Hub Group Inc (HUBG) 2007 Q3 法說會逐字稿

Good afternoon and welcome to the Hub Group third-quarter conference call. We will begin with a discussion of the financial results led by Terri Pizzuto, Executive Vice President, Chief Financial Officer and Treasurer, followed by an overall business discussion, to be conducted by Dave Yeager, our Vice Chairman and CEO.

The Company will make its prepared presentation followed by a question and answer session. Mark Yeager, President and Chief Operating Officer, will join us for the question-and-answer session.

At this time all participants are in listen-only mode.

Comments made by Hub Group employees during this conference call may contain forward-looking statements. Actual results could differ materially from those projected in these forward-looking statements. Our SEC filings contain additional information about factors that could cause actual results to differ materially from those projected in these forward-looking statements. Copies of these SEC filings may be obtained by contacting the Company or the SEC.

Now I would like to introduce Ms. Terri Pizzuto, the Chief Financial Officer of Hub Group. Please proceed, ma'am.

Thanks, Denise. I want to begin by covering three things. First, we had a record quarter. Second, our operating margin was 5.9%. Third, we had a few onetime items in the quarter. Here are the key numbers.

Hub's third-quarter diluted earnings per share is up 27% from 2006. The third-quarter operating margin was 5.9%. That's compared to 5.1% last year. The three onetime items included in the quarter are number one, a bonus adjustment of $0.01 a share or $0.5 million net of tax. This bonus adjustment relates to reducing incentive comps that we recorded in the first half of the year.

Number two, a tax benefit of $0.03 a share or $1.2 million. This tax benefit relates to a change in Illinois tax law that required us to revalue our deferred tax liability.

And number three, about $300,000 of pre-tax costs related to the DNJ deal that we terminated. The net impact of these onetime items was $0.04 a share. Without these onetime items, we still had a record quarter and 15% earnings per share growth.

Now I'll discuss details for the quarter, starting with revenue. Intermodal revenue was down 5%. This decrease is due to a 2% volume decline, a 2% price decrease and a 1% mix change. While we are not happy about the volume loss, the good news is that when you compare the third quarter of 2006 to the third quarter of 2007, we preserved our gross margin despite a tough freight market.

Truck brokerage was flat on slightly lower volume. What we did here is turn around the 6% revenue decrease that we saw last quarter.

I want to remind you that we have a difficult comp for highway in the fourth quarter. Last year, we had some special projects in the fourth quarter that we won't be doing this year.

Logistics revenue was 4% higher than last year. This increase in revenue came from several new customers and an increase in business from existing customers. As you know, because of a contract change for a large customer, in the second quarter, we are now reporting net margin as revenue for that customer. Without this change, our logistics revenue would be up about 25%.

Hub's gross margin as a percentage of sales increased to 13.8% compared to 13.3% last year. Our logistics and Intermodal businesses drove this increase. Hub's total costs and expenses in the third quarter were $32.8 million compared with $35.5 million in 2006. We promised we'd keep a close eye on our costs and that we would reduce costs where we could. That's exactly what we did. We had 1,064 employees, excluding drivers, at the end of September. That's a decrease of 32 people compared to the end of June. About half of those people came out of the truck brokerage group. Another reason costs and expenses are lower than last year is because we had about $2 million less in variable compensation for bonus and commission. The bonus includes the pre-tax adjustment of $900,000 that I talked about earlier. We tightened our belts and continue to critically evaluate all of our costs.

We expect that quarterly costs and expenses will be in the range of 34 to $36 million for the fourth quarter of 2007. The key metric that we use to benchmark against our competition is gross operating margin. Hub's third-quarter gross operating margin was 5.9%. This is the highest operating margin in Hub's entire 36-year history. We accomplished this because we had stringent cost controls and good pricing discipline.

The effective income tax rate for the third quarter was about 35% because of the tax law change I talked about earlier. We are forecasting that our effective tax rate for the fourth quarter will be about 40%. Remember that we do have a dispute with the IRS that should be resolved during the fourth quarter. If we win, we will have $1.5 million reduction in tax expense in the fourth quarter. So this could bring the effective tax rate below the 40%.

