Pacer International, Inc. Q3 2008 Earnings Call Transcript

Nov. 3.08 | About: Pacer International, (PACR)

Pacer International, Inc. (NASDAQ:PACR)

Q3 2008 Earnings Call Transcript

October 28, 2008, 5:00 pm ET

Executives

Joe Doherty – VP and Treasurer, IR

Mike Uremovich – Chairman and CEO

Larry Yarberry – EVP and CFO

Brian Kane – EVP and COO – Intermodal Segment

Analysts

Tom Wadewitz – JP Morgan

Jon Langenfeld – Robert W. Baird

Alex Brand – Stephens, Inc.

Ed Wolfe – Wolfe Research

John Barnes – BB&T Capital Markets

Todd Flower – KeyBanc Capital Markets

David Campbell – Thompson, Davis & Co.

Operator

Ladies and gentlemen, welcome to the Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Joe Doherty, Vice President and Treasurer, Investor Relations. Please go ahead, sir.

Joe Doherty

Thank you, Ricardo. I'd like to thank you for joining us today for Pacer International's Third Quarter Earnings Call. Presenting today will be our Chairman and CEO, Mike Uremovich and our EVP and CFO, Brian Kane. Also present for the call today is our EVP, Larry Yarberry.

By now, you should have received our press release, which was issued at 4 O'clock Eastern Time today. In the press release, you will find a statement of operations reflecting our third quarter results compared to the same period last year as well as year-to-date 2008 compared to last year. Also included in the release is a balance sheet as of the end of the third quarter and a statement of cash flow for the first nine months of 2008.

And as usual, before we start our presentation, we need to make our normal disclosure regarding forward-looking statements and predictions of future operations. Such statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on management's beliefs or interpretations of currently available information. These statements and assumptions involve certain risks and uncertainties and the actual events may differ from expectations as specified from time to time in filings with the Securities and Exchange Commission. We assume no duty to update these statements as of any future date.

As information, a replay of this earnings release conference call will be available through November 28th on the company's Web site www.pacer-international.com. Also, by tomorrow, we will be filing our 10-Q with the Securities and Exchange Commission.

Now, I'd like to turn our meeting over to our Chairman and CEO, Mike Uremovich for some opening remarks.

Mike Uremovich

Thank you, Joe. Before we get started on the substantive issues today and Brian will take us through the numbers I wanted to take a moment to publicly acknowledge the contribution that Larry Yarberry has made to the company since its founding.

As many of you know, Larry will be retiring at the end of this year, and Brian Kane has moved into his role as Chief Financial Officer. But I don't want to go unsaid how much we appreciate the support and the hard work and dedication that Larry provided this company during its founding time and during its IPO and during last difficult economic time. But I did want to acknowledge that. So thank you very much, Larry, from all of us, we will miss you, and trust that we can call on you when and if we need some advice and counsel.

Larry Yarberry

Thank you.

Mike Uremovich

Okay. Having said that, what I would like to do now is turn to Brian Kane, our Chief Financial Officer and have him take you through third quarter results and the results for the first nine months of 2008.

Brian Kane

Thank you, Mike, and good afternoon, everyone. We appreciate you joining us. As Joe mentioned, this afternoon, after the market closed, we reported our third quarter results. In a difficult environment, we are pleased to report that our earnings per share was $0.59 versus our prior year earnings per share of $0.38. The current quarter did include a one-time tax benefit of $0.10 a share. Without the tax benefit, our EPS of $0.49, was up 28.9% over the prior year quarter.

Revenues for the third quarter were $556 million, an increase of $66.9 million or 13.7%. Net income was also up at $20.4 million as compared to $13.4 million in the comparable prior year period. Without the effect of the tax benefit, our net increase – net income increased $3.5 million or 26.1%.

For the nine months, our revenues were $1,584,000,000, up $155 million or 10% or 11%. Net income for the nine months was $48.5 million as compared to $33.7 million for the comparable nine months of 2007. And again, without the tax benefit of $3.5 million, our net income was up 33.5% over last year.

Looking at our liquidity, cash from operations was $49.9 million for the nine months of 2008 as compared to $74 million in the comparable period of 2007. 2007 did include the benefit of a legal settlement and the 2008 period included a cash payout of incentives.

In addition, we paid $10 million more in cash taxes in 2008 than in 2007, with a portion of this increase being the final balance of 2007 taxes paid this year. Our accounts receivable increase commensurate with the increase in revenues, and our day sales outstanding remains consistent with prior periods.

