Hub Group Inc (HUBG) 2014 Q3 法說會逐字稿

Hello, and welcome to the Hub Group Inc third-quarter 2014 earnings conference call. I am joined on the call by Dave Yeager, Hub's CEO, Mark Yeager, our President and Chief Operating Officer, and Terri Pizzuto, our CFO.

(Operator Instructions)

Any forward-looking statements made during the course of the call represent our best and good-faith judgment as to what may happen in the future. Statements that are forward-looking can be identified by the use of words such as believe, expect, anticipate, and project. Actual results could differ materially from those projected in these forward-looking statements.

As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to your host, Dave Yeager. You may now begin.

Thank you. Good afternoon, and welcome to Hub Group's third-quarter earnings call. It's been a challenging quarter as we faced headwinds in numerous areas. We have seen deteriorating rail service, equipment shortages, driver shortages, and a challenging legal environment in California. Although the obstacles thrown at us in the third quarter were significant, we believe these are short-term issues, and we're optimistic about 2015. I will now turn the call over to Mark, so he can walk you through the details.

Thanks, Dave, and hello, everyone. As always, I will start by taking you through our operating results. Consolidated big-box intermodal volume was down 2%, with a 4% volume decrease in the Hub segment and a 16% volume increase in the Mode segment. For the Hub segment, local east volume declined 10%. Transcon volume declined 5%, and local West volume grew 2%.

We saw volume declines and cost increases out of Southern California, due to driver, container, and chassis shortages, as well as terminal and train capacity constraints. Overall, rail service declined throughout the quarter. On-time service was off double digits, on both a year-over-year and a sequential basis. We do not expect a meaningful improvement in rail service until the spring of 2015, as the rails work on adding crews and locomotive power.

For the quarter, we saw transit time increase 8/10 of a day, and saw a significantly higher percentage of shipments left on the ground. In addition, our ability to reposition boxes in the West was severely restricted by network congestion in key corridors. As a result, utilization of our containers deteriorated from 13.6 to 15 days, and we were unable to execute on our plans for equipment repositioning and new container deployment.

During much of the quarter, we had hundreds of boxes waiting at the Port of Los Angeles for UP chassis support, and hundreds more marooned in Seattle, waiting to be repositioned to LA. The deterioration in utilization effectively reduced our fleet size by 10%, producing less capacity than 2013. At the same time, we experienced difficulty accessing rail owned containers, and saw an 11% decline in EMP usage over the course of the quarter, as a result of constrained rail box availability.

Driver shortages in Southern California, where we recently changed our model from owner-operator to company drivers, exacerbated the problem. While we anticipated retaining 75% to 80% of our drivers in Southern California, we actually retained just 55%, as many drivers decided they would prefer to remain owner-operators, even if it meant switching companies. This shortage forced us to outsource significantly more work to outside drayage providers, purchase drayage in the spot market, utilize nontraditional dedicated power, lease tractors and drivers, and fly in HGT drivers from other markets.

As you might imagine, this has been an expensive exercise, and we are not yet back to normal operations in Southern California, but it has enabled us to continue servicing our customers. Despite all of our operational challenges, we have kept on-time performance to our customers above 90% during this highly disruptive period. We believe the California driver shortage and the extra costs we are incurring as a result are a temporary problem. As the demand actually slows down in the second half of the fourth quarter, we will be able to bring drivers home, and terminate expensive leased tractors. We will then concentrate on rebuilding capacity through hiring company drivers in Southern California, and outsourcing to a select group of independent drayage providers.

On a more positive note, we are making progress in a number of areas. Pricing improved throughout the quarter, and our pricing discipline in local East produced improved margin on a per-unit and aggregate dollar basis. We are also no longer having issues with the UP over chassis supply, gate reservations, or repositioning. We are currently in the process of onboarding 3,500 new containers, for a net increase of 1,500 units in 2014. We have already received 2,694 of the new containers, and the deliveries will continue through mid-November, with an expected year-end fleet size of approximately 27,500 units.

As you can see from our press release, we also ran into significant issues this quarter with our efforts to develop a new integrated user interface for load planning and intermodal dispatch. After three years of work and significant investment, we have come to the conclusion that the interface we developed will not provide adequate stability or responsiveness for deployment in the field. We are currently evaluating options with several much less complicated paths that can A, produce similar efficiencies and empty mile reductions, B, capitalize on existing proven technology, and C, keep us focused on our core competency: moving freight. We believe this can be accomplished in a relatively short period at a manageable cost, and that it is a better solution for us in the long term.

It has been a learning experience in terms of our IT capabilities. Clearly, we need to strengthen some skill sets and reevaluate our buy versus build decisionmaking going forward. In the interim, we are instituting a number of operational and pricing process changes that will help us improve utilization, reduce costs, and lower empty miles. We set a goal of 2% empty mile reduction in 2015, and everyone here is committed to achieving it, despite the One System setback.

Specifically, we are reengineering our operational workflow and responsibilities, including improving appointment setting, which will enhance utilization and reduce empty miles. We are defining tracking and tracing, which will have customer service focus on the customer, and dispatch focus on street execution. This effort will also reduce redundancy. We are also improving driver communications through Qualcomm Workflow, which will help us improve equipment turns and assist in our driver retention efforts. We remain on track to improve equipment management and utilization through satellite tracking. We have installed our satellite tracking system on 1,285 of our containers, and will continue installations on 1,315 more units later this year.