Now turning to our balance sheet and how we used our cash, we had $40 million in cash and no debt at the end of September. Free cash flow for the third quarter was about $10 million. DSO deteriorated a couple of days, due mainly to our retail customers slowing up payments. We are working on improving that.

During the quarter, we spent about $1 million on capital expenditures. For the full year, we think capital expenditures will be in the range of 9 to $10 million.

We now have all of our 2,000 new 53-foot containers. These containers were financed with operating leases that have about a six-year term.

We are disappointed that we weren't able to complete the DNJ acquisition, but this was the right decision based on the results of the due diligence. While we are always looking for good acquisition candidates, we will also use our cash to buy back stock.

In October of 2006, the Board authorized the purchase of up to $75 million of our common stock. That authorization expires on June 30th, 2008. During the third quarter, we purchased about $24 million worth of stock. In October, we purchased an additional $3 million worth of stock. That equates to purchasing about 835,000 shares in the last half of the year. This means we can still purchase up to $35 million under the current authorization.

Now I'm going to discuss 2007 full-year earnings guidance. For 2007, we expect that our earnings from continuing operations will be in the range of $1.39 to $1.44 per diluted share. This excludes the $0.04 a share tax benefit that I mentioned earlier that we could have in the fourth quarter. The weighted average diluted shares are estimated at about $39.5 million for 2007. These shares assume no more repurchases under our share buyback plan.

To wrap it up, we feel good about our strong financial performance this quarter in a weak freight market. Our operating margin of 5.9% was a new record. And finally, we are excited about the organizational changes that Dave will discuss that we think will put us on the right track to grow our business. And with that, I'll turn it over to Dave.

Great. Thank you, Terri. We are very pleased to deliver another record quarter with earnings per share up 27% over a record quarter last year. We managed this growth despite a sluggish economy. The market was highly competitive in the third quarter with the usual suspects cutting price irrationally to gain volume. As you know, peak season got off to a slow start and the pricing environment has remained unstable. Not surprisingly, Hub's Intermodal volumes were impacted by the weak freight market. While we were able to grow Intermodal volume by 5% in the second quarter, our Intermodal volume was down about 2% in the third quarter.

Many of our major retail customers were down in the third quarter. In fact, a reduction in business from our retail customers more than accounts for our volume decline. As is further evidence, retail has represented 32% of our overall business for the last several years. In the third quarter, retail accounted for only 27% of our revenue. And while we have not lost any retail customers, the volumes were down this past quarter. We were able to increase our consumer product volumes, but not enough to make up for the retail shortfall.

On the positive side, our ISO business and that of our wholesale services continues to grow and we continued to control costs, consistent with our model. In addition, rail service continues to improve and our fleet utilization remains good.

As always, capacity off the West Coast is a challenge this time of year, but we have been able to meet the needs of our customers. We've taken delivery of all 2,000 new 53-foot containers. These containers were manufactured in China and arrived the U.S. via the port of Los Angeles, providing us with additional capacity in southern California during peak. We plan to retire the older containers in our rail-owned fleet after peak to ensure an appropriate fleet size in '08.

As expected, the railroads did take some price increases this fall with most of the increases taking effect on September 1st. The largest of these increases were off the West Coast. Despite the fact that some of our competitors did not seek to pass on the increases, we worked hard to pass them onto our customers in order to preserve margin.

Our efforts to increase the amount of dray we perform took a step back this quarter. We lost over 100 drivers in the past few months as we converted our operations in the Midwest to Comtrak. We knew going in that with these conversions, we could lose some drivers due to an adjustment to the pay scale and the requirement that the drivers adopt Comtrak's technology and their processes. We still plan to integrate our two remaining QS operations into Comtrak after the 1st of the year. We do not expect the driver attrition we experienced in the Midwest as the pay scales on the West Coast are similar with Comtrak's pay.

