for example, I think we see more volatility in ocean because the carriers are trying to push through GRIs on various lane segments. They're trying to pair these alliances together to try to hold up prices. And they come in and come in for 3, 4 weeks, and then the price drops back down to normal. So I think there's a fair amount of fatigue in the industry around the perpetual GRIs in the ocean, and that does cause margin compression and for our salespeople and procurement people to be spending quite a bit of time managing that. The air tends to work more around the peak. So it's a slightly more seasonal and predicable thing. Obviously, the spot market fluctuates, and there are similar structural issues with the asset providers in air, as Eric mentioned. But that would be my best comparison, is that the GRIs that are coming in ocean, particularly in places like the APAC, Asia to Europe lanes are at an all-time frequency, and then they don't really stick. They stick and then they go away, and they stick and go away. So it's just quite a bit of work and pressures our margins.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

And then going back to the airfreight volumes, maybe I didn't write the numbers down right. But you talked about August, September, I believe, being up 10% to 15% year-over-year in volumes. And then October was up 10%, but that doesn't make sense if the overall quarter is only up 8.8%.

Edward G. Feitzinger

So August is 10%, September is 15%, October is 2%, so the total is 9%.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

So 2%? Okay.

Edward G. Feitzinger

Total is 9. Yes.

David G. Ross - Stifel, Nicolaus & Co., Inc., Research Division

Got it. That makes a lot more sense. And then last question, on contract logistics, you talked about where revenue was growing, but where is new business specifically coming from, I guess, both in geography and industry?

Edward G. Feitzinger

Sure. So we're seeing a very nice new business growth in our Americas contract logistics business. We had a very good first half in terms of sales. So we're very excited about that because that was part of our strategy and that's played out. We're seeing growth in Africa and our distribution businesses. That's a little dampened this quarter because of some of the issues from some of the strikes in the automotive sector that impacted our third quarter top and bottom line numbers there. And we're seeing growth, as you can see in the numbers, in our Asia Pacific business, which would be primarily on the contract logistics side.

Operator

And our next question is a follow-up question from the line of Jack Atkins with Stephens Inc.

Jack Atkins - Stephens Inc., Research Division

On the customs brokerage business, you saw some pretty substantial revenue growth there, but also some substantial net revenue margin compression. Could you maybe walk us through the puts and takes of what's going on in that segment, just so we can model that correctly?

Edward G. Feitzinger

Sure. There are 2 factors that are impacting that. So one is that we have an improvement in sales in our customs brokerage. We've invested in that product for the last several years, and that's paid off particularly in some emerging markets. The other piece is that, as we've gone into OneView, we are changing the treatment of inland transportation revenues. And that moves from, in the past, being put into either the air or ocean segment, to being placed in the brokerage segment. So an example would be if you have a transaction that's just brokerage that we're then handling the inland. In the past, where all that would have been a revenue that you would have seen a foot into, for example, air or ocean, depending on -- typically ocean, in that case. And now, that will show up in the brokerage line. So that's a little bit of an example of a change, which, again, increases our accuracy of really understanding where the product growth is occurring, but does create a little bit of an apples to oranges comparison when you look at numbers from 2 years ago. So you should expect to see an increase in customs brokerage as we go forward and get all the countries on OneView solely because of that change.

Jack Atkins - Stephens Inc., Research Division

Okay, okay. That's very helpful. And then just lastly here, going back to the airfreight peak. Could you maybe just talk about, from a big picture perspective, how the tech launches and just the broader airfreight peak season has shaped up relative to your expectations? Have we been seeing the sort of boost in airfreight demand relative to expectations? I think they were out there in the marketplace in July, August, September. And then, how would you expect the remainder of peak season to play out? You mentioned that your November volumes may not be reflective of the overall market. Sort of what are you seeing out there? Do you have -- that gives you confidence or a lack of confidence in the overall peak season?

Edward G. Feitzinger

So I say, first of all, I think that as is normal in December, the peaks -- any peak here is tapering off. It was certainly driven by a combination of product launches, inventory replenishment and capacity coming out of the market in some -- with some key carriers. So those effects effectively boosted the prices and the ability of the asset providers to drive the price up in the market, primarily in October and November, and that's begun to taper off, and it was specific to certain outbound markets in Asia. So I would say we're at the end of it. It was relatively short, and -- but also, somewhat acute as well.

Operator

[Operator Instructions] And our next question does come from the line of Kelly Dougherty with Macquarie.

Kelly A. Dougherty - Macquarie Research

I think this would be just a quick clarification question for Rick. You mentioned adjusted operating expenses, less purchase transportation increasing about 4%. So I just wanted to understand what the adjustments are there. Because I think you said that they do include transformation-related expenses. So what do you adjust out versus what you leave in, so we can kind of think about how we should do that going forward?

