C.H. Robinson Worldwide, Inc. (NASDAQ:CHRW)
Q4 2013 Earnings Conference Call
February 5, 2014 08:30 ET
Tim Gagnon - Director, Investor Relations
John Wiehoff - Chief Executive Officer
Chad Lindbloom - Chief Financial Officer
Good morning, ladies and gentlemen and welcome to the C.H. Robinson Fourth Quarter 2013 Conference Call. At this time, all participants are in a listen-only mode. Following today’s presentation, Tim Gagnon will facilitate a review of previously submitted questions. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, February 5, 2014.
I would now like to turn the conference over to Tim Gagnon, the Director of Investor Relations.
Thank you and good morning everybody. On our call today will be John Wiehoff, our Chief Executive Officer; and Chad Lindbloom, our Chief Financial Officer. John and Chad will provide some prepared comments on the highlights of our fourth quarter, and we will follow that with a response to pre-submitted questions that we have received after our earnings release yesterday afternoon.
Please note that there are presentation slides that accompany our call to facilitate the discussion. The slides can be accessed in the Investor Relations section of our website, which is located at chrobinson.com. John and Chad will be referring to these slides in their prepared comments.
I would like to remind you that comments made by John, Chad or others representing C.H. Robinson may contain forward-looking statements, which are subject to risks and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management’s expectations.
Before I turn it over to John, I would like to mention that similar to our first three quarters earnings releases, we have provided pro forma financial measures for net revenue and income from operations to provide meaningful insight and an alternative perspective of our results of operations. We believe that these pro forma financial measures reflect an additional way of analyzing aspects of our ongoing operations, that when viewed with our actual results, provides a more complete understanding of the factors and trends affecting our business. A reconciliation of actual results to pro forma numbers is provided in Appendix A and B at the end of the slide deck.
With that, I will turn it over to John to begin his prepared comments on Slide 3 with a review of our Q4 2013 results.
Alright, thanks Tim. Thanks for everybody listening into the call. I am going to start my prepared comments on Page 3 of the deck that show our GAAP reported earnings for the year and then we will have a lot of comments on this page, because as Tim said, while the 2013 results are reflective of our ongoing business, the 2012 numbers are not comparable because of the transactions that are reconciled in the appendix.
Looking at Page 3, I think a couple of data points that are relevant is just for the year 2013, our total revenues of $12.7 billion does reflect a 12% increase over the prior year. That increase is about half organic growth and half acquired revenue largely from the Phoenix International acquisition and obviously scale and size do matter in our business and it is important that we continue to grow that top line and have a stronger presence in the marketplace so that we can take advantage of our scale and size in the marketplace.
If you look at the EPS for the quarter of $0.62, again it’s not comparable to the prior year. In our earnings release and pro forma information, it shows $0.66 as the pro forma adjusted for the prior year. Obviously, we are not happy with the $0.62 or the $2.65 of EPS for the year. This 2013 marks the first time in 16 years as a public company, where we were not successful in growing our EPS over the previous year. In addition to the decline because of the gains and the transactions of the previous year, it also is down from the pro forma numbers on the following page that I will talk to more. So we understand it’s a disappointing finish to a challenging year and we are committed to changing and making sure that we improve that in the future.
Turning then to Page 4, this is a page that I will have most of my comments on. Again, it’s reflecting the 2012 numbers adjusted to exclude T-Chek for the entire period and to include Phoenix International’s history for the entire period even though we did not own the business for all of 2012. Page 4 has most of the key metrics that we look at in terms of evaluating our business and performance starting with the total revenues that I talked about before. I mentioned that about half of our top line growth or 6% of that $12.7 billion came from organic growth. So if we are looking at the pro forma information here, that’s the 6.2% increase in our total revenues. So you can see that was for the year in the fourth quarter that book slowed to 3.8% in revenue growth.
If you look at the net revenue, an increase of 1.3% for the year, but a decline of 2.1% for the fourth quarter, so both the revenue and the net revenue declining more in the fourth quarter or growing less than the year-to-date numbers. Similarly, when you look at the operating expenses, we have always talked and continue to believe that the appropriate way to look at that is separating personnel and non-personnel or SG&A expenses into the two different categories. You can see the year-to-date increase of 6% of total operating expense and the fourth quarter increase of 4% for operating expenses. So the expense growth in the fourth quarter, the growth rate did slow, but obviously not fast enough in relation to the net revenue change and how the business is performing. So income from operations for the quarter down 11.6% on a pro forma basis.
As I mentioned earlier, EPS was not shown on this slide, but that would show for the quarter $0.62 of EPS diluted compared to the previous year of $0.66, which is about a 6% decline. Chad will make some comments about share repurchases and the changes in the capital structure. So that part of the strategy is working in terms of the decline in earnings being less at the EPS level than it is at the income from operations line.