From a brokerage perspective, the truck market remained soft. Unlike '04 and '05, most major freight indexes show that supply exceeds demand. Our truck brokerage business improved from the 6% revenue decline in the second quarter with revenue flat in the third quarter as we continue to bring on solid opportunities.

Our logistics business continues to perform well with revenue growing 4%. Earlier this year, we told you that we had landed two new logistics accounts that would start up in the third quarter. Both of these accounts are now fully operational. We've also recently won several smaller logistics awards that will be implemented in the fourth quarter.

We've had our current management structure in place since our organizational realignment in early '04. This change helped us reinvigorate the Company and as a result, our margins and profits are up. And while we are having another very strong year and had a record third quarter, we believe we have not been tapping our full potential.

I'm pleased to announce today that we have made some organizational changes to help address these issues. Effective immediately, David Marsh, who has ably led our truck brokerage group since 2004 will become our Chief Marketing Officer. David will be responsible for all sales, Intermodal customer service and Intermodal pricing. David has demonstrated the ability to grow our brokerage businesses these last four years. Since taking over in early '04, our brokerage business has grown 145% and its profitability has more than doubled. He replaced ten of 18 directors and completely revamped our brokerage product and processes.

Now while our core Intermodal product is in much better shape than brokerage was in '04, we looked for David to help us significantly improve our sales effort. We are purposefully putting our sales, customer service and pricing groups under one individual so that these groups are aligned and focus on our goal of growing volume and profit.

We'll also be changing the structure of our sales and marketing organization. Prior to the realignment of Hub Group in '04, we had a strong and significant national account sales group. With the change in '04, we assigned many of our strongest national account people to managing salespeople versus managing accounts. This will be changed. We are reinvigorating our national account effort by the creation of a national accounts group, who will solely focus on large customers and gaining share of those large customers.

From a pricing department perspective, our pricing analysts have been generalists, whereby they've been negotiating pricing for rails and drayage. This will be changed so that we will have specialists in each of the areas, who will focus on driving the best price per service. In a soft freight market, we believe this will allow us to optimize profitability.

And finally, customer service. In the past, rail operations and customer service had been one. We have gradually changed that to reflect a pure customer service function group and a pure Intermodal operations group. Customer service will be restructured yet further to optimize the custom experience, focusing particularly on differentiating the experience for our largest clients.

I'm also pleased to announce that Chris Kravas, who has been in charge of strategy and yield, will be our Chief Intermodal Officer. In this role, Chris will assume responsibility for Intermodal operations and retain responsibility for yield and fleet management. For the past few years, Chris has been an instrumental part of helping us improve margins and reducing our costs. We look to Chris to continue our history of operational excellence and look for ways to continue to use technology to more efficiently service our clients. Chris will also be responsible for increasing the profitability of business already in-house. We look for him to use forecasting to improve the allocation of our capacity and to optimize our usage of fleet versus non-fleet containers. We also expect improvements in how we purchase drayage and the allocation of the drayage business between contract and outside suppliers.

I'm very enthusiastic about this new structure and believe it will help us continue on the winning streak we have enjoyed over these last few years.

In conclusion, we are very pleased with our record earnings this quarter. We know we have some work to do on growth but our underlying cost structure, diverse customer base and vendor relationships position us well. These advantages, coupled with the restructuring we've announced today, will help facilitate our growth over the long-term.

At this point, we can open up the line to any questions you may have.

(OPERATOR INSTRUCTIONS). Edward Wolfe, Bear Stearns.

Good afternoon. I apologize. I'm in a car and doing my best to digest this and if I come in badly, Scott will pick up for me.

Intermodal volumes, can you take us through a little bit of how we went from kind of accelerating in a difficult Intermodal market to decelerating kind of with the market this quarter?

Well, I think, Ed, first of all it's, to a large extent, as I said in the prepared remarks, if you look at our overall revenue, our retail accounts declined dramatically, and I think that's just plainly a -- what's occurring within the retail market -- their sales are down. They are tightening on inventories. And as a result of that, again, we went from the retail representing 32% of our volume down to 27%.

