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HUB GROUP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The information contained in this quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "expects," "hopes," "believes," "intends," "estimates," "anticipates," and variations of these words and similar expressions are intended to identify these forward-looking statements. Forward-looking statements are inherently uncertain and subject to risks. Such statements should be viewed with caution. Actual results or experience could differ materially from the forward-looking statements as a result of many factors. We assume no liability to update any such forward-looking statements contained in this quarterly report. Factors that could cause our actual results to differ materially include: • the degree and rate of market growth in the domestic intermodal, truck brokerage and logistics markets served by us; • deterioration in our relationships with existing railroads or adverse changes to the railroads' operating rules; • changes in rail service conditions or adverse weather conditions; • further consolidation of railroads; • the impact of competitive pressures in the marketplace, including entry of new competitors, direct marketing efforts by the railroads or marketing efforts of asset-based carriers; • changes in rail, drayage and trucking company capacity; • railroads moving away from ownership of intermodal assets; • equipment shortages or equipment surplus; • changes in the cost of services from rail, drayage, truck or other vendors; • increases in costs for independent contractors due to regulatory, judicial and legal changes; • labor unrest in the rail, port, drayage or trucking company communities; • general economic and business conditions; • inability to successfully protect our data against cyber attacks; • significant deterioration in our customers' financial condition, particularly in the retail, consumer products and durable goods sectors; • fuel shortages or fluctuations in fuel prices; • increases in interest rates; • changes in homeland security or terrorist activity; • difficulties in maintaining or enhancing our information technology systems; • changes to or new governmental regulations or duties on imported equipment; • significant increases to health insurance costs due to the Affordable Care Act; • loss of several of our largest customers and Mode agents; • inability to recruit and retain key personnel and Mode sales agents and IBOs; • inability to recruit and maintain company drivers and owner-operators; • changes in insurance costs and claims expense; • changes to current laws which will aid union organizing efforts or change the classification of owner-operators; and • inability to identify, close and successfully integrate any future business combinations. 13 -------------------------------------------------------------------------------- Table of Contents EXECUTIVE SUMMARY Hub Group, Inc. ("we", "us" or "our") reports two distinct business segments, Hub and Mode. The Mode segment includes only the business we acquired on April 1, 2011. The Hub segment includes all business other than Mode. Hub Group (as opposed to just Hub), refers to the consolidated results for the whole company, including both the Mode and Hub segments. For the segment financial results, refer to Note 2 of the consolidated financial statements. We are the largest intermodal marketing company ("IMC") in the United States and a full service transportation provider offering intermodal, truck brokerage and logistics services. We operate through a nationwide network of operating centers and independent business owners. As an IMC, we arrange for the movement of our customers' freight in containers and trailers over long distances. We contract with railroads to provide transportation for the long-haul portion of the shipment and with local trucking companies, known as "drayage companies," for local pickup and delivery. As part of the intermodal services, we negotiate rail and drayage rates, electronically track shipments in transit, consolidate billing and handle claims for freight loss or damage on behalf of our customers. As of September 30, 2014, approximately 71% of Hub's drayage needs were met by our subsidiary, Hub Group Trucking, Inc., which assists us in providing reliable, cost effective intermodal services to our customers. Hub Group Trucking has terminals in Atlanta, Birmingham, Charlotte, Chattanooga, Chicago, Cleveland, Columbus (OH), Dallas, Hammond (IN), Harrisburg, Huntsville, Indianapolis, Jacksonville, Kalamazoo, Kansas City, Milwaukee, Memphis, Nashville, Newark, Los Angeles, Perry (FL), Philadelphia, Portland (OR), Salt Lake City, Savannah, Seattle, St. Louis, Stockton, and Titusville (FL). As of September 30, 2014, Hub Group Trucking leased or owned 1,072 tractors, leased or owned 448 trailers, employed 1,047 drivers