Couple of other metrics on this page that are important, we always talk about our operating income to net revenue relationship. So you can see for the year 39.9% dropping to 37.2% for the year-to-date. As a refresher, for those of you who have followed the story when we went public 16 years ago, that was at 28%. It got up to around 42% at the peak in 2008 and ‘09. And over the last four or five years as we have had a more challenging environment, it worked its way back down to 37.2% for the year. In that operating income to net relationship, there are some mix issues. Obviously, we have talked a lot about Global Forwarding and the fact that it is a global more overhead intensive business that changes some of the mix. You see some of the acquisition amortization up above that changes, the benchmarks or components of that operating income to net revenue and then the acknowledgement of reduced profitability over the last five years, all having an impact on that relationship.
It is important to look at the year-to-date stuff, because a lot of our costs are annual in terms of annual incentive contracts and a lot of different operating expenses that will get trued up on an annual basis. However, the current quarter showing pretty 38.7 down to 34.9 does reflect what I mentioned earlier that with a decline in net revenue and a increase in operating expenses that obviously puts downward pressure on that ratio and that happened more in the fourth quarter than it did on a year-to-date basis, but that operating income to net revenue is a key metric that we continue to look at and the deterioration of it is being driven by topics that we have talked about at length over the last four to five years primarily truckload margin compression. More than half of our revenue comes from truckload services and we will talk more about it, but that’s obviously the lead driver. In this quarter, there were some lost business in our sourcing service line that also had a pretty significant contribution to it.
Last comment I will make on this page is that when you look at operating expenses and we will talk in this call about how we intend to manage differently and approach the expenses differently. But if you look at 6% year-to-date operating expense increase and personnel expenses of 4.8% increase, elsewhere in the decade shows that we had about 7% headcount increase. And for a number of years now we have been talking about investing in our network and investing in our personnel to go after market share. And part of what I think is important to understand is that we do have a very high pay for performance culture at Robinson.
And everyone of us that’s making those decisions around the balance of hiring and market share goals and gains versus the profitability of the corporation, the pay for performance has driven a significant reduction and realized pay over the last five years. And again while we are adding people to the network the personnel costs are not growing at the same percentage as the level of heads that we are adding primarily because of a reduction in variable pay programs that impact all of us at Robinson in terms of the performance. So we do feel that that is the strength of the model. Its part of what aligns our decision making with our shareholders and it is something that we will talk more about as I talk through the remainder of the deck.
Turning then to Page 5 on the total transportation results, this schedule really highlights some of the challenges that I have already referenced in terms of our margin contraction and our performance. If you look at the total net revenue growth of 1.7% for the quarter and 11% for the year, again the year was driven primarily around some of the acquired net revenues. I think it’s helpful to look at the longer term trends on the net revenue margins, so we this longer term graph that we have been referencing for the last several years. If you look on the year-to-date down lower right hand portion of that chart that shows the 2009 to 2013 total transportation net revenue margin percentages. You see it moving from 20.2% in 2009 to 15.3% in 2013.
Over the last four years we have talked at length on a lot of questions and comments, today I will get back to these same topics. But really if you look at the economic recession and the change that happened four and a half years ago, probably the dominant topics that have been affecting all of the transportation results and margins, but especially the North American truckload are in addition to the cyclical fluctuations that we always have had and will have that showed some of the peak in 2009. I would say the other categories of environmental changes are just around changing supply chains and how shippers are focusing on efficiency rather growth.
On the truckload side you have the cost changes, the regulatory changes, CSA, hours of service all those things that have changed the landscape of the cost of capacity and the truckload component of the cost equation in our business. A lot of changes around technology both shipper investments as well as 3PL and competitor investments in technology and the transparency and the changes around pricing that it’s leading in all of the different services and then just the escalation of competition and the changes in the competitive landscape especially in the truck brokerage world and the third party landscape. So you see all those factors over the last five years, we have been trying to ourselves as well as responding to questions to try to understand the components of that and what is driving it, but obviously over the last five years since the recession the combination of all of that has put downward pressure on our margins that has impacted our results.
When you look at the transportation business as a whole for 2013 with somewhere around $11 billion of total transportation services and then you look down below and factor in conservatively 4% to 5% margin compression, that margin table down below also has some favorable mix shift to higher margin businesses, primarily Global Forwarding and management services when you look at the longer term transportation. So if you look at a business of around $11 billion of transportation with again considerably 4% to 5% margin compression over that period of time, while somewhere around $400 million to $500 million of margin opportunity or margin comparison on that $11 billion of freight. Over that five-year period of time, we have been able to modestly grow our operating income to somewhere around $100 million or I think low-single digit percent. So it is I think important to understand that if you look at the scale of the business and how we have gone after market share that while we have been under margin pressure and we have been under a lot of competitive stress that we have done a lot with our variable pay and we have done a lot in the scope of our network and productivity to try to manage our results and get through this in a more favorable way.
Moving then to Page 6, some comments then on each of the different transportation services, obviously starting with truckload, it is more than half of the net revenue of the business. We did see some very meaningful tightening of our North American truckload market in December and January. I have shared in the past the types of metrics that we look at to gauge that market dynamics around demand and supply. One of the primary ones being the route guide performance and route guide deterioration to look at if freight is moving as planned or if there is a lot of change or disruption. For us, I know in the industry there has been a lot of discussion about improved environment and changes, what we did in December and January is some pretty meaningful movement in the deterioration of those route guides and some tightening in a lot of different areas of capacity that has continued to lead through some disruption and price increases.