I think the other issue is that we may have been a little bit slow. We didn't react as quickly as we might, and I don't think we've lost much volume but some of our competitors have been very aggressive from a pricing perspective. And so I don't think it's that we lost business, but we may not have been quite as -- achieved the same volume that we had anticipated in bids.

Why do think that the regional business all of a sudden this quarter slowed down? What changed in the marketplace? That's what I'm trying to understand.

The retail business? I think it's just plainly that number one, the retailers are slower than they were at this time last year. I think number two, Ed, that they are very aggressively working on tightening their inventory.

Yes, I think the retailers had disappointing sales in September due to the uncertain economy and the lingering summer weather. Apparel sellers, furniture stores, and department stores were the biggest losers.

Do you think for fourth quarter, minus 2% volume is where we should be or is it getting worse? How do we think about it?

I don't think we're getting worse, no. I would not anticipate us -- I would say that we will be more flattish to slightly up, which I know is contrary to what my Chief Financial Officer may be thinking. But I do think that that is -- and there's some reasons for that. It's not just pure guess or pure wish. It is, there is an extra business day. And I think the whole key, Ed, is going to be how long peak goes. Does it go in fact to mid November through Thanksgiving till mid-December? We don't have a clear vision of that right now and that's why we are -- the range is candidly a little wider than we would normally offer.

Okay, Terri, you and certainly Tom before you have always been kind of conservative in the operating expenses. You gave guidance for the quarter of I think was -- what was it, 34 to 36 (multiple speakers)?

34 to 36.

You are exactly right, yes.

And you came in better than that this quarter. Is there a reason why 33 should become 34 to 36, or are you trying to stay conservative not knowing the volume exactly how it might come in?

Well, let me tell you some of the differences between Q3 and Q4 that we were thinking about when we gave that guidance. Number one, we won't have the onetime benefit of the $900,000 related to the reversal of the bonus that we recorded in the first half of the year. There's also one more payroll day and we will probably have a few more heads than we had in the third quarter since we are beefing up our sales personnel and adding a few heads in other departments.

Okay. (multiple speakers)

So that is kind of how to think about it.

Can we look out to 2008 and say that is a run rate going forward at this point or is it too early to know?

Yes, it's too early for us to know. We will give that guidance.

We haven't really gone through the budgeting --

The budget process.

Process completely. So that is something we can give you a little bit more color on later.

Okay. On the truck brokerage side, volumes are doing the opposite; they are improving. We are seeing this happen at J.B. Hunt, where truck is going down and Intermodal is going way up. And is there a quick pro quo that you are pushing some stuff this quarter away from Intermodal back to brokerage after last quarter, doing the opposite or how do we think about that?

No, -- it's just simply that we've been able to somewhat rate the ship, where -- and I think in the fourth quarter we will be getting over a couple of accounts we had lost from a brokerage perspective.

Yes, we do have a tough comp though and --

It does have a difficult comp, yes.

In the fourth quarter because we did have some special project work. So I guess how we would think about that, Ed, is it could range anywhere from maybe down 3% to up 3% in revenue for Q4.

And the acquisition -- what happened? This is the second time in two quarters where you saw something obviously in due diligence. What happened?

Yes, there were certain representations that management made about the business and how it was doing and when we did our due diligence work, we found that the business was not performing as well as what management had represented.

Yes, and this is candidly causing us to reconsider the size of the acquisitions. We are going through the same work and through the same expense from a legal perspective and an audit perspective at acquiring a Comtrak and $100 million of revenue as we do something that's $12 million. So I think you'll see us being a lot more selective and also be delaying until we are 100% positive it's going to go through any announcements.

Are there any costs in the third or fourth quarter related to that deal not happening or is it -- or the deal in general?

We mentioned the $300,000 of costs this quarter that we expensed in Q3, so we will not have any in Q4, Ed.

Okay. There's been a lot of talk recently in the ports of L.A. about the driver status and getting rid of the owner-operator drayage. Can you talk a little bit about what impact, if any, that might have on your business?