and contracted with 1,821 owner-operators. We also arrange for the transportation of freight by truck, providing customers with another option for their transportation needs. We match the customers' needs with carriers' capacity to provide the most effective service and price combinations. As part of our truck brokerage services, we negotiate rates, track shipments in transit and handle claims for freight loss or damage on behalf of our customers. Our logistics service consists of complex transportation management services, including load consolidation, mode optimization and carrier management. These service offerings are designed to take advantage of the increasing trend for shippers to outsource all or a greater portion of their transportation needs. Hub has full time marketing representatives throughout North America who service local, regional and national accounts. We believe that fostering long-term customer relationships is critical to our success and allows us to better understand our customers' needs and specifically tailor our transportation services to them. Hub's yield management group works with pricing and operations to enhance Hub's customer margins. We are working on margin enhancement projects including matching up inbound and outbound loads, reducing empty miles, improving our recovery of accessorial costs, using Hub Group Trucking more, and eliminating or improving low contribution freight. Hub's top 50 customers represent approximately 63% of the Hub segment revenue for the nine months ended September 30, 2014. We use various performance indicators to manage our business. We closely monitor margin and gains and losses for our top 50 customers. We also evaluate on-time performance, cost per load and daily sales outstanding by customer account. Vendor cost changes and vendor service issues are also monitored closely. 14-------------------------------------------------------------------------------- Table of Contents Mode has approximately 240 agents, consisting of 101 sales/operating agents, known as Independent Business Owners ("IBOs"), who sell and operate the business throughout North America and 139 sales only agents. Mode also has a company managed operation and corporate offices in Dallas, a temperature protected services division, Temstar, located in Oak Brook, IL and corporate offices in Memphis. Mode's top 20 customers represent approximately 35% of the Mode segment revenue for the nine months ended September 30, 2014. We closely monitor revenue and margin for these customers. We believe Mode brings us highly complementary service offerings, more scale and a talented sales channel that allows us to better reach small and midsize customers. RESULTS OF OPERATIONS Three Months Ended September 30, 2014 Compared to the Three Months Ended September 30, 2013 The following table summarizes our revenue by segment and business line (in thousands) for the three months ended September 30: Three Months Three Months Ended September 30, 2014 Ended September 30, 2013 Inter- Hub Inter- Hub Segment Group Segment Group Hub Mode Elims Total Hub Mode Elims Total Intermodal $ 460,935 $ 123,438 $ (22,626 ) $ 561,747 $ 470,196 $ 102,105 $ (11,962 ) $ 560,339 Truck brokerage 84,208 87,420 (181 ) 171,447 84,417 81,708 (549 ) 165,576 Logistics 146,692 34,563 (1,063 ) 180,192 123,960 33,611 (505 ) 157,066 Total revenue $ 691,835 $ 245,421 $ (23,870 ) $ 913,386 $ 678,573 $ 217,424 $ (13,016 ) $ 882,981 Revenue Hub Group's revenue increased 3.4% to $913.4 million in 2014 from $883.0 million in 2013. The Hub segment revenue increased 2.0% to $691.8 million. Hub intermodal revenue decreased 2% to $460.9 million due to a 4% decline in volume and slightly lower fuel surcharges, partially offset by an increase in price and mix. Hub truck brokerage revenue decreased slightly to $84.2 million. Price, fuel and mix combined increased 12%, which was primarily due to a 10% increase in length of haul. Volume was down 12%. Hub logistics revenue increased 18% to $146.7 million due to growth with existing customers and customers we onboarded last year. Mode's revenue increased 12.9% to $245.4 million in 2014 from $217.4 million in 2013. Mode intermodal revenue increased 21% while Mode truck brokerage revenue increased 7% and Mode logistics revenue increased 3%. Mode's intermodal volume increased 16% while truck brokerage saw increases in price and mix to offset a 7% volume decline. Mode's logistics revenue increased 3% due to growth across multiple business lines. 