Overall, while our cash from operations is lower than the prior years, we continue to have a strong cash flow that allows us to reinvest in our business even in a tight credit environment.

Capital expenditures were $14.7 million, up $12 million over last year. This increase is due almost entirely to our investment in SAP. Total CapEx for the year are expected to be in the $20 million to $25 million range. I did mention the SAP. We have implemented the financial modules at seven of our eight business units, and we expect all business units to have the financial modules completely installed by the end of this year. The installations have gone well, and we expect to implement the on – excuse me, we expect to implement the operating system in a phased approach during 2009.

Our debt level at the end of the quarter was $44.5 million, and we paid down $12 million of debt in the third quarter, for a total repayment of $20 million during the first three quarters.

Given the recent turmoil in the credit markets, we may choose to increase our cash position rather than pay down additional debt in the fourth quarter. And our bank group supporting our credit facility remains strong.

I'd like to now get into some detail about our business segment performance. Revenues in our Intermodal segment were $430.2 million, an increase of $44.2 million or 11.5%. We had revenue increases in all three lines of business, Stacktrain, Rail Brokerage and Cartage. The majority of the revenue increase was driven by higher fuel surcharges.

Stacktrain's average fuel surcharge was 41.1% in the third quarter as compared to 21.2% in the third quarter of 2007. A portion of this increase was paid to our underlying service providers. Due to the timing of the underlying indexes, the cost side lags, and we expect an increase in our rail cost in the fourth quarter even though our fuel surcharge is currently declining.

From a volume perspective, the Stacktrain third party domestic volumes were 1.3% lower than the previous year. In an increasingly difficult freight environment, this was slightly better than the 3% decline we saw in the second quarter, but reflects the stiff competition in the wholesale market, lower trucking – lower truck pricing as capacity competes for the available freight.

Our Rail Brokerage domestic volumes were down 10.5% in the quarter as compared to the prior year. As we discussed last quarter, Rail Brokerage lost several bids earlier this year and we had a couple of significant customers that went bankrupt.

However, the Rail Brokerage volume that is on Stacktrain was only down 1.5% in the third quarter as we continue to make a strategic effort to sell the Stacktrain network. Overall, Rail Brokerage now represents approximately 28% of the Stacktrain third party domestic volumes as compared to 27% in the third quarter of 2007.

In the automotive line of business, our volumes declined 20.4% compared to the prior year. As we discussed in our last earnings call, we are continuing to see plant closings and significant sales declines among the automakers. Some of these closings are for significant periods of times.

The declines in the OEM manufacturer volumes obviously have an impact on Tier 2 and Tier 3 suppliers that we have been targeting for volume growth. Our outlook for volumes in the fourth quarter into 2009 in the auto line of business are for continued depressed volumes.

In the international line of business, our volumes declined in the third quarter by 8.4%, primarily due to the loss of a customer. This was a low margin account, and while we'll see a decline in revenue and volume on going forward, the operating income impact will not be significant.

Of the remaining customers, we did see volume increases, and our volumes were up 3.5% in the third quarter for these customers in a market where the overall international rail shipments are down.

Our Cartage unit saw positive revenue growth and growth in operating income. More importantly, our Cartage business continues to grow its share of pickup and delivery for our retail Intermodal business. Our retail (inaudible) increased at 11.2% in the third quarter of 2008 as compared to the third quarter last year.

Our overall Intermodal segment margin for the quarter, revenues less the cost to purchase transportation was 22%. This was down slightly from the prior year quarter, where the margin was 22.2%. While we did have the benefit of increased fuel surcharge revenues, these were offset by lower pricing to maintain equipment flows, increased costs from our underlying vendors, including fuel cost, and other higher costs associated with our BN volumes.

In our Logistics segment, we had operating income of $1.8 million in the quarter, as compared to $1.9 million in the prior year quarter. While we are not completely satisfied with the earnings level in this segment, we are pleased that we have moved past the losses incurred in the first two quarters of this year.

Specifically, our Transport business unit, which had been problematic in the first two quarters of this year had positive operating income in the third quarter. Our revenues in the segment were $126.8 million, an increase of $23.5 million.

We did see revenue increases in all the business units in this segment with the exception of Supply Chain Services unit, which was down 1.6% due to the loss of a customer late last year.

From an operating income standpoint, all business units in the Logistics segment were positive in the quarter, with the exception of Highway Brokerage. We saw year-over-year increases in operating income in our Warehouse business unit and continued strong performance from our International business unit as a result of the strong export market.