This is obviously something that is still a work in process. It really is kind of a political football at this point in time. I would find it difficult to believe that you could get rid of the owner-operator base and their capacity and put in all green trucks. I do think that you could make a conversion over a series of years, but it depends upon how strong the union is going to be there if they're going to be able to push this through, I guess it's the port authority. Mark, do you have anything to add to that?

No, I think that's right.

But if it is pushed through, how does that impact your model? How do you deal with that?

It doesn't really impact our model. Since we don't really do the pure pickups in southern California, we don't actually receive the freight until it's been translated. So it would have no impact on us. It would impact our customers because it certainly would increase their costs.

Okay. Thanks a lot for the time. I appreciate it.

Alex Brand, Stephens.

Thanks. Good evening. I just want to understand on the pricing dynamic, where we are now. I mean I understand there's aggressive pricing in the quarter. It's, I guess if yours down 2%, you felt like you had to respond to some of that and you would have hoped to get more volume out of that. Now you got a price increase. What's the sort of outlook for that sticking through at least the rest of the peak season?

Well, we think that the price increase, it is a regionalized increase, predominately off of the West Coast. The West Coast market remains relatively firm. So we believe that the price increase will hold. We're certainly going to work diligently to make sure that that happens.

To the extent that prices have come down, I don't think we anticipate that we're going to see further erosion in price within the marketplace. We think it's pretty much reached its bottom, particularly in the Chicago/L.A. market, where we saw a lot of that price erosion in order to feed West Coast demand. So we think it's probably stabilized at this point.

Is that another way of saying that the unnamed competitors are being more rational now?

Well, I can't say that we can confirm that. There still is some irrational pricing out there. It doesn't appear to be continuing to fall, however.

Okay. So similar to what Ed asked Dave on volume, and Dave sounds somewhat optimistic on volume, we don't think we're going to have a run rate here of down volume and down pricing for the foreseeable future? Economy notwithstanding?

Well, the down volume, no. I mean we are very focused on maintaining or we want to grow that business. From a pricing perspective, I think that it will be -- the real tale will be after the first of the year at post peak, when we see the amount of capacity out there and how aggressive some may become. I think that's a bit of a wild-card right now, Alex, so I don't really want to give a prediction on that.

Okay, and another outlook based question. If I look at your guidance, which looks like it forces most of us to come down for Q4, is the outlook basically look it's okay right now, but if peak season were to sort of stop in mid to late November, then there's no cushion in the numbers so the numbers need to be more conservative? Am I thinking about that the right way?

You know, Alex, we wanted to give you the best estimate that we could. And because it's a challenging freight market, it makes it more difficult to predict or forecast earnings. So we gave you the best and tightest range we could.

Yes, I know that it's a little bit wide with a $0.05 variance there. And it is dependent upon the length of peak. Again, you hit it right on the head there. If it does, in fact, go into mid-December, certainly the range will encompass wherever we are or we believe it will.

Now, if -- things being the way they are, Dave, are you sort of continuing -- do you still have a comfort that you can drive respectable profit growth in the current environment? So I'm not asking you to make a macro call. If it's no better and no worse, can you continue to drive profit growth for the foreseeable future?

Yes, we still have areas of improvement that we can make internally. And again, a lot of what these organizational restructuring is specifically focused on that. It is two-part. It is one, under Chris Kravas' group, with yield in rare -- Intermodal ops. They're going to be focused on increasing our yield. And there's a lot of areas we can do it through better optimization of our drayage through better utilization of our equipment and specific routes that are more profitable than others. And then you have the sales side to grow our volume, and that's under David Marsh.

And you get those three groups, which have always reported separately -- customer service reported to an individual, sales to an individual, pricing to an individual. This way you've got the umbrella; one guy has got the responsibility to grow the business. So I do believe that we still have a lot of areas for improvement internally.

Okay. Just one more if I could. The stock buyback -- it seems like you guys were relatively aggressive in Q3 and you've already bought more in Q4. You have enough cash on your balance sheet to complete the rest of your authorization, but not to do that and make acquisitions at the same time. Is there any color you can give us for what the appetite is for leverage and whether or not you feel like you are comfortable that the balance sheet can handle it, and if you need to buy stock, you can do that and you can make acquisitions at the same time?