In addition, we are implementing an optimization tool to help us improve our pricing. This tool has been implemented in a pilot stage this quarter, and will be fully launched in 2015. It will help us expand margin, grow our business, and improve network efficiency, by making better pricing decisions. Our partner in this endeavor is a proven industry leader, and this approach, which has gone from concept to reality in just six months, is an example of our new IT strategy at work. With all these process improvements, we are confident that we are looking at a more normalized Q1 of 2015.

Despite the California challenges, Hub Group Trucking continued to grow, with our drivers handling 1% more moves, and 8% more loaded miles. Hub Group Trucking moved 71% of Hub drayage during the quarter, compared to 66% during the last year. We also did 68% more moves for Mode transportation.

The California situation contributed to higher attrition this quarter, producing a net loss of 46 drivers for the quarter, and bringing the total driver count to 2,868 at the end of September. With peak demand ramping up and less drivers to handle the moves, we are extremely appreciative of the loyalty, dedication, and hard work that our drivers demonstrated during the quarter, to be able to accomplish these results. As of right now, our driver losses in California are leveling off, and we are now beginning to add drivers. October has seen net driver adds, and we believe we will have a positive fourth quarter from a driver add perspective.

As we reported earlier this year, we placed an order for 300 trucks, and have now received 216 of those units, with the remainder arriving before the end of the year.

Our truck brokerage division saw flat revenue and 12% volume decline for the quarter, as we focused on price increases during bid season to offset underlying cost changes in the marketplace. We also had less high value-added business in the quarter. The Mode transportation truckload division experienced a 7% volume decline for the quarter.

We saw continued double-digit growth in Unyson Logistics, with an 18% revenue increase. This quarter, Unyson Logistics was named a Top 10 3PL from Inbound Logistics for the sixth year in a row, a Quest For Quality winner from Logistics Management for the fifth time, a Top Innovative 3PL from Global Trade Magazine, and a Top 100 Best Supply Chain Partner by Supply Chain Brain. We are very proud to see Unyson flourish as a leader in the logistics industry, and believe we are well-positioned to pass our $0.5 billion goal this year.

Although Mode's logistics revenue increased a more modest 3% year over year, it excelled in other ways, including a consolidated top line growth of 13% and 21% intermodal revenue growth. Also, during the quarter, Mode continued to strengthen its pipeline of potential recruits, and onboarded five new IBOs and four new sales agents to the network. Additionally, during the quarter, Mode completed the launch of a new suite of analytical dashboards for its network of independent business owners. The dashboards provide metrics and alerts to help our IBOs manage their business, and improve financial results.

In other positive news, Hub Group was honored to once again receive the SmartWay Excellence Award from the US Environmental Protection Agency. We are proud to be at the top of the environmental advocacy movement in the transportation industry, and will continue supporting the cause, by growing our fleet of environmentally friendly day cab tractors and encouraging our customers to consider intermodal conversion options. At this time, I will pass the call on to Terri for the financial details of our quarterly results.

Thanks, Mark, and hello everyone. As usual, I would like to highlight three points. First, the tough intermodal operating environment, with poor rail service and driver availability issues hurt Hub's gross margin. Second, Unyson Logistics had a solid quarter with 18% revenue growth. And third, on a high note, Mode delivered another quarter with 2.9% operating margin.

Here are the key numbers for the third quarter: there were two unusual costs that I want to explain. First, as we reported in our 8-K, we had a $10.3 million charge related to claims alleging the owner-operator drivers in California were misclassified as independent contractors. This includes $9.3 million in settlements for individual drivers and $1 million of related legal, communications, and implementation costs.

Second, there was an $11.9 million charge related to writing off software development costs for One System since we decided to terminate the project.

All the numbers that I am going to report today are adjusted to exclude the $10.3 million and the $11.9 million charges, which represents a total of $0.37 per share.

Hub Group's revenue increased 3% to $913 million. Hub Group's diluted earnings per share was $0.49, compared to $0.50 last year.

Now, I will talk about details for the quarter, starting with the financial performance of the Hub segment. The Hub segment generated set revenue of $692 million, which is a 2% increase over last year.

Let's take a closer look at Hub's business lines. Intermodal revenue decreased 2%. Intermodal volume was down 4%, and fuel was down slightly. Price and mix combined were up. The good news is that price increased sequentially as the quarter progressed. Loads from consumer products customers were down 10%, loads from paper customers were down 32%, and loads from durable customers were down 7%. These declines resulted partially from pricing actions we took to improve freight mix. Rail service issues, which triggered capacity shortages, and lack of dray power in key markets also contributed to the decline. We estimate the volume shortfall due to these rail service and dray issues cost us about $0.02 per share this quarter.

Truck brokerage revenue was flat. Price, fuel, and mix combined were up 12%, and were offset by a 12% decline in volume. Length of haul increased 10% to 704 miles.

Logistics revenue increased 18%. This increase is due to growth from customers that we onboarded last year, and existing customers.

Hub's gross margin decreased by $3.1 million. Intermodal gross margin was down because of rail service issues and higher drayage costs. Rail service severely impacted our third-quarter results. Rail service deteriorated further in September to the lowest levels we have seen all year, and it continued to decline in October. 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. Service problems were compounded by chassis shortages and insufficient gate reservations on the West Coast. We estimate the rail service issues cost us about $0.07 per share in the third quarter.