So in the past, several quarters when we have talked about customer pricing increasing in a 2% to 3% range and carrier costs increasing more than that, which you see for the fourth quarter of 2013 is that our customer pricing on average for the quarter up 3.5% for a mile, but the carrier costs increasing at around 5%. So both of those numbers moved up fairly aggressively during the quarter, moved up even more aggressively in the December and January. We will come back to that topic more in 2014 and some of the Q&A, but one of the things that a lot of the themes around the questioning is how we are we adapting to pricing, how are we adapting to the changing market. We are moving – pricing moved in the fourth quarter, pricing is moving in January, it really is more a function of the fact that as we talked about the last four years in this balanced environment, we have moved to a much more committed relationship with the vast majority of our customers to take market share and to grow in a balanced environment which was required during that period of time.
We have talked about the fact that when the market turns and depending upon how quickly and aggressively it turns it can take time to reprice business and to go after transactional opportunities that result as the byproduct of that and to a large degree which you are seeing in December and January is that period of time where things can get worse before they get better from a pricing and margin standpoint. And we have seen some pretty significant change in the North American truckload market conditions over the last 60 days.
Again, I will come back to some more comments around pricing in our truckload services, but one of the things that I think is relevant when you look at our 5.6% decline for the quarter. I know we have asked ourselves around that how long does it take to reposition the pricing, how long does it take to get after some of that transactional opportunity. And one of those things that we believe is unique or different this time versus other inflection points that are similar to this that we have had in the market is that for all the reasons that we talked about the last four years around the capacity shortage and some of the truckload challenges of driver shortage and the absence of new equipment coming into the marketplace. When you add on to that some of the weather challenges in the December and January period that we do believe that the contribution of tightness from the reduction in supply was probably more unique this time around then just simple growth in the freight side of it. Well, there is clearly some demand increase as well too and those are all the factors that we have to manage through. We do think that the dynamics around what’s causing the tightness and what’s the most appropriate way to manage through the transition in the marketplace does have some unique elements to it this time around.
Moving then to Page 7 on our LTL results, 3.2% net revenue increase for the quarter. Both costs and price moving up as we have said multiple times in the past because we use a variety of tariffs and different pricing things it’s hard to quantify apples-to-apples exactly around what types of price increases are there, but there is no question that pricing is moving up both in the quarter and year-to-date with some more modest net revenue margin compression. So a 4% volume increase translating into a 3.2% net revenue increase.
And as we commented down below, while all of our transportation services and the 3PL market is more competitive than it was several years ago in the LTL arena, it does feel as though it’s maybe even more competitive simply because of the fact that the capacity side is a more constant in the marketplace. In terms of access to it and things like technology are more important around the automation of the process. So it allows for more aggressive market share goals by us and competition to go after greater volumes of freight.
On Page 8, in our intermodal results, what you see for the quarter a 9.4% net revenue increase, less volume, but improved pricing and net revenue margin. We have talked over the last several years about our intermodal business and how it consists of more transactional and truckload conversion opportunities that we feel we are very capable of and do a good job of bringing our customers intermodal solutions where they pertain in the marketplace. It has been our challenge and continues to be to build our capabilities on the higher volume more dense intermodal opportunities. Those are generally served more effectively with dedicated container and dedicated rate solutions that contribute to efficiencies based on the volume. So while we have made some minor investments there, we do need to continue to work on our operating structure and the capital commitments that it takes to serve the larger, more dedicated intermodal opportunities and grow that portion of our business in a more sustainable way. So while we are happy with the 9% net revenue increase for the quarter, it really is more reflective of just ongoing re-pricing and shift of mix in the business rather than a trend that will sustain itself in the next couple of quarters.
Moving to Page 9, then I am talking about Global Forwarding erosion and customs business Page 9 reflects the GAAP numbers again, so what these numbers reflect around those net revenue increases of 37% for ocean and 12.8% for air, 36.7% for customs reflects a partial quarter of Phoenix activity rolling into our Global Forwarding results. Probably the most important point by our view on Page 9 is the bottom message that for the year and again in the quarter based on TEU ship rankings we were the number one NVOCC in volume from China. Eastbound that was one of the strategic goals as we have talked about with both Phoenix and C.H. Robinson having focused largely in that corridor in the past really retain and grow that volume in a way that creates a competitive advantage, so that’s probably one of the most positive strategic achievements.
Moving on to Page 10, where the information that we presented in the past is in a more comparable format for our Phoenix integration update, I am not going to go into the same level of detail as I have into the past around the two year integration plan. But from a year one standpoint, the second bullet on this slide highlights some of the key things that we really did focus on in year one around office combinations, agent rationalization, gateway and operational processes and feel pretty good about how all that went and where we are in year – at the end of year one of our plan.