Obviously, we have our Board meeting later on this week. That will be one of the topics of discussion. Certainly, we are not adverse to buying back shares and making acquisitions. And again, our balance sheet is pristine and certainly our free cash flow is significant. So we would have no issues with going into some debt and then also having the ability to the service that debt.

Yes, we have a $50 million untapped credit line right now that we could use.

And we just have that just to have it.

Right.

Okay. That's good. I appreciate the help, guys.

Mike Halloran, R. W. Baird.

Just looking at the volume trends through the quarter, could you just talk about how they progressed on a year-over-year basis for you, generically, not [into it] specifically.

On a year over year -- what do you mean?

Just when you look at your volume growth trends, obviously, you were down 2% for the broader quarter. Did that get worse as the quarter progressed? Was it pretty constant through the quarter? Could you talk about the trends there?

We really don't talk about that on a month-by-month basis, but it was relatively consistent for the entire quarter.

Okay. And then could you just delve a little bit deeper on what -- you were down 2% this quarter. The environment doesn't seem to be getting any better here. Could you talk about what gives you the confidence in the fourth quarter that volume has come back a little bit? And then I guess related to that, how far into the organizational restructuring are you currently and do you anticipate that that's going to be some sort of benefit in the upcoming quarter as well?

To address the last issue first, this is the direct result of a go-to-market strategy that we had worked through with Bain earlier in the year. I do not believe it's going to have benefits for us in Q4. I do think that this is a longer-term play, that, again, we're going to be -- these types of changes. Our pricing will incrementally improve. Our yield will incrementally improve as we better optimize our equipment and our drayage utilization. So those are all incremental areas of improvement. And certainly, as we can service our large customers better, that will, in fact, allow us to earn the right to handle more of their business and gain share. So that it's not going to be an immediate impact.

Back to your other issue, as far as with why we believe that in fact we will be able to grow volume or not be down 2%, again, first of all, we do have an additional business day. So that is very, very helpful for us.

Second of all, we do have a decent pipeline. And during this peak period, we also have -- our fleet is up somewhat versus the prior year. So I think all those things give us a bit of an advantage while peak lasts. And the whole issue is going to be how long does peak go.

That's fair. And then, on the acquisition side, it seems you're going to be more focused on the larger acquisitions. Could you talk a little bit about the pipeline out there for larger acquisitions and if they're -- just how plentiful the opportunities are and what valuations are looking like?

This is still a work in process. And as much as the DNJ deal just recently fell apart and I -- we are doing some soul-searching at this point in time. The pipeline, I can't say that the pipeline is as full for acquisitions as it is for in fact new customers. But it's something we're going to be -- there is still -- there's some in the pipeline, but it's in the very early evaluation stages and nothing would happen in 2007.

That's fair. I appreciate the time.

(OPERATOR INSTRUCTIONS). Todd Fowler, KeyBanc Capital Markets.

Terri, with the head count numbers, can you talk a little bit about when -- the 30 people were basically let go. Is that something that you saw the run rate from the expense reduction or the entire amount of that during the third quarter or will that ramp up and you'll see a little bit more of a benefit in the fourth quarter?

We saw most of it throughout the quarter.

Okay. So there wouldn't be a sequential improvement then in the fourth quarter?

No. And as I mentioned earlier, we do intend to increase head count a bit on the sales side.

Okay. Did you give numbers for what the head count increase will be then?

No.

Okay. And then just I guess directionally then, obviously it seems like a big portion our a large number coming out of truck brokerage. Does that strategically change the focus there when you think about the longer-term growth rates of that business? Historically we were talking about I think mid-teen type growth and you're obviously pulling out a large portion of people there. Does that change what we should think about that business growing at?

No, we still believe -- it's more of a function of the market and responding to that market. We were building up with the expectation that it would be growing in the high teens from a volume and sales perspective. When in fact we saw it going the other way, we decided to cut back on some of the buildup and so that is a direct result of that. Mark?

