Note: an earlier version of this article misleadingly described Echo’s earnings performance as a ‘miss’, based on the disparity between the GAAP and non-GAAP numbers.
Echo Global Logistics (NASDAQ: ECHO) reported second quarter earnings on July 24 after markets closed. A soft freight environment against especially tough comparisons meant that Echo’s gross revenue dropped 12.8 percent year-over-year to $553.8 million, and GAAP earnings per share fell 31.3 percent year-over-year to $0.19. Adjusted, non-GAAP earnings-per-share came in at $0.42, in-line with the Street’s expectations.
Net revenues contracted 5.8 percent year-over-year to $100.6 million.
Spot market volumes have been notably soft this year, and spot freight represents slightly less than half of Echo’s revenue. Echo managed to grow contracted, less-than-truckload, and managed transportation volumes in what freight brokers have told FreightWaves is a highly competitive bidding environment.
Still, Echo widened its net revenue margin to 18.2 percent, a 134 basis point improvement over the second quarter of 2018.
Notably, Echo lowered its full-year guidance significantly from its last projections in the first quarter. During its first quarter conference call, Echo chief financial officer Kyle Sauers said that he expected full-year revenues to come in between $2.3 billion and $2.5 billion; after the second quarter, Sauers lowered his estimates to $2.1 billion to $2.25 billion.
“We are pleased with our performance during the quarter given the softer freight environment and the weak spot market,” said Doug Waggoner, Echo’s chairman and chief executive officer.
One of the ways to think about the increasing digitization and automation of freight brokerage – which should show up in productivity gains – is to analyze the relationship between headcount and revenue growth. If a third-party logistics (3PL) company can consistently grow revenue at a faster rate than headcount, then the productivity of its brokers is improving.
While Echo’s first two quarters in 2019 saw negative revenue growth, the company is also slowing its pace of hiring. In the first quarter, sales employees and agents grew 5.5 percent sequentially, but the pace of hiring slowed to 4.6 percent growth in the second quarter. (On the earnings call, Echo management said that most of the headcount growth was in client salespeople, not necessarily carrier reps).
To some degree Wall Street analysts had anticipated the tough business environment Echo faced in the second quarter, especially a June that was softer in terms of volume than 2018, but also unexpectedly tight in terms of capacity due to a prolonged hangover from Roadcheck week.
“We expect ECHO to realize significant year-over-year improvement in gross margin [GM] percent in the second quarter of 2019 due to the decline in truckload spot rates,” wrote UBS analyst Thomas Wadewitz in a July 12 note. Spot rates represent a freight broker’s cost to buy trucking capacity, so falling spot rates can widen margins.
“Given the evidence of some tightening in June, we anticipate a slight sequential decline in GM percentage for ECHO in the second quarter and a similar GM percent level in the second half of 2019 (compared to the second quarter),” Wadewitz wrote.
Susquehanna equities analyst Bascome Majors, in his second quarter preview note published July 12, said that while contract rates have been outperforming spot, they could turn negative in the third quarter, which may hit truckload valuations across the board.
“On a Y/Y [year-over-year] basis, contract rate growth has continued to outpace spot rates for the tenth straight month, with May all-in contract rates +1.1 percent Y/Y vs. dry van spot rates – 24.1 percent,” Majors wrote. “Admittedly, contract rates have been steadily decelerating since their third quarter 2018 highs, and it looks increasingly likely that contract rates will briefly turn negative in the fall, especially if spot rates underperform historic seasonality (four of the last six weeks seen week-over-week underperformance).”
Echo management presented their results during an earnings call after the release and took questions from equities analysts.
Allison Landry from Credit Suisse seized on a comment made by CEO Doug Waggoner that Echo was now back in the M&A hunt and asked if he could provide more color. Waggoner said that valuations had become more reasonable, and that Echo was mostly looking at non-overlapping niche businesses — whether geographical, like Mexico or Canada, or in modes like flatbed and tanker — including managed transportation companies, which by definition would not have much customer overlap.
Jack Atkins from Stephens asked if Echo management could quantify over-capacity and if, on the other side of the coin, Echo had noticed any attrition among smaller carriers leaving the market. Dave Menzel, Echo’s president and chief operating officer, called out a carrier survey that Echo conducted toward the end of 2018 in which small carriers reported adding anywhere from five to 10 percent capacity to their fleets. Beyond that, it was difficult to quantify, Menzel said, but he added that Echo had not seen any capacity bleed off yet, based on the time it took Echo’s brokers to cover loads.
When asked about the bidding strategies of upstart digital freight brokerages, Echo management demurred except to say that they appeared to target large, enterprise shippers and regional lanes. When asked by Morningstar’s Matthew Young if digital brokers’ pricing strategies were “irrational,” Menzel said that bidding for contracted freight was always very competitive.
One interesting point that Dave Manzel made about the contracted freight business is that Echo is seeing more ‘mini-bids’ that are priced according to market conditions and tend to be of shorter duration than typical year-long agreements.