Higher drayage cost also negatively impacted our third-quarter profitability. In late August, we changed our driver model in California from independent contractors to employee drivers. While many of our independent contractors accepted job offers, we thought that a higher percentage of the independent contractors would accept the offers. In order to fill the gap, and ensure that we met customer expectations, we flew in over 50 drivers to California from other markets, and rented tractors for them. We also paid higher costs for third-party drayage carriers. We estimate these actions cost us about $0.02 per share in the third quarter.

Truck brokerage gross margin declined, because of lower value-added services. Helping offset some of these declines was an increase in logistics gross margin, due to growth with customers we onboarded last year and existing customers.

Hub's gross margin as a percentage of sales was 9.3%, or 60 basis points lower than the third quarter of 2013. Intermodal gross margin as a percentage of sales was down 90 basis points, due primarily to poor rail service, and increased drayage cost. Truck brokerage gross margin as a percentage of sales was down 80 basis points because of higher purchased transportation costs, and lower value-added shipments. On the plus side, logistics gross margin as a percentage of sales was up 50 basis points, due to more cost-effective purchasing.

Hub's cost and expenses decreased $700,000 to $41.2 million in the third quarter of 2014, compared to $41.9 million in 2013. This decrease primarily relates to lower bonus expense. A significant portion of our bonus is tied to earnings per share. Because we are not meeting our EPS goal this year, we do not expect to pay any earnings per share based bonus. As a result, this quarter, we reversed the $3.3 million of EPS-based bonus that was accrued at the end of June. Bonus expense was down $2 million year-over-year while salaries and benefits were up $1.4 million, due to annual increases and higher headcount.

Finally, operating margin for the Hub segment was 3.3%, which was 40 basis points lower than last year's 3.7%.

Now I will discuss results for our Mode segment. Mode had a solid quarter, with revenue of $245 million, which is up 13% over last year. The revenue breaks down as $123 million in intermodal, which was 21%, $87 million in truck brokerage, which was up 7%, and $35 million in logistics, which was up 3%.

Mode's gross margin increased $3.2 million year-over-year due to growth in intermodal and truck brokerage. Gross margin as a percentage of sales was 11.9% this year and last year. Mode's total cost and expenses increased $2.1 million compared to last year, due primarily to an increase in agent commissions. Operating margin for Mode was 2.9% or 20 basis points higher than last year's 2.7% operating margin.

Turning now to headcount for Hub Group. We had 1,473 employees, excluding drivers, at the end of September. That's down 8 people compared to the end of June.

Now, I will discuss what we expect for 2014. Our financial results for September were worse than we projected at the time we filed the 8-K because of higher than expected driver attrition in California, combined with further deterioration of rail service in September. We project that our 2014 diluted earnings per share will be between $1.69 and $1.74. This excludes the one-time costs associated with the driver settlements and the technology write-off.

Our guidance assumes that rail service does not improve nor deteriorate, and that the increased drayage cost we saw in the third quarter will continue into the fourth quarter. We project intermodal volume will be down between 3% and 7% in the fourth quarter. We think we will have about 36,850,000 weighted average diluted shares outstanding. Our cost and expenses will probably range between $66 million and $68 million in the fourth quarter.

Turning now to our balance sheet and how we used our cash. We ended the quarter with $93 million in cash, and $72.6 million in debt, including $19 million of capitalized leases. We spent $29 million on capital expenditures this quarter, including $18 million for tractors $6 million for containers, and the remainder for technology investment. That brings total year-to-date capital expenditures to $76 million. Estimated capital expenditures for the fourth quarter are between $55 million and $60 million. Approximately $18 million is for tractors, and $32 million is for containers. Just as we have done all year, we intend to finance these purchases with debt.

I am happy that our Board has authorized a $75 million share buyback, which expires in December of 2015.

That wraps up the financial section, and I will turn it back to Dave for closing remarks.

Okay, thank you, Terri. Again, thank you for your participation on this call. We are obviously not pleased with the third-quarter results, nor our guidance for the remainder of 2014. However, we do believe that many of the issues that have negatively impacted our earnings are temporary, and that they will be remediated quickly.

Additionally, we believe that the rails are working diligently towards solving their service issues. As our Board is demonstrating with the $75 million share repurchase authorization, we are bullish about our growth prospects, and our positioning across service lines. And with that, Terri, Mark and I are happy to take your questions.

(Operator Instructions)

Ben Hartford, Baird.

I guess just to pick up where Dave, you left off there at the end, believing that many of these issues are temporary. Which issues at the moment, do you think are not temporary? I know there is a number of things that you have highlighted here. Which issues do you think are not temporary, or things that you cannot solve at some point in time?

I think the major issue that we do not control is railroad service. Our rail partners have told us that they expect that they will be getting back to normalized operations and normalized service by the spring of 2015. What they're doing is adding locomotives and adding crews.

But that is the one area that is beyond our control. Certainly, the drayage in Southern California is within our control, and something we think is very fixable, as well as just some of the inefficiencies that have resulted from the rail service. We do believe that as we get out of peak, that in fact, that alone should improve some of the rail service.

Okay. And if we are to believe what the rails are telling us, there should be improvement. But at some point in time during 2015, consistent with what you just said, and eventually getting back to and exceeding 2013 levels, that service issue as well should be viewed as quote-unquote temporary. It's just simply out of your control at the moment. Is that fair?