Yes, I think that's right. And then other thing that needs to be understood is that in this market, capacity isn't as difficult to source so it doesn't require quite as much work.

That's fair enough, I guess. Nobody would argue with that point. And then Dave, I think you made some comments in the prepared remarks or maybe, Terri, you mentioned this, but you talked about the container fleet and doing some retirements. Could you go over exactly what you were talking about I guess from a numbers standpoint or maybe just kind of go over those points again?

Sure. As you know, we have a fleet that is comprised of 7400 boxes which are under an operating lease that -- directly with Hub Group. We then have another 3,000 on the Union Pacific that they own and another 4,000 on top of that that are owned by the BN. Those four -- and Norfolk Southern -- that operate on the BN. We are going to be retiring all of our 48's by the end of this year. That's about 1400 containers.

The other boxes, the rail-owned boxes, we are right now analyzing our fleet to see what the optimal size is. And in all candor, I think in this environment, we are evaluating if, in fact, it's better to have a larger fleet, which we control, and, therefore, have the responsibility for, or if it's better to play the field and use other outside service providers to supply the equipment.

And I guess as a follow-up with that, I mean are there any costs associated with doing this retirement. And secondly, if you make a decision obviously to control more of your own boxes through operating leases or direct ownership, what sort of lead-time do you have or do you need to actually grow the fleet or to increase the fleet through ownership?

The lead time to increase through ownership is probably just a couple of months. It's really not -- again, because the economy is a little bit slow, there's a fair amount of capacity to build containers.

Yes, I think that the major driver there is negotiating the terms with the rail. And that would be the main thing, getting the boxes in. We would want to time it in all likelihood similarly to how we've timed it this year and the previous year so that the majority of the landings are in and around the busy time on the West Coast.

I would emphasize, Todd, that the containers which we have the operating lease for, there's no questions about those. Those run -- the operating lease is contiguous -- runs at the same time as our rail contract and so those will always be in-service.

Yes, and you're right we both talked about the 2,000 containers that we got in, Todd, those are the red boxes and those are included in the 7400, as Dave mentioned.

Okay, good. No, that's helpful. And then, Dave, just to be clear on the QS conversion, it sounds like or maybe I just don't remember correctly, but are you pushing back the conversion of the two remaining facilities or is that still progressing on schedule?

We decided to postpone it until after peak just because you don't want too much noise during peak season. You really need to focus on execution to make sure we are meeting our clients' demands. So we did intentionally push it off till after the first of the year. But again, we believe that we have some issues here in the Midwest with the way that we were paying drivers. And essentially, what was occurring is that any time we would be able to optimize a driver, they were getting 100% of the benefit and we were getting none of it. So it kind of defeats the purpose of building volume and building base, but we are over that in the Midwest now. We're very stable on our driver count now and we really don't anticipate any issues in southern California as the pay scale there is based on productivity, which is similar to the Comtrak model.

Okay. And then what has the driver count been, just to have that number?

1,165. That includes employees and owner-operators.

Okay. Do you break out the drivers separately?

That would include Company drivers and owner ops; that's the total drivers.

Fair enough. And then just real quickly, lastly, Terri, thinking about the gross margins, I think that historically, you've seen gross margins in the fourth quarter be compressed or feel some pressure. I think the last year might have been a little bit of an anomaly. As we think about the fourth quarter this year, any thoughts on what you would anticipate? We saw very strong gross margins through the first and second quarter, sequentially a little bit of a softening here in the third quarter. Any directional thoughts I guess on what you would anticipate based on this market, what we've seen historically, what we've seen recently, for the fourth quarter on the gross margin line?

We would think it would be similar to perhaps the third quarter. But we mentioned during the first quarter and second quarter calls that that 14.4% was a little high, so it could be similar to what we experienced in Q3.

So we will use recent history, I guess?

Yes.

Okay, fair enough. Thanks a lot, guys.

At this time, we have no further questions in queue. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.

Thank you.