If you look at on a pro forma basis on the deck up above 8.5% net revenue increase for the quarter was our best increase of the year in terms of pro forma activity. You see 4.6% for the year on this pro forma basis. So what we have left is the more aggressive ramp up of cross selling and integrating some of the account management and growth opportunities as well as technology and driving further operating efficiencies in the Global Forwarding business during the year two and beyond with that.
Slide 11, the other logistics services reflects the continued efforts to diversify our business and focus on other than transportation solutions you see a 14% net revenue growth in the quarter. We continue to feel positive about the pipeline and the growth opportunities in here. And again I would say pretty every much every quarter that, while this is only 3.5% of the net revenue of the corporation of $67.9 million for the year 2013 that the customers that represent this service line also include significant transportation customers. So that when we think about it from a market share gain and account management standpoint, our capabilities to integrate with our customers in a more comprehensive way and drive value and solutions in the supply chain that go beyond transportation are an important part of the future and how we are trying to position ourselves from a strategic standpoint.
Moving then to my last slide on the service lines before I turn it over to Chad on Page 12, our sourcing results, what you see for the quarter is a 15% net revenue decline in our sourcing business and a 7% decline for the year. We talked about the lost business in our sourcing division in our last call, as well as our Investor Day comments by quick – just quick refresher on a couple of data points in our sourcing business. Its where buying and selling, distributing fresh foods and vegetables produce, predominantly the large retailers and food service businesses. The sourcing business at Robinson is more concentrated. There are about 20 accounts that make up well over half of the business. And it’s predominantly the large retailers that have consolidated very similar to how the produce industry has consolidated.
The way we earn business in that division is generally by innovating and helping those buyers and sellers of fresh foods and vegetables to bring new ideas to the market. There might be products from a part of the world to create year around supply, it might be packaging innovation. It might be a promotional opportunity to expose new categories. Often times when we earn those businesses we get to serve them for an extended period of time around may be even managing the item or the category and replenishing and filling those orders for a long period of time.
One of the risks that we have is that when those buyers make strategic changes around how they are stocking their produce department or the types of items they are carrying or where they are sourcing from their vendors, we can lose orders. And in fact that’s what happened with our largest sourcing customer in the fourth quarter is that we continued to see the elimination of some items that have been ordered from us for a number of years that resulted in last business and a net revenue decline for the sourcing business.
The net revenue loss from the lost business was the majority of the decline in the net revenues for the quarter. But there also were some weather issues that impacted the broader sourcing business and helped to contribute to some of the net revenue margin decline moving from 8% to 6.8% in the quarter. The weather things, obviously we believe will correct themselves and that we will able to improve some of those margin opportunities around the weather related items, but the lost business as it – we do expect that that will continue. We don’t know with certainty until orders show up or don’t show up. But at this point it looks pretty clear that lost business will continue to impact our sourcing results for the majority of 2014.
With that, I will turn it over to Chad for some comments on our financial section.
Okay, thank you, John. On slide – I am on Slide 13 now. You can see while our operating cash flow is down for the year on the GAAP perspective, the timing of the tax payment from the gain on sale of T-Chek had a significant impact. We had a positive impact of about $100 million in the last quarter of 2012 because the taxes for the gain are approved, but they were paid in the first quarter of 2013. So you can see on the third row of that chart if you adjust for the timing of those tax accruals and tax payments, we actually have significant increase in our cash flow both for the fourth quarter and the year compared to 2012.
Our CapEx including our investments in capitalized software, which is both internally developed software as well as purchase software. The total of the capital – of those capital expenditures for the year were slightly lower than the predicted at $48 million. In 2014, we expect to spend about $40 million to $45 million in capital expenditures including that software. Our total debt balance at the end of the quarter was $875 million, that was made up of the $500 million long-term debt that we entered into in the third quarter and the – we have $375 million outstanding on our line – on the revolving line of credit which has a maximum of $500 million.
Moving on to Slide 14, we have talked about our capital structure a lot lately, but I kind of recap what our current goals and plans are. We currently have a goal of distributing at least 90% of our annual net income through ongoing share repurchases and dividends. This goal could change based on investment opportunities or other capital needs. We expect maintaining this program will hold our debt balance somewhere in the range of 1 to 1.5 times EBITDA. As we have mentioned at our Investor Day, we would consider going as high as 2.5 times EBITDA for the right acquisition opportunity.
Looking at 2013 in specific, we used $310 million of cash in ongoing share repurchases and paid $220 million in dividends. These distributions totaled over a 120% of our net income. The higher than normal distribution was driven in part by our strong operating cash flows. In addition to that more normal ongoing activity, we entered into a $500 million ASR program with two banks. The source of the funds was the long-term debt that I mentioned earlier. One of the two banks terminated their ASR plan on December 11, which resulted in a delivery of an additional 1.2 million shares. The other bank’s ASR is still open and we will close between now and April 16, 2014. The precise closing date of their ASR is completely at their discretion. If they have terminated their plan on January 31, they would have delivered us an additional 1.2 million shares. Our ending diluted share count was approximately 149.7 million shares and this will go down when the second bank closes their ASR.