15 -------------------------------------------------------------------------------- Table of Contents Gross Margin Hub Group's gross margin increased slightly to $93.2 million in 2014 from $93.1 million in 2013. The Hub segment gross margin decreased 4.7% to $64.1 million. The intermodal and truck brokerage margin declines more than offset the increase in logistics gross margin. Intermodal margin declined because of rail service issues and increased drayage costs. Rail service severely impacted our third quarter results. Slower train speeds and late trains hurt fleet utilization by 1.4 days which led to higher repositioning and accessorial costs as well as more empty miles. Service problems were compounded by chassis shortages and insufficient gate reservations on the West Coast. Higher drayage costs also negatively impacted our third quarter profitability as a result of our business model change in California from independent contractors to employee drivers. In total, the rail and drayage issues impacted intermodal gross margin by approximately $6 million in the third quarter. Truck brokerage gross margin is down because of lower value added services. Logistics gross margin is up due to growth with customers we onboarded last year and existing customers. Hub's gross margin as a percentage of sales decreased to 9.3% as compared to last year's 9.9%. This decrease is due to lower yields in intermodal and truck brokerage slightly offset by an increase in logistics yield as a result of more cost effective purchasing. Mode's gross margin increased 12.4% to $29.1 million in 2014 from $25.9 million in 2013 due to growth in intermodal and truck brokerage. Mode's gross margin as a percentage of revenue remained consistent at 11.9% in both 2014 and 2013. CONSOLIDATED OPERATING EXPENSES The following table includes certain items in the consolidated statements of income as a percentage of revenue: Three Months Ended September 30, 2014 2013 Revenue 100.0 % 100.0 % Transportation costs 89.8 89.5 Gross margin 10.2 10.5 Costs and expenses: Salaries and benefits 3.4 3.6 Agent fees and commissions 1.9 1.6 General and administrative 1.5 1.6 Depreciation and amortization 0.2 0.2 Driver settlements and related costs 1.1 - Impairment of software 1.3 - Total costs and expenses 9.4 7.0 Operating income 0.8 3.5 Salaries and Benefits Hub Group's salaries and benefits decreased to $30.9 million in 2014 from $31.9 million in 2013. As a percentage of revenue, Hub Group's salaries and benefits decreased to 3.4% in 2014 from 3.6% in 2013 due to increased revenue and lower costs. 16 -------------------------------------------------------------------------------- Table of Contents The Hub segment decrease of $0.8 million was due to decreases in employee bonuses of $2.0 million, due to our current estimate that no earnings per share based bonus will be earned in 2014, and commission expense of $0.3 million, partially offset by increases in salaries of $1.1 million, due to higher headcount and merit increases, and employee benefits of $0.4 million. Mode's salaries and benefits expense decreased to $3.4 million in 2014 from $3.6 million in 2013. The decrease was due primarily to decreases in both employee bonuses and salaries of $0.1 million each due to reduced headcount. Hub Group's headcount as of September 30, 2014 was 1,473, which excludes drivers, as driver costs are included in transportation costs. As of September 30, 2014, Mode had 124 employees. Agent Fees and Commissions Hub Group's agent fees and commissions expense increased to $16.6 million in 2014 from $14.6 million in 2013. These expenses as a percentage of revenue increased to 1.9% in 2014 from 1.6% in 2013. The Hub segment agent fees and commissions expense decreased by $0.4 million in 2014 due to a smaller Hub agent program. The Mode segment agent fees and commissions expense increase of $2.4 million was due to the increase in gross margin. General and Administrative Hub Group's general and administrative expense increased to $13.9 million in 2014 from $13.8 million in 2013. As a percentage of revenue, these expenses decreased to 1.5% in 2014 from 1.6% in 2013. The Hub segment increase of $0.1 million was due primarily to increases in repairs and maintenance expense, outside sales commissions and general insurance of $0.2 million each as well as travel and entertainment and other taxes, each for $0.1 million. These increases were partially offset by decreases in rent expense of $0.5 million, equipment lease expense of $0.1 million and outside consultant expense of $0.1 million. Mode's general and administrative expense remained consistent at $1.7 million in both 2014 and 2013. Depreciation and Amortization Hub Group's depreciation and amortization increased to $2.0 million in 2014 from $1.6 million in 2013. This expense as a percentage of revenue remained constant at 0.2% in both 2014 and 2013. The Hub segment's depreciation expense increased to $1.6 million in 2014 from $1.1 million in 2013. This increase was related primarily to depreciation for the new corporate headquarters and more depreciation related to computer software. Mode's depreciation expense decreased to $0.3 million in 2014 from $0.5 million in 2013. The decrease in expense was primarily related to less depreciation related to computer software. Driver Settlements and Related Costs In the third quarter of 2014, the Hub segment recorded a charge of $10.3 million. This charge includes $9.3 million in settlements for individual drivers and $1.0 million of related legal, communication and implementation costs. This expense as a percentage of revenue was 1.1% in 2014. See Note 8 of the notes to unaudited consolidated financial statements for more details. 