That's the one thing, yes. Agreed.

In the meantime, how much can you control with regard to pricing? How much does pricing solve some of the issues that you are experiencing here and now, and maybe what is the approach, what is the mentality, as you head into 2015, thinking about price as a lever to solving some of these gross margin issues?

I think there is a couple of issues that we have. First and foremost, obviously, is price. We do remain very disciplined in our approach to the bids. We really won't see many, of course, into the middle of the first quarter of next year. Most of the bids are done by now.

But we will retain the discipline. We do see truck pricing increasing substantially, probably in the 6% range, and we think that with the constraints that we are seeing with the rails, that in fact, we will be in a strong pricing position. I would add that we have also had internal areas that we can focus on and attend to, and Mark had talked about them a little bit in his prepared remarks, where we feel as if we can bring a lot of efficiencies and reduce our costs by actions that are taken in house. And again, those are within our control, and something we can do expediently.

Okay and washing out the back half of this year, thinking about the first quarter in 2015, you mentioned that the first quarter should be a more normalized first quarter. But it sounds like 2015 will be a build-up if rail service doesn't normalize or begin to improve until the second quarter. But do you think that at some point in time during 2015, assuming that there is any discernible improvement in rail service, that you can have a gross margin trajectory that anywhere resembles what you might have thought what you had at the beginning of this year, as you look into 2015?

Yes. I think we definitely feel that. If you try to take all of the costs associated with the network disruption out, we actually feel that we made progress throughout the quarter with pricing, and that there is reason to be somewhat optimistic about the pricing environment, particularly with what's likely to be a tight capacity situation in the over the road market. So we think that we will be able to work our way through a lot of these congestion issues, and that, certainly coming in to the next bid season, as long as we stay disciplined, there will be an opportunity for us to get price, and to get back to enhancing our margins. At the end of the day, if we pulled all of this away, I don't think you would be unhappy with the pricing profile of our business right now.

Okay. And then the last one, I will turn it over to somebody else. Just to think about the business strategically, there's a lot of concern, putting these issues aside, there is a lot of concerns about how much gross margin an IMC ought to earn in this type of environment. Are you confident that given fixing some of these temporary issues, and if we are into a capacity environment this cycle that is meaningfully tighter than it has been in prior cycles, and rates, truckload and intermodal rates continue to rise, that you can, from a normalized base, expand gross margins in the core Hub business? Is that a realistic frame of mind from an investor's point of view?

We absolutely think that we can. We are doing some things with pricing to change some of those processes and add some new tools that help us understand the market better. And, yes, we feel like we can get back to more historic margin levels with our core product with intermodal, particularly given the market dynamics that are out there. But I think we are going to go into the year with a better understanding of the market.

We're also going to go into the year with a better business base, a business base that isn't as price-driven as we entered the year last year. So I think given that, and the external industry dynamics, and what we are doing internally with our own processes, we can go back and make some progress from a price perspective to get back to levels that we saw prior to 2011.

Right. As Mark alluded to earlier, if we hadn't experienced all of the operational issues with rail service and the driver situation in California, we think our gross margin would be up. We did increase customer rates to cover the cost increases. We were pretty happy with that. And in total, the rail and dray issues cost us about $6 million in gross margin. So had it not been for those things, gross margin would be up.

Right. That's helpful. Thank you.

Scott Group, Wolfe Research.

So, help us understand this price versus volume mix a little bit better. I understand, I thought that the strategy entering the year was, we're going to be pushing pricing more aggressively and if we lose some volume, okay. But we are seeing the volume declines a lot worse than the pricing increases, so it doesn't seem like it's working, and we've got rail volumes that are growing and the other IMCs are growing volume, so I am not sure exactly what is going on, why the mix of volume is down so much more than the price is up?

Go ahead, Mark.

I'm not sure that's true, Scott. The area that we are down volume predominantly is local East, and if you look at local East in the quarter, we improved margin on a per-unit basis. We also improved the total margin dollars generated by our book of business in the local East market. So, there has been a trade-off undoubtedly between price and margin, but I think the pricing efforts have produced a better margin than we would have, and a better outcome than we would have experienced, if we've had gone out and chased volume.

I would just add that most of the price increases really came in to play in the third quarter. That says a lot of the bids came through, and as far as the volume shortfall, again, that's going to happen when you are focused on price.

Yes, and I think the other factor you do have to take into account here, is where we ended up not hitting anticipated volume levels, largely because of the congestion issues. The Southern California market also happens to be our highest margin business. So when we ended up shrinking throughout the third quarter for rail service congestion and dray power reasons, we did not have as much of that in the mix as we would have otherwise anticipated.

It's really only in the last 10 days that we have started to see an uptick in Southern California year over year.

So what pricing are you seeing in the fourth quarter?

We don't have much new pricing kicking in, in the fourth quarter. It will just carry over from what we've had so far, because not that much business reprices in the fourth quarter. But year over year, we expect to see the same price increase that we saw in the third quarter.

I thought that Dave just mentioned that a lot of pricing kicked in at the end of the third quarter, so I just wanted to get pricing tracking up in the fourth quarter.

Yes, we don't disclose price increase numbers, but we did see a positive trend throughout the quarter, particularly in September.

Okay, okay and then Dave, I just want to ask one for you strategically. So you've got several different businesses now between intermodal, brokerage, and Mode, and logistics, and it seems like it's been tough to get them all working at the same time. Any considerations at the Board level?