With that, I will turn it back to John for one more slide of prepared comments talking about 2014 and forward.
So my comments are on Page 15, the 2014 thoughts and initiatives. On the top of that chart is a recap of our Investor Day, long-term growth goal, for those of you who didn’t participate in that last year given the changes over the last three or four years and the changes in the environment through our long range planning process, we took a look at how we thought we could perform over a longer period of time given the environment over the last four years. What we did at that point is lower our long-term growth targets to something that we thought was more realistic of the types of market share gains and operating leverage that we could gain in a more competitive environment like this. We stated then and would reiterate now that, that plan assumes that margins will fluctuate, but it also assumes margin stabilization from the previous periods. When we communicated this plan last fall, we did not anticipate the more aggressive margin compression that we have experienced towards the tail end of ‘13 nor did we contemplate the lost business in the sourcing division. So, we still believe in that long-term growth target. We still believe that, that is our benchmark and a reasonable goal for the longer term next 5 to 10 years of C.H. Robinson performance, but results will fluctuate and margins will fluctuate and during periods of time where we have contraction, it will be difficult or we won’t be able to achieve those goals.
So well, we still believe in that long-term growth target. The next bullet point talks about the fact that similar to the fourth quarter of 2013 our net revenues have decreased in January of 2014. We do not have our books closed yet and we do not have the precise numbers for January of 2014, but the themes that we have talked about on this call unfortunately some of them are carrying into the year in 2014, that market tightening on the truckload side that we discussed has continued to-date in the first quarter of 2014. Those price increases of 3.5 and 5 that I referenced in the fourth quarter those have continued to escalate into January. Again, we have to scrub these for the quarter and we have to look at fuel numbers, but probably something more in the customer pricing up 5 and carrier cost up 7. So, again, we have to get out ahead of this and at some point make sure that we stabilize or expand the margins that we are doing on our pricing. But as the market is moving, we are moving customer prices and we are reacting to the marketplace, but it has been a challenge to get out ahead of it and to manage through margin stability or improvement in the North America truckload piece.
In addition as I mentioned earlier, we have some of the lost business trends that are going to carry into ‘14 for a while. And while we will talk more specifically in some of the Q&A about the expense management, obviously the run-rate coming into the year is something that we have to manage down over time and is going to take a while to get in line.
Pricing will be a high priority in 2014. As I mentioned before that in these market conditions, we do have a long history of adapting to what’s going on in the market and it’s just a period of time where we feel like we can add a lot of values to our customers in the marketplace to adapt to these market conditions. We have to serve them and honor the commitments that we have made over the last year as these contract cycle through and we will get into some more specifics around how the pricing works and how we expect that to play out, but at the same time, it’s very clear that in these changing market conditions that while pricing is always important that it will be a very critical focus for us in 2014.
The last bullet point of our growth continuing to be a top priority through leveraging our current resources, we do intend to manage differently in 2014. The firm leveraging our current resources does imply that we intend to have a different attitude about our hiring and our addition of resources to the network during 2014. We do believe that in the environment that we are in now and if you look at the various pieces of our business that what we believe in the investments that we have made over the last couple of years that during this type of market condition, we should be able to leverage some of those investments to continue to go after market share gains with current accounts and current resources that we have in place.
There is also a number of other things that we have been working on for the last couple of years around automation and operational productivity, regionalizing our North American business to share resources more efficiently across North America, and an enterprise sales approach around segmentation and going to the market more effectively that initiatives like that that we have been working on for a number of years to position ourselves for more competitiveness into the future. It’s just become clear that in the balance of productivity and managing the cost structure versus growing the business and going after market share gains that we have to tilt that balance more aggressively and manage the cost structure of the company down more aggressively sooner than perhaps we have been thinking over the last couple of years. So while we will be working hard to improve price and to manage the margin and the customer relationships just like we always have, it’s also time to prove some of the return on the investments that we have been making and go after market share gains with more aggressive expense management in our network.
So I will finish the prepared comments by restating what I said in the beginning. We are not happy with the fact that our earnings per share decreased for the quarter. The formula for managing this business is straightforward and is similar to what it’s been in the past. You have to manage those account relationships and go after growth and business in the marketplace, manage pricing and margin and control the cost structure and productivity and balance with that to grow both your market share and your earnings. So there is a bunch of this that we have to own and we do and we are on it, we understand it, we know how to manage it and we will improve it. There is a bunch of this that is just reflective of a very challenging market dynamic and increased competition and changes in supply chains that may not go away in the near future, but we have to continue to adapt to the company and adjust to that.
Those are the prepared comments that we have. With that, I will turn it over to Tim who has organized the questions that were submitted. So we can go through the Q&A portion of the call.
Thank you, John. Let me first start by thanking all of the analysts and investors for taking the time to submit questions. We received a lot of great questions and we will do our best to get through as many as we can in the time allotted. John and Chad will kind of share in the duties to respond to the questions and I will facilitate by first asking the question and then either John or Chad will respond. So we will get right into that now.