17-------------------------------------------------------------------------------- Table of Contents Impairment of Software In the third quarter of 2014, the Hub segment recorded a charge of $11.9 million related to the write-off of software development costs as a result of our decision to terminate a long-term technology project. This expense as a percentage of revenue was 1.3% in 2014. See Note 9 of the notes to unaudited consolidated financial statements for more details. Other Income (Expense) Hub Group's interest expense increased slightly to $0.4 million in 2014 from $0.3 million in 2013 due to higher debt. Provision for Income Taxes The provision for income taxes decreased to $2.9 million in 2014 from $12.4 million in 2013. This decrease was primarily due to the decrease in pretax income. Our effective rate was 38.9% in 2014 and 39.9% in 2013. The 2014 rate was lower primarily due to the enactment of Pennsylvania income tax changes in July 2013 which increased our 2013 effective rate. Net Income Net income decreased to $4.5 million in 2014 from $18.6 million in 2013 due primarily to the driver settlements and related costs and the software impairment charge, partially offset by less income tax expense. Earnings Per Common Share Basic earnings per share were $0.12 in 2014 and $0.50 in 2013. Basic earnings per share decreased primarily due to the decrease in net income. Diluted earnings per share were $0.12 in 2014 and $0.50 in 2013. Diluted earnings per share decreased primarily due to the decrease in net income. 18-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 Compared to the Nine Months Ended September 30, 2013 The following table summarizes our revenue by segment and business line (in thousands) for the nine months ended September 30: Nine Months Nine Months Ended September 30, 2014 Ended September 30, 2013 Inter- Hub Inter- Hub Segment Group Segment Group Hub Mode Elims Total Hub Mode Elims Total Intermodal $ 1,352,130 $ 337,618 $ (54,865 ) $ 1,634,883 $ 1,350,262 $ 284,056 $ (34,280 ) $ 1,600,038 Truck brokerage 254,582 252,480 (717 ) 506,345 247,512 234,551 (1,110 ) 480,953 Logistics 420,581 95,767 (1,811 ) 514,537 318,375 90,195 (915 ) 407,655 Total revenue $ 2,027,293 $ 685,865 $ (57,393 ) $ 2,655,765 $ 1,916,149 $ 608,802 $ (36,305 ) $ 2,488,646 Revenue Hub Group's revenue increased 6.7% to $2.7 billion in 2014 from $2.5 billion in 2013. The Hub segment revenue increased 5.8% to $2.0 billion. Hub's intermodal revenue was flat at $1.4 billion. Hub truck brokerage revenue increased 3% to $254.6 million primarily due to favorable mix, which was mainly due to a 6% increase in length of haul, partially offset by a 9% decrease in volume. Hub logistics revenue increased 32% to $420.6 million related primarily to growth with customers we onboarded last year and existing customers. Mode's revenue increased 12.7% to $685.9 million in 2014 from $608.8 million in 2013. Mode's intermodal revenue increased 19% while Mode's truck brokerage revenue increased 8%. Mode's logistics revenue increased 6%. Mode's intermodal volume increased 15% while truck brokerage saw increases in price and mix. Mode's logistics revenue increased due to revenue growth across multiple business lines. Gross Margin Hub Group's gross margin increased 1.7% to $280.5 million in 2014 from $275.9 million in 2013. The Hub segment gross margin decreased 2.2% to $199.3 million. Hub's $4.6 million gross margin decrease came primarily from intermodal. Intermodal margin declined primarily due to higher transportation costs related to a challenging intermodal operating environment. The first quarter weather related gross margin impact in intermodal was approximately $2.2 million and included a couple of percentage points of lost volume, sub optimization of the network, slower box turns, increased equipment and accessorial costs, higher fuel and accident costs. The second quarter was impacted by the unfavorable timing of cost increases and worse equipment utilization year over year due to rail service issues. Rail service continued to deteriorate year over year in the third quarter, further impacting equipment utilization. Slower train speeds and late trains hurt our fleet utilization by 1.4 days and caused us to incur higher repositioning and accessorial costs as well as more empty miles. Gross margin was also negatively impacted in the third quarter due to increased costs associated with chassis shortages and insufficient gate