Are there parts of the business that may be worth looking into selling off and focusing on our core businesses? Is there maybe any discussion of doesn't it make sense to be part of a bigger company in total? Can you maybe give us a sense of how you are thinking about that with the Board?

Okay. Well obviously, we always do discuss, does it make sense to remain independent or part of a larger Company. That's always a topic of conversation, and we are always open to that discussion, if it makes sense for ourselves, our shareholders, and our other stakeholders. As far as the business units, and we have had discussion of should we want to spin off the business lines.

Unyson has been very, very profitable and a great growth vehicle, and it also helps feed, to some degree, some of our intermodal and some of our truck brokerage business. Plus Unyson is very reliant on our existing relationships in order to get a lot of their outsourced activity. So I would think it is a little more difficult to in fact, divest that, just simply because there is some overlap. Certainly it is separate systems, certainly it's a different business, but there's also some relationship sales ties that are difficult to take out.

From a Mode perspective they've grown great. Jim Damman and his team have done a wonderful job, and the IBOs have done a great job in continuing to focus on their business, and growing it over this period. It of course also is very separate, but we've had no discussions about the potential for spinning it off.

Okay. Thank you.

Kelly Dougherty, Macquarie.

Just to go back to a similar point we talked about, UP obviously reported really strong domestic intermodal volumes, up 13% this morning, and pricing up 4%. I believe you're their largest intermodal partner, so can you help us think about how to reconcile some of those numbers? Just wondering if there is concern about losing relevance with them if you walk away from some meaningful business. I know most of what you're walking away from is not in the West. Or maybe help us think about how the issues in Southern California, reconcile those numbers. Just a way to think about is there any change in your relationship with UP that's a little bit bigger than what's going on right now?

Well, we certainly are, a critical partner with UP. We are their largest intermodal customer. We did grow local West, shrank a little bit in transcon. But by no means is the gap closing significantly. I think, we are one of their absolute anchor customers across the railroad, not just with the intermodal product.

A lot of their growth is coming from premium service. Certainly they're growing quite well there, and they're growing with the IMC community. But for three of the last four years, we have produced a lot more growth than their other channel partners. So we made a deliberate decision to exit some business that was not profitable. Most of that was not on the UP.

We certainly would have grown more with the UP if we would not have seen these service issues, if they would have been a little more forthcoming in helping us reposition our boxes into critical markets, if they would have let us in the gates, if they would have not left our boxes on the ground. So to a certain extent, some of the volume growth is attributable to them not necessarily stepping up and helping us, the way we would have liked to have seen. But nonetheless, we continue to have a strong relationship with them, and we think we are a critical partner of theirs, and they are a critical partner of ours.

And I appreciate that color, and you have worked out these issues with them of them being a little bit more supportive, and moving things around, and getting you access? I mean were there others that they were putting in priority, or their own stuff? Can you just help us get some comfort around why it is going to be much better going forward?

Yes. I mean honestly, we don't know if we were given the correct level of preference here. We did have trouble getting chassis, for example, for boxes that were stuck at the Port of LA. That was extremely frustrating, and we know their volume was up out of LA. So we would have liked to see better chassis support in LA.

On the positive side, they have rectified that situation. They have also corrected much of the other issues that I was just talking about. On-time performance remains an issue, LOGs remain an issue, however gate reservations are not an issue, and repositioning is not an issue right now. So they have resolved a number of these issues and made some progress, and worked better with us in the last couple of weeks.

But it still remains a challenging environment. And I think you always think that you should get better treatment than what you are typically getting, but at the same time, we are trying to make the best of a situation, and make sure we are covering our customers' freight and maintaining our on-time performance levels in the 90s, which we have been able to do.

That's fair enough. Thank you. I just had one other quick question on the load balance and dispatch system that you decided to go a different route. How integral was that system in your expectation to be able to improve margins going forward? Because I think you talked about feeling confident, and being able to get back to the levels you thought you would be at, if some of these service issues and dray issues went away. Just wondering what we should think about if you have to go back to the drawing board with it?

Yes. We put a lot of effort and a lot of time and a lot of resources into One System, and it is unfortunate, and it was a critical component to our strategy to reduce empty miles, which is a significant way for us to lower our costs. There's no question about it. We learned a lot during that process and we learned what we need and one of the good things is, we believe that there are now products out available in the market that did not exist three years ago, that can serve many of those purposes, and can help us reduce empty miles.

So we've got some process changes that we can implement very near term, and then we can go out into the marketplace and secure that intellectual capital that was really associated with One System, in a much more efficient manner. It's something I think we can get done in months rather than years. Certainly, probably not something that would be helping us reduce empty miles next year, but something that would be in the process of onboarding at that point in time. Unfortunate outcome. It was definitely a part of our strategy, but we are working our way around it.

Thank you, again.

Todd Fowler, KeyBanc.

I guess I wanted to focus a little bit on the fourth quarter, and based on the updated full-year guidance, I'm coming up with a range of $0.36 to $0.41 for the fourth quarter, so a deceleration from where you were in the third quarter, and it sounds like the volumes are going to be down a little bit more than what they were in the third quarter. Is that just the expectation that the service is getting worse and the costs are continuing on the dray side, or is there something else happening related to volumes as we move through the end of the year?