And the first question is for John and it relates to headcount. So why does headcount still need to go up at such a rapid pace relative to net revenue? How long does that continue, our employees beginning to get somewhat disgruntled with the pay for performance incentive comp structure due to recent performance? And has that lead to higher turnover? So, a lot there.
Okay. So, some of this was covered in the prepared comments with the fact that we have been doing over the last couple of years what we have done for the majority of time, which is to look at our headcounts, investments largely in correlation to volume while we have always had productivity initiatives and we have as many today as we ever have. Our historic benchmark looked at headcount and staffing additions highly correlated to volume. As I stated in the comments, we do have a different approach to that during 2014. It’s not without risk. We have to drive market share gains and productivity in the network and obviously we want to be smart about the balance of that. So the tradeoffs between market share and investing in the network and adding resources to go after it versus margin and productivity is something that we struggle with everyday, but we are taking a different approach going into 2014.
To the question of employees with variable comp and incentive pay and is that causing turnover or morale issues, I don’t think our industry is unique in the standpoint that expecting more with less has put some strain on our workforce. And as I mentioned earlier the variable pay and pay for performance culture that we have does create tension in our network around the fact that people are working as hard as they ever have and in many cases making less money for it. I think that’s just a reflection of the times. Statistically, I don’t, our turnover has not accelerated, although anybody who is involved in any service business you know that it’s more about which turnover you are having and are you keeping the right people those who are still on the bus motivated with the right morale. And it’s a challenge that we have to manage just like every other business that is going through margin compression and productivity expectations. But this company has a very strong culture of pay for performance. We all understand it. We are all part of it, and its just one of the risks of the business that we will have to continue to manage.
Thanks John. Second question is for Chad. Does CHRW have any meaningful cost levers remaining to pull? Is it possible to drive further cost from the network or does further margin improvement now depend on volume increases and pricing?
As you know the bulk of our operating expenses are personnel. John, both in his prepared remarks as well as answering the last question covered a lot of the personnel expenses all focused on SG&A. We also believe we have some room to leverage our SG&A expenses in 2014. We have always aggressively managed our expenses and will continue to do so in the future. We have received some questions about Phoenix integration expenses doing away. From the time of the acquisition, we have said that people managing the integration are the leadership of the company, not external consultants or dedicated people. There are still significant ongoing integration work into 2014, both the systems as well as integrating the go to market strategy that John mentioned earlier.
We believe we have a strong team that will now begin to focus more on the integration of sales and the go to market strategy and growth as the other integration efforts reduce. Our total SG&A expenses for 2013 including amortization was about $327 million or about $82 million per quarter. When you look at the pro forma Q4 2012, you will see that that was $80 million for the fourth quarter. Many of the SG&A expenses are predictable like rent, communication cost, depreciation, amortization, many others are far less predictable like claims and bad debt expense. Because of this, our SG&A expenses will continue to fluctuate quarter-to-quarter.
In 2013, we had $74.3 million in the first quarter, $84.7 million in the fourth quarter. In Q1, we have low bad debt and claims expense. In Q4, we had relatively high bad debt and claims expense, so that made up – those two expense categories made up of our half the variance between the high and the low for the quarter. We feel like the average of $82 million is a good benchmark for 2014, it will fluctuate from quarter-to-quarter like it always has, I am sure and obviously the first quarter will be a relatively difficult comparison.
Thanks, Chad. The next question is for John. Your guidance assumes that gross margin stabilized. Do you think that it is – that is possible in 2014? Do you expect to meet your long-term EPS guidance of 7% to 12% this year?
I addressed this somewhat earlier, but obviously with the net revenue decline in January and continued margin compression with the run rate of increased expenses, it’s not realistic to assume that margins are going to stabilize or that we will achieve those long-term targets in the first part of 2014. So the answer would be no. We still do believe in that long-term target. And as I mentioned earlier through re-pricing efforts that can take a couple of quarters and better expense management throughout the year, we do believe that our earnings growth opportunity is much better in the second half of 2014 than it is in the first quarter.
Okay, thanks John. The next question again for John, how did weather impact your business in the fourth quarter, what impact as that had quarter-to-date?
I mentioned in the sourcing area that a number of the crops that we buy and sell and distribute were impacted by weather throughout 2013. Some of those volumes were impacted in the fourth quarter as related to weather freezes and different things that happened. So there was definitely an impact in the sourcing business. In the transportation business, there were days in December and January, where you could correlate to really cold weather and the absence or decline of transportation volumes. In the past, we have always believed that most weather activities that volume would come back after a period of time, I don’t know in some of the January whether that was true or not, it does feel like some of the worst weather days in the month of January did diminish volumes pretty significantly, where there wasn’t a corresponding rebound to it. So that’s another thing that we will study more over time, but it does feel like weather was a contributor to some of our challenges over the last couple of months.