reservations. Higher drayage costs also negatively impacted intermodal margin in the third quarter as a result of our business model change in California from independent contractors to employee drivers. Truck brokerage margin was flat while logistics margin growth was driven primarily by growth with customers we onboarded last year and existing customers. As a percentage of Hub segment revenue, gross margin decreased to 9.8% in 2014 from 10.6% in 2013. This decrease is due to lower yield in intermodal and logistics. Mode's gross margin increased 12.7% to $81.2 million in 2014 from $72.1 million in 2013 due primarily to growth in truck brokerage and intermodal gross margin. Mode's gross margin as a percentage of revenue remained consistent at 11.8% in both 2014 and 2013. 19 -------------------------------------------------------------------------------- Table of Contents CONSOLIDATED OPERATING EXPENSES The following table includes certain items in the consolidated statements of income as a percentage of revenue: Nine Months Ended September 30, 2014 2013 Revenue 100.0 % 100.0 % Transportation costs 89.4 88.9 Gross margin 10.6 11.1 Costs and expenses: Salaries and benefits 3.9 4.1 Agent fees and commissions 1.7 1.6 General and administrative 1.7 1.7 Depreciation and amortization 0.2 0.2 Driver settlements and related costs 0.4 - Impairment of software 0.5 - Total costs and expenses 8.4 7.6 Operating income 2.2 3.5 Salaries and Benefits Hub Group's salaries and benefits increased to $103.5 million in 2014 from $101.5 million in 2013. As a percentage of revenue, salaries and benefits decreased to 3.9 % in 2014 from 4.1% in 2013. The Hub segment salaries and benefits increase of $2.6 million was due primarily to increases in salaries of $4.1 million, employee benefits of $0.7 million, compensation related to restricted stock awards of $0.4 million and payroll taxes of $0.1 million all primarily due to increased headcount. These increases were partially offset by a decrease in employee bonuses of $2.2 million, due to our current estimate that no earnings per share based bonus will be earned in 2014, and a decrease in commissions of $0.5 million. Mode's salaries and benefits decrease of $0.5 million was due primarily to a decrease in employee bonuses of $0.5 million and salaries of $0.1 million, partially offset by an increase in compensation related to restricted stock awards of $0.1 million. Agent Fees and Commissions Hub Group's agent fees and commissions expense increased to $45.8 million in 2014 from $41.5 million in 2013. These expenses as a percentage of revenue increased to 1.7% in 2014 from 1.6% in 2013. The Hub segment agent fees and commissions expense decrease of $1.2 million was due to a smaller Hub agent program. The Mode segment agent fees and commissions expense increase of $5.5 million was due to the increase in Mode's gross margin. General and Administrative Hub Group's general and administrative expense increased to $44.0 million in 2014 from $41.7 million in 2013. As a percentage of revenue, these expenses remained consistent at 1.7% in both 2014 and 2013. 20-------------------------------------------------------------------------------- Table of Contents The Hub segment increase to $38.7 million in 2014 from $37.1 million in 2013 was due primarily to increases in outside consultant expense of $1.3 million, travel and entertainment expense of $0.5 million, outside sales commissions of $0.5 million, repairs and maintenance expense of $0.4 million, general insurance expense of $0.3 million, other taxes of $0.2 million, temporary labor expense of $0.2 million, training expense of $0.1 million and office expense of $0.1 million. These increases were partially offset by decreases in rent of $1.5 million, bad debt expense of $0.3 million and a decrease in loss on sale of fixed assets in 2014 of $0.2 million. Mode's general and administrative expense increased to $5.3 million in 2014 from $4.6 million in 2013. The increase was primarily due to a lower gain on the sale of equipment in 2014 as compared to 2013 of $0.5 million and increases in outside consultant expense and repairs and maintenance of $0.2 million each. These increases were partially offset by a decrease in travel and entertainment of $0.1 million. Depreciation and Amortization Hub Group's depreciation and amortization increased to $5.9 million in 2014 from $4.8 million in 2013. This expense as a percentage of revenue remained constant at 0.2% in both 2014 and 2013. The Hub segment's depreciation expense increased to $4.7 million in 2014 from $3.2 million in 2013. This increase was related primarily to depreciation for the new corporate headquarters and more depreciation related to computer software. Mode's depreciation expense decreased to $1.2 million in 2014 from $1.6 million in 2013. The decrease in expense was primarily related to less depreciation related to