Richard G. Rodick

To what -- when we say adjusted, we're backing out severance and the tax rate, on more normalized tax rate. In the increased operating costs, we had the amortization increase of the new system, and then the duplicate of costs that we referred to, and then some currency adjustments or negative impact from currency.

Kelly A. Dougherty - Macquarie Research

Okay. So the duplicative costs will roll off as you get everything ramped up, and then just the amortization, the currency are the ones we should think about going forward?

Richard G. Rodick

Correct. So...

Kelly A. Dougherty - Macquarie Research

Okay. And then just a quick follow-up, if I may, on currency. The rand have obviously been a headwind for you guys for a while. Is there anything that you can do to actively hedge that or to kind of stop that from being as much of an issue? Or do you see anything that would change meaningfully in South Africa that would have you think that things are going to turn around, and maybe you don't need to? I'm not sure if that would be the case or not.

Richard G. Rodick

Well, what we try to do is anytime that we have a contract that's not paid, that we're able to pay in other currencies, we hedge those. So we lock in the rates. So we minimize the impact. And, really, there's nothing else that we do to try to hedge those results. The -- historically, the rand has gone up and down, and it's been low in the last couple of years. And we think when it rebounds, our results will benefit from that. But right now, there's nothing we do to try to hedge our results and take any risk there. It's just if we're paying any bills or have any contracts that are in other currencies, we try to lock those in immediately to take out the volatility.

Kelly A. Dougherty - Macquarie Research

Okay. So it's not like you kind of make any forecast about, here's where we think the rand is going to go over the next few quarters and maybe since we don't see any kind of meaningful changes, we might temporarily try to hedge ourselves? Or do you think maybe that the rand turns around and works in your favor any time soon?

Richard G. Rodick

It might. We can't really forecast that. But we don't do anything to try to hedge those earnings or anything like that.

Operator

And our next question does come -- is another follow-up from the line of David Campbell with Thompson, Davis & Company.

David P. Campbell - Thompson, Davis & Company

You seem to be a little bit, I'd say, more than a little concerned about gross margins, net yields in the airfreight business. Yet, the third quarter results show the same gross margin as a year ago and actually a sight better than the second fiscal quarter. So I'm trying to understand why not just take more business at that yield? What's wrong with that?

Edward G. Feitzinger

Well, I mean, if you look at the -- I guess we want to be very careful about our growth in terms of just going after new revenues that don't necessarily have the appropriate margins. And if you look at the underlying cost per shipment, if you look at the overall compression, we want to be managing that business quite carefully so that we can match our capacity and demand and go forward. We're not really interested in pursuing volume for volume's sake, and we're just being careful about looking at our portfolio and our clients, and making sure we're picking the right ones that will bring us long-term margin. And as Eric had mentioned before, we can bring value, too, in other ways than just a cost play.

Eric W. Kirchner

But, David, we are very aggressive out in the market looking for every opportunity we can. But the challenge comes in, some of the procurement behavior has just changed over the years. And you'll see things like customers putting out eBids. So you'll get the opportunity to bid for business. But if you don't have a good -- if you don't have a relationship or a good understanding about that customer's business, what you normally experience is a benchmarking exercise. And then, often, the pricing environment is used to go back to the incumbent and lower the rate. So the challenges, as Ed alluded back to, is for us to find the right kind of customer that we can get a fair margin on the transportation business, but then also sell and provide other services, like customs brokerage or distribution, or other things, beyond just the airfreight. So it's not for any lack of being aggressive and trying to take share appropriately. But the concern that we would have is if we continue to see this margin compression that doesn't result in enough net revenue, then it makes us much more elusive to get to the margin targets that we're focused on.

David P. Campbell - Thompson, Davis & Company

Despite the fact that you're getting out -- you may get more business as a result of taking lower yields in airfreight, you get more business in business brokerage and distribution or sea freight and you're also lowering your operating expenses. And so on a net-net basis, you're ahead...

Eric W. Kirchner

You're right. And that's where -- that's what we're focused on. Because where we can get those things, it makes sense for us. It's not just -- we try not to make a decision just solely off of the transportation margin. We try to look at those other things that you just pointed out because that helps the overall business. So you're exactly right.

Operator

And at this time, there are no -- there is no further time for any additional questions. I would like to turn the call back over to management for any closing comments.

Richard G. Rodick

Thank you, operator. I'd like to thank all of you for participating in our call today. On behalf of all of us here at UTi, thank you for your continued interest and your ongoing support.

Operator

Thank you. Ladies and gentlemen, that will conclude the UTi 2014 Third Quarter Conference Call. We do thank you for your participation on today's call. You may now disconnect your lines at this time.

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