Thanks, John. The next question is for Chad, what are your growth expectations for Phoenix, which to us means Global Forwarding in 2014? Are there additional opportunities to benefit from the company’s increasing buying scale this year that did not benefit results in 2013?
Right. We have talked about the combined marketing and the increased focus on cross-selling and going to market with Phoenix in 2014. We believe that we will continue to add market share. So obviously a lot being a major player in the Trans-Pacific lane, a lot of how well we do and how quickly we grow will be dependent on how fast the market grows and we will – we also feel comfortable that we will continue to add market share. As far as leveraging the buy scale, yes, we think we still have some room to grow. The new ocean contracts went into effect in May of 2013. So for the first four months, we are operating under the old contracts of both Phoenix and C.H. Robinson. We think that these new contracts will continue to add the efficiency and we also feel like the more we get the two companies integrated from an operational perspective, we will find even greater opportunities to consolidate volume, to increase the profitability of our LCL business, which will create greater density and also continue to leverage the progress that we have made in our air gateways.
Okay, thanks Chad. The next question again for Chad, can you discuss how CHRW did season with customers’ works namely when does it begin and end and is there a bellwether customer that sets market expectations for pricing?
Our transportation business is very fragmented or very diverse with the large number of customers. No transportation customer is greater than 3% of our business or greater than 2% actually. So there is no single bellwether customer that really signifies what we think rates are going to do. When you look at, I have read about the industry and when we look at our own contracts, 70% of contracts happened in the first half of the year or even in the first four or five months of the year. Obviously, shippers choose to bid when they feel it’s – when it’s advantageous. Sometimes shippers, even if contract expires, will continue to try to tender us rates under those old contracts. That is the point of view of the shippers. Robinson and almost all of our truckload contracts as well as the industry as a whole have the ability to raise prices during a contract. Obviously, every time you do that, you risk losing freight or creating a competitive situation, which could lead to lost freight. As John mentioned earlier, we are going to continue to focus and focus even harder on our pricing with our existing customers and we may lose some business through that, but we understand the need to address some of our lower margin business on a case-by-case basis with customers throughout 2014.
Thanks, Chad. So the next question is for John. North America truckload volume growth meaningfully decelerated in Q4 ‘14 or Q4 ‘13 to up to 6% versus 9% in Q3 despite a strong spot market, we think – we typically think of market volatility as a favorable environment for a broker to operate in as they generally benefit from additional spot market opportunities as large carrier capacity get soaked up. Were there factors that constrain CHRW’s ability to leverage the strong spot market last quarter to grow shipments? Do you think more of the spot market traffic is going to the brokerage arms of asset-based carriers?
So there is a lot of components to that question and it ties in briefly to what I talked about earlier that going into this year and currently we do have a very high volume of committed customer relationships. So when the market begins to tighten like this, it puts strain on those margins and on those commitments to serve as the customer commitments that we have out there. The transactional volume increases require a shipper that’s willing to pay more. They require available capacity to actually meet that transactional opportunity. And again, in our world, the boundaries between committed and contractual and transactional vary more than they would for an asset carrier, where it’s clear whose equipments the freight is moving on. So we do see an increase in transactional opportunities and spot bids and trades like that, that we are going after, but we are not as successful in adding significant volumes of transactional freight as we have been in periods of the past when the market begins to tighten. Whether the shippers are actually choosing to ship at a higher rate, at what degree they are doing that, we know some of it, whether we are winning as much share around that in the past or not, whether competition is the bigger factor, it’s hard to tell. If we are missing out on that freight, we don’t necessarily get informed, where it’s going whether it’s an asset-based competitor or another broker or where that freight might be going. So that’s something that we are definitely monitoring. And as our market conditions continue to change, it is a clear point of emphasis to make sure that we are pursuing transactional opportunities in addition to our committed freight.
Thanks John. And the next question again for John, in your prepared remarks, you had indicated that truckload rates to customers increased 3.5% year-over-year while costs were up 5% year-over-year, how did these two measures trend in January? What percentage of CHRW book of business is currently operating under contractual agreements? When do these contracts predominantly end?
As I mentioned earlier that in January, the sort of preliminary estimates were more around pricing up – customer pricing up 5%, cost up 7%. And remember in our business, since we are working with predominantly meeting with small carriers who like a very fluid pricing arrangement that the vast majority of our truckload capacity is sourced on a fluid or spot market type basis, where the percentage of the freight that works with the customers is much more committed. Again, the definitions vary in each account, the definition of commitment and how long that last varies by each account. Most all of the contracts have 30-day notification periods, where as Chad mentioned earlier, we can propose different pricing, but then it all comes down to the load acceptance and the volumes on how each shipper and carrier in the marketplace are balancing the changing market conditions. So as I mentioned earlier, we revisit pricing daily. It is an hourly topic around here, around monitoring where we have margin issues, where we have losses and the pricing adjustment that it takes to correct those and it is thousands of unique relationships and account managers to figure out what is the right technique and timing in terms of adjusting those margins.