No. I think that the volumes, it's what we are expecting, from our bids over the prior nine months. So it really is nothing other than that, and we are not expecting the rail service to deteriorate. We don't think that's a fact. We don't think that will occur. If anything, I think we might see some slight improvements, as volumes have a tendency to tail off.

I would suggest though, we do expect higher costs in Southern California. We actually today had 64 drivers from out of town that we are paying for. In addition to their normal wages, we are paying per diem and a variety of other things, so there are a lot of expenses. But we have made commitments to our clients, and basically we are investing, if you will, by spending this -- having this additional expense in those relationships.

Yes, let me give you a little more color on the fourth quarter, Todd. Rail service issues could range between $0.07 and $0.10 a share for worse utilization as compared to last year, volume shortfall, more empty miles and higher repositioning costs. The cost of driver availability issues in the fourth quarter in California could have between $0.03 and $0.06 a share impact, and that would consist, like Dave, said of the usually high cost associated with flying the drivers into California from other markets, paying third-party drayage carriers higher costs, and short-term leases on trucks, which are expensive, as well as the additional maintenance.

We think that those costs will go down in 2015 as we hire more drivers, reduce maintenance with more cost-effective trucks, and work with third-party drayage companies to more cost-effectively outsource drayage. So in total, the cost of the rail service issues and the driver availability issues in California in the fourth quarter is estimated to be between $0.10 and $0.16 per share.

Got it. That helps, Terri. Just as a follow-up, Dave, we are coming up on the intermodal bid season, and it seems like there are a lot of things that have been happening to your business in the second half of this year. What is your approach to bids? Do you look at 2015, and is it a year where you can grow in line with what the market is growing and do it profitably, or do you have to focus more on the network, and make sure that the business is running the way you want it to, before you go out and try to take on additional volume in this environment?

I think that we can get to what the industry is growing at, in relatively short order. We are going to have a two-three months lag here before the bid season really kicks in. That will also give us time to implement some of the enhanced processes that Mark had talked about before. We feel very comfortable that we will be able to get back into a growth mode at a profitable level, which is a critical component. We will continue to stay very focused on price, in addition to controlling our internal costs.

Okay. That makes sense. Thanks for the time.

Alex Vecchio, Morgan Stanley.

It's Alex in for Bill Greene. One of the things that some of the truckload carriers have been talking about recently is the benefit from lower fuel for truckload, over intermodal. I just wanted to get your thoughts on how much of a risk do you think is lower fuel, assuming it persists going forward. How much of a risk is that to the intermodal growth dynamic for you?

I would suggest to you that even if fuel goes back down to $1 a gallon, that with the current driver situation, that I don't look for an awful lot of renewed competition for over the road in intermodal lanes. It just is not going to make any sense over the near term, and I don't think that they can build the driver capacity quickly enough on lanes that might be over 1,000 miles.

Okay. Got it. And then just sort of switching gears a little bit. Just wanted to get the thoughts on the net container additions. I think you talked about adding 1,500 net increases for year-end, but your utilization is down, and I'm just trying to understand, why are you increasing your CapEx and your container additions if your utilization is going down?

Our utilization is not down because the boxes are sitting idle. Our utilization is down because service is taking a lot of days out of our ability to cycle the boxes. So if anything, we actually need more capacity right now, in this circumstance, to handle the same number of loads.

To give you a little example, to complete a circuit, as we think about it, positioning boxes, so a box from Chicago to Seattle, repo down to LA, LA back to Texas. That's a cycle that's fits into our strategy, and it's a cycle that usually takes about 22 days. It was taking over 60 days this quarter to get that done in many instances, so that kills your box utilization. We really actually feel like we need those extra boxes, and we're also confident that as this gets more normalized, we're certainly going to be able to fill those boxes.

We turned down a lot of loads in the third quarter because we did not have boxes. Our volume levels would have been significantly higher, under just normalized turn-down conditions on the West Coast.

Okay. That makes sense and that's helpful. Okay. Thanks very much thanks very much for the time.

Brandon Oglenski, Barclays.

This is Keith Mori on for Brandon. I just had a question. Remind me. Clearly there's a lot of network issues on the railroads, a lot of congestion, and a lot of things that are outside of your control, per se. Could you maybe talk a little bit about the things that you are doing internally to improve utilization over the next six months? We know rail service is going to be an issue. You said is it's going to happen until at least spring. What can we do between now and then to get better outcomes in that segment?

Yes, I mean, there's no question. We are doing a few things, some of them are very near-term, some of them are longer-term. On the very near term, we are working very closely on coordinating our process flows, all the way from customer service to all the way load planning to driver management.

So we are looking at, for example how we are setting appointments, to make sure we are optimizing the truck capacity that we have, and also to make sure that we are picking the right empties from the right places to take and add to pools, and these along those lines. So really looking how we're managing empties, how we're managing dead days, and how we're managing markets with the dray capacity that we have.

The big thing that we have got, that's currently in the works, is satellite tracking, obviously. We are well underway there, and that will enable us, we believe, to take about a day out of normalized utilization. So I'm not talking about the 15 days minus a day, more like the 13.6 days minus a day. That is something that will take a little bit longer.

We probably won't really see the full benefits until 2016, but between now and then, we are working a lot on the operational processes that can help us eliminate dead days, can help us make sure that we are spinning the boxes as quickly as possible. Even if we don't see significant rail service improvement, there's a lot we can do with our own internal processes, just to make sure we are keeping those boxes moving, and also to make sure we are at the right price levels to make sure we maintain network balance and network fluidity.