computer software. Driver Settlements and Related Costs In 2014, the Hub segment recorded a charge of $10.3 million. This charge includes $9.3 million in settlements for individual drivers and $1.0 million of related legal, communication and implementation costs. This expense as a percentage of revenue was 0.4% in 2014. See Note 8 of the notes to unaudited consolidated financial statements for more details. Impairment of Software In 2014, the Hub segment recorded a charge of $11.9 million related to the write-off of software development costs as a result of our decision to terminate a long-term technology project. This expense as a percentage of revenue was 0.5% in 2014. See Note 9 of the notes to unaudited consolidated financial statements for more details. Other Income (Expense) Hub Group's interest expense increased to $1.2 million in 2014 from $0.9 million in 2013 due primarily to the increased interest expense related to higher debt. Provision for Income Taxes The provision for income taxes decreased to $22.6 million in 2014 from $33.1 million in 2013. Our effective rate was 39.1% in 2014 and 38.6% in 2013. The 2014 rate was higher primarily due to the elimination of the federal research credit effective January 1, 2014. Net Income Net income decreased to $35.2 million in 2014 from $52.6 million in 2013 due primarily to the driver settlements and related costs and the software impairment charge, partially offset by less income tax expense. 21-------------------------------------------------------------------------------- Table of Contents Earnings Per Common Share Basic earnings per share decreased to $0.96 in 2014 from $1.43 in 2013. Basic earnings per share decreased primarily due to the decrease in net income. Diluted earnings per share decreased to $0.96 in 2014 from $1.42 in 2013. Diluted earnings per share decreased primarily due to the decrease in net income. LIQUIDITY AND CAPITAL RESOURCES During the first nine months of 2014, we funded operations, capital expenditures, capital leases, repayments of debt and stock buy backs related to employee withholding upon vesting of restricted stock through cash flows from operations, cash on hand and proceeds from the issuance of long-term debt. We believe that our cash, cash flow from operations and borrowings available under our Credit Agreement will be sufficient to meet our cash needs for at least the next twelve months. Cash provided by operating activities for the nine months ended September 30, 2014 was approximately $58.6 million, which resulted primarily from income of $35.2 million and adjustments for non-cash charges of $47.5 million partially offset by the change in operating assets and liabilities of $24.1 million. Net cash used in investing activities for the nine months ended September 30, 2014 was $75.5 million, which includes proceeds from the sale of equipment of $0.4 million. Capital expenditures of $75.9 million related primarily to tractors of $42.1 million, containers and transportation equipment of $18.1 million, the construction of our new corporate headquarters of $7.8 million and computer hardware and software of $7.7 million. We expect capital expenditures to be between $55 million and $60 million in the fourth quarter of 2014, primarily for the purchase of tractors and containers. We intend to finance the purchase of the containers and tractors with secured fixed rate debt. Net cash provided by financing activities for the nine months ended September 30, 2014 was $40.7 million. We used $3.2 million of cash for stock tendered for payments of withholding taxes, $1.6 million for capital lease payments and $4.2 million for repayment of long term debt. These payments were offset by proceeds from the issuance of debt of $49.3 million and excess tax benefits from share-based compensation of $0.4 million as a financing cash in-flow. We have standby letters of credit that expire at various dates in 2014. As of September 30, 2014, our outstanding letters of credit were $6.1 million. As further discussed in Note 5 of the notes to unaudited consolidated financial statements, during the nine months ended September 30, 2014, we incurred additional borrowings of $49.3 million, which require monthly principal and interest payments of $0.9 million through September 2019. Our unused and available borrowings under our bank revolving line of credit were $43.9 million as of September 30, 2014. We were in compliance with our debt covenants as of September 30, 2014. On October 22, 2014, our Board of Directors authorized the purchase of up to $75.0 million of our Class A Common Stock. This authorization expires December 31, 2015. We may make purchases from time to time as market conditions warrant, and any repurchased shares are expected to be held in treasury for future use. 22 -------------------------------------------------------------------------------- Table of Contents |