Okay, thanks John. And the next one again for John, we saw some robust trucking activity in late November and for some of December and if the market tightness seems to be continuing in January. Isn’t this the type of market volatility during which you have historically enjoyed significant share gains? Do you feel that will be the case in Q1? How long does it typically take for your net revenue margin to stabilize after an inflection in truck demand?
When we look back over the last 10 or 20 years, assuming history is a relevant guide for how we will react and how we will be able to adapt these things. On average, it can take two to three quarters for pricing changes to go through. Now, it’s dependent upon the time of year, the severity of the tightening and the price increases. I don’t know if December and January is indicative of what 2014 will be like in its entirety or if things will escalate in terms of tightness, but it can take a quarter to at least to get through the more committed business and re-price some of that. And again how successful that is depends upon how well we anticipate the future market conditions. We have commented a lot over the last four years that with the increased pressure on a lot of our customers around their supply chain in the competitive factors, price increases are challenging to get through in today’s marketplace. That will continue to change as market conditions change, but if you look at the environment over the last four years, it does make for where, this is hopefully an inflection point and hopefully an opportunity to add more value to our customers, but it does take time to work through and probably two to three quarters would be the right guide from a historical standpoint.
Thanks, John. The next question is for Chad and a sourcing question. Do you expect your sourcing business to grow in 2014 at the 4% to 8% long-term rate you are expecting? Is there any other color you can give on the large customer you have lost in terms of dollars or impacts of overall net and margins as well as EPS?
Okay, I will start with the question about the overall impact of the large customer. It is our – they were our largest customer in sourcing and will likely be either customer number one or two after this. So I think it’s very important to understand that we did not lose the customer as John mentioned there are just certain commodities or that they are not going to order – that they don’t plan on ordering from us going forward. As far as quantifying that, it’s based on what we know today, it’s somewhere around 10% of the total sourcing net revenues. As John mentioned sourcing has a much more concentrated customer base for us and we did lose a significant portion of the customer, but expect that to be at least 10% of our net revenues. As far as well we grow at our long-term rate in 2014 that would be extremely difficult to achieve. Our sourcing division does have plans to return to positive growth even with this 10% headwind, but that is an admittedly aggressive plan. As far as operating margins and EPS, our sourcing division has operating margins about equal to the consolidated numbers. So really the answer to that question is how successful will they be at replacing the net revenues.
Thanks Chad. The next question is for John and an intermodal question, are you interested in intermodal acquisitions, does the XPO, Pacer deal change, how you think about expansion in the intermodal space, if you aren’t looking for intermodal M&A, are you thinking about adding to your own container count. What else can you do to increase your presence in the intermodal segment of the market?
I started to discuss this earlier, I am looking at our results and we feel very positive about our knowledge of intermodal market, the relationship between truckload and intermodal and where it makes sense to ship by which mode of transportation and our ability to execute on an intermodal shipment. The challenge that we have or the growth opportunity that we have is in the more dense freight, the larger volume commitments where asset commitments do serve those relationships better. It just creates so much more operating efficiency that it’s very difficult to be price competitive if you don’t have that. So the answer to the question is yes we are interested in both, we are interested in looking at continuing to grow our organic capabilities with either more equipment commitments or dedicated drayage type solutions that will help solve that business or if the right acquisition opportunity comes along that we think will create value and be able to be well integrated into our culture that we would pursue that as well. So we are very interested and committed to growth in the intermodal space and are looking at both whatever type of investments that we could make to move us forward in that.
Thanks John. Next question for Chad, CHRW recently lowered its long-term growth target, is the company planning on revisiting its long-term incentive compensation to reflect CHRW’s new targets to try to help employee morale retention?
We are constantly analyzing our compensation programs, balancing the variable cost model with the maintaining our employee base. So yes we spent a lot of time on this. When you look at the equity grants that were made to the leadership, so the top 350 or so people in the company basically branch managers although we have two executives and corporate directors, we did change the vesting formula for our equity. So instead of it being the average of operating income plus – the average of operating income and EPS plus 5%, we went to EPS plus 10%. Again this is just for the new awards. The vesting formula for the awards that were granted previously to December of 2013 stays at their original growth plus 5% formula. Last year so the – beginning last year so the awards done in 2012, which is the vast majority of the people, but a small amount of the total, relatively small amount of the total amount of the equity awards, we went to time-based with them as we have previously announced. So those more individual contributor and key up-and-coming leaders in the network, their equity awards are time-based. So we did adjust equity programs. We have not adjusted any of the other programs at this point.
Thanks, Chad. Unfortunately, we are out of time. I apologize that we couldn’t get to all the questions today. We appreciate you and thank you for taking a part in the call today. The call will be available for replay in the Investor Relations section of the C.H. Robinson website at www.chrobinson.com. It will also be available by dialing (800) 406-7325 and entering the passcode 4660962#. The replay will be available at approximately 7 PM Eastern Time today. If you have additional questions, please feel free to call me at (952) 683-5007 or e-mail as well. Thank you again. Have a good day.
Thank you. This concludes the C.H. Robinson’s fourth quarter 2013 conference call. Thank you for participation. You may now disconnect.
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