Okay. That was really helpful. And I guess another question is around next year's growth. We see intermodal could maybe be an issue until mid-year. Truck markets are tight, but should be favorable for Mode looking forward. Should we be thinking that you can return to growth rates in the double digits next year, or what is your thought process of growth for next year?

I think domestic intermodal will probably grow overall in the mid single digit range, and that is where we are targeting as well.

I guess to follow-up to that be in the other segments with the truck brokerage, are these segments enough to maybe help address some incremental growth and earnings while intermodal is in line with the market?

Next year?

Yes.

Yes, we think so. Logistics had great growth this year, and so we hope to continue that into next year, in 2015. Truck brokerage has been a work in progress, and we're making a lot of changes. And so next year, hopefully in the second half of the year, we would expect to grow.

I think the other segment, Mode, has posted very solid double digit growth as of late, which three years ago or two years ago we would not have necessarily anticipated.

Okay. Thank you for the time and I will let the queue go on.

Matt Brooklier, Longbow Research.

I wanted to follow up on truck brokerage, market very tight. Good demand in general. You obviously had some headwinds on the intermodal side. One would think that maybe that would have also provided some opportunity to shift some freight from intermodal, into truck, yet your volume was down on a year-over-year basis, and it sounds like you're doing a little bit more work to try to improve things there. But I just wanted to get a sense for more color on what negatively impacted truck brokerage in the quarter, and what are some of the things you are doing to improve that division, and maybe how do we look at fourth quarter?

Yes, it was not a great quarter for Highway. There's no question, to reiterate what Terri said, it's clearly a work in progress at this point. We have put a new team in place there, in terms of helping to guide the model a little bit. The model itself, to be honest with you, Matt, is not really well adapted to effectively operating in the spot market. It's not what they do. They are more carrier managers than they are spot brokers.

That being said, clearly they were not able to bring on a lot of new opportunities at this point, yet. We are working very hard to develop our carrier base more carefully, and we are working very hard to be more selective in bringing business on. We have had a period the last year and a half, where we brought some business on that honestly we weren't able to execute on. We've been maybe too cautious, and maybe we missed an opportunity this quarter.

We are confident that this is a team that can succeed. They have succeeded with highway in the past, and we think that they bring a good strategy to the table. We will be able to perform well and perform a valuable service, particularly as people are more and more concerned about getting reliable capacity for consistent, or sometimes more complicated business. It's probably not something that is capable of turning on a dime and capitalizing on tightness in a specific market scenario.

Can we develop that capability? Maybe. That's probably not something we will be able to fix near term.

Okay. But I guess I mean is the thought process here that this tighter market, and truck brokerage not performing as well, and maybe being a more contractual, that potentially you have reassessed what the business looks like, what the mix looks like, and potentially you're doing more spot business on a go-forward basis? Or do you keep what you have in place, and focus on the execution portion of it?

There was a time when we had more capabilities to work the load board market, those kinds of things. We have gotten away from that, in all honesty, the last couple of years, as load boards really died. We directed ourselves much more towards carrier management.

So when things tightened up we weren't necessarily in a great place to be able to capitalize on that. It is certainly a market we would like to build better capabilities around, and it is a market that, honestly, a lot of our big customers would like to see us participate more aggressively in. It is definitely something we are investigating.

Okay. And then the incremental outsource drayage that is currently a headwind, and I think the 64 drivers that you've had to fly in from other markets, what's your sense as to how quickly you can start to improve upon that? Can you start to accelerate finding replacements for the drivers right now who are displaced, and starting to ramp down what you are doing in terms of outsourcing drayage?

I'm just trying to figure out how long does it take? Is it a quarter? Is it two quarters? Very tight driver market, and it would be difficult to replace all of them in a short period of time, but I just wanted to hear your thoughts on that.

Yes, sure, Matt. Absolutely. What I think you have to do is think about it in steps. And probably our first step is to get the guys who are in LA from out of town home. And we're pretty confident we will be able to do that, certainly by Thanksgiving. We want to get those guys back.

Then we want to get rid of the expensive leased tractors, leased drivers, those kinds of things, because that's a much higher cost than outsourcing to traditional carriers. Then we phase more and more out of the spot, third-party business that we are currently having to buy, and direct a lot of it towards some key strategic dray partners that we are in the process of developing. What we want to do is phase out of those other higher-cost options and really concentrate on adding Company drivers, but also having a much closer relationship with a select few dray partners that handle consistent bundles of business for us.

So we think that will enable us to have an adequate driver supply in place going into 2015. That market really does slow down quite a bit, which will help us. So we don't think we are that far away.

We don't think it's multiple quarters. We think we can go into 2015 with our cost much more normalized in that market.

And I would add also that despite the shortage with drivers, we do believe that we can add them. We pay a very good wage, and in addition to that, if you think about it just from a lifestyle perspective, our drivers are our home every night. And I think that's part of the issue with the over the road driver, it's not an attractive lifestyle. And certainly driving a truck is a hard job, but certainly, if you're home every night, it makes it a lot easier.

And we do think it leveled out, and we are now in the building process. We have even seen some of the guys who went away to competitors, come back. We are hoping to see more of that as well.

Okay. Appreciate the color.

Kevin Sterling, BB&T Capital.

Are you concerned about driver classification issues in states other than California?

California was the place where the law seemed to be evolving the most rapidly. It is something that we are in the process of watching. I think there have been decisions in some other circuits that give us concern, but there is no plan immediately to make any classification changes, or to make any model changes, at this point in time.

It really is a state-by-state issue and with California being the most extreme, so we are just looking at each state in determining what our course of action should be.

Right. And I am sure California, I imagine it's probably your biggest state, in terms of drivers. Is that fair?

No. Actually, it's not. Texas would be larger and Illinois would be larger as well.

I think Illinois is a bigger trucker count.

Okay. And then a lot of discussion about the rail service issues. What would - what has been the biggest impact on your operations, is it utilization? Is it having to do more over the road? If you had to rank them, what is the biggest negative impact?

Rail service issues we estimate cost us about $0.07 per share this quarter and certainly the biggest part of that was probably utilization and repositioning costs. Then, accessorial costs and more empty miles. Those were the main buckets.

And that doesn't take into account all the lost business.

Right. That's another $0.02 of volume shortfall.

Right.

Okay. And last question here you know you talked about scrapping your in-house system that you are trying to build. If there's one thing you can put your finger on that went wrong, what would that be? Is it maybe just collection of data or is there something else there that really gave a decision - where you made a decision to scrap it?

Yes, I mean the real problem lies at the very root, and it was an early decision that was made. I think we decided on a very complex approach, and a very complex architecture. I am not a systems guy so I will probably get this completely wrong. But the reality of what happened, as we took it out into the field, we could see that the linkages between the modules wasn't functioning correctly. But what we also observed was that the way we had built this system was very complex and required a lot of interaction between different databases, and some very complicated tools were at the base of that architecture. And we reached the conclusion that even if we fixed these linkages, it's very possible that this architecture would never have the stability and responsiveness that we need, to manage our business. So unfortunately, I think those mistakes that ended up forcing us to abandon this project were made very, very early on in the process.

Okay. Thank you, Mark. I appreciate that and thank you for your time this evening.

Justin Long, Stephens.

Terri, I just wanted to follow up on the EPS headwind all-in from the service issues and drayage in the fourth quarter. You talked about that being $0.10 to $0.16 per share. I just wanted to make sure that I was clear on the all-in impact in the third quarter. You said $0.02 from volume, $0.07 from rail service, and an additional $0.02 from drayage. Is that correct, that it was in all-in $0.11 impact in 3Q?

That's exactly right.

Okay, great. And I know you're not going to give 2015 guidance until next quarter, and there are a lot of moving pieces that we have talked about, but can you just speak to your of confidence at this point, and you can start to see earnings growth start to inflect higher next year versus the flat to down trends we're seeing right now?

We really haven't even finished our budget for next year yet, so we don't want to give guidance on that until February, when we release our earnings for fourth quarter. There are a lot of moving parts, and it depends on rail service. And rail service, as Mark and Dave mentioned earlier, is not projected to get better until the spring. So we have that headwind in the first half of the year.

We don't know what kind of winter we are going to have. Realistically, we won't see any growth from bids and new pricing until the second half of next year. We think that we will have volume growth in the second half of next year, but probably not in the first half of the year.

Okay. And, one last one if you don't mind, I know this year has been a heavy CapEx year. But as we return to a more normal level of CapEx over time, how are you thinking about the potential free cash flow of the business? Is there an easy way to talk about that?

Sure. We have a share buyback authorization in place for $75 million, and certainly, we intend to execute on that opportunistically. And then our first use of cash though would be acquisitions. We have seen some interesting companies in the market. We are looking for something that would be complementary to our service lines, a good cultural fit, immediately accretive, and not a fixer-upper.

Okay. Thanks. I will leave it at that. I appreciate the time.

Scott Group, Wolfe Research.

I was hoping maybe -- we talked through a lot of issues on this call between rail service and drayage and drivers, and I think a few other things. Maybe Dave or Mark, can you just go through each one, one more time and just give us a sense. Which one is -- is it getting worse right now? Do you feel like it's stable right now, or do you think are any of them improving right now? It's not clear to me what is still getting worse, and what if anything is stable, and maybe there is something that is starting to get a little better at this point?

Well sure, I think the things that have gotten better are some of the issues that we were talking about with being able to reposition boxes, being able to get in the gate, being able to get chassis support. Those things have gotten better. There's no question about that.

Right now, rail service has not gotten better, as of yet. We had some fits and starts, and a little bit of improvement here with a step back there. So it's hard to say within the fourth quarter, rail service is not trending well, and it certainly didn't trend well throughout the third quarter. So we think that fix is still something that's out there in the 2015 world.

From a dray perspective, the costs are going to be ongoing at least through Thanksgiving, when we can start to bring some guys home. So, I think while we are not losing more drivers in that sense, it's leveled off. We have certainly continued to incur some unusual expenses, just to make sure that we can meet our customer requirements. Utilization is, I would suspect, is going to get a little bit better over the course of the quarter, but then you hit December, and of course, that's never a good month from a utilization perspective, but it will probably be more normalized compared to last year at this time. So end of the day, I think that's where we come out. The one area that I would say appears to be improving, which we are optimistic about, is price.

Okay. Thank you.

Great.

We have no further questions at this time. I will now turn the call back over to David Yeager. Please go ahead.

Thank you again for joining us on the call today. Certainly, as always, if you have any additional questions, Terri, Mark and I are available at any time. Again, thank you for your participation today.

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.