In our Highway Brokerage business unit, we are adding resources in a controlled fashion in order to grow this business. We are adding personnel and regionally focused teams to sales and carrier procurement in a controlled fashion to – in order to grow this business.

Each team has performance goals regarding volume levels at various points from their formation. We saw revenue growth in the third quarter of $3.1 million as compared to last year. However, our operating income for this business unit was down slightly, as the newly added teams have not yet ramped up to target volumes. We expect to see operating income grow in the future as these teams start to reach their performance goals.

Our SG&A expenses were up $3.1 million in the quarter. The increase was largely from an incentive accrual of $3.1 million, an increase in non-capital SAP expenditures of $1.6 million, and higher labor cost. In 2007, we had a restructuring charge of $2.4 million, which did not reoccur this year.

Our total employment, as of September 30th, was 1,566, an increase of 81 as compared to the end of the third quarter 2007. These headcount increases are primarily in the IT area, related to the SAP project, and increases in our Highway Brokerage unit as we discussed earlier.

We are also investing in an increase in our retail sales force, as we look to grow our capabilities in that area. Other than these increases, we remain diligent in controlling our SG&A cost.

Interest expense for the third quarter was $100,000, a decrease of $1.3 million from the prior year, resulting from decreased debt levels and reduced interest rates. In addition, we capitalized $400,000 of interest related to our SAP project.

As I mentioned above, we had a $3.5 million tax benefit related to the expiration of the federal statute of limitations on a portion of our FIN 48 reserves for uncertain tax positions. We do not expect this to reoccur in future quarters.

Without the benefit, taxes increased by $3.2 million in the quarter based on our increase in earnings. Our tax rate excluding the benefit was 40.9% in the quarter, and is commensurate with previous quarters. We expect our full year tax rate to be approximately 40%, excluding the one-time tax benefit.

Finally, our container count as of the end of the third quarter was 29,269 and our weighted average diluted share count was 34,847,000.

In summary, we continue to have a strong financial position and solid earnings in an increasingly difficult economic environment. We remain focused on our initiatives and are executing against them.

And with that, I'll turn it back over to Mike Uremovich, our Chairman and CEO, to discuss in more detail the status of the business and our initiatives.

Mike Uremovich

Thank you, Brian. And once again, thank all of you for joining us. Obviously, today's freight and financial market conditions are difficult and our crystal ball is no better than yours. We had a solid quarter in these tough conditions, and we remain focused on the fundamentals of the strategies that we can affect and that we know are essential for our future success. But, we can't do anything about the general state of the market, and we certainly can't stop any freight recession that might occur. We can and will stay focused on those strategies that we believe will create a prosperous and strong pace.

We have a good record as a high – in the high service industry as a strong intermodal and logistics provider, and we plan to continue to build on that position.

Our strategies remain the same as we have communicated earlier and I'd like to just touch on our progress in those areas. First, we will continue to have a world-class intermodal product that is valued by both our wholesale and retail customers. We have seen progress in that regard. Our customer satisfaction numbers are up, our service quality is competitive and improving, and we are holding our own in a tough market.

Pacer, at this point, does not participate in the shorter haul markets that have exhibited the strongest intermodal growth in recent months. We have always focused on the long haul transcontinental markets, where intermodal has traditionally enjoyed its strongest advantage.

When fuel costs rose dramatically, some of the shorter haul lanes became intermodal competitive, and Pacer was not at that time in a position to move quickly into those markets. Whether these markets remain strong as fuel declines is arguable, but we felt it more important for us to focus on our core business and prepare ourselves for a different rail environment. We may turn our attention to these markets if they appear sustainable.

It is admittedly tougher to grow market share in a soft economy, but it is something on which we remain focused. Intermodal may, as in 2001 to 2003, see its share versus truck improve as customers look increasingly for lower cost transportation. This could particularly be the case now that rail service has shown sustained improvement and reliability.

At the same time, we are seeing very aggressive truck pricing in some markets as carriers compete for dwindling freight. We remain very alert to market changes, and remain hopeful that any freight recession during 2009 would be modest.

Our second major strategy is to expand the use of our pickup and delivery services within our own network. We've seen progress here too. In those cities where we have established presence, our Pacer Cartage drivers now handle roughly 45% of direct Pacer business. This represents about one-third of our overall Cartage and we expect this number to grow. That number is up roughly 5 percentage points since this time last year.

We will continue on growing the driver fleet in major hubs of our network, adding cities where volume or opportunity makes it appropriate. We'll continue to consider acquiring in those situations. And while we have several under consideration, none are close enough to fruition that I can comment specifically on them.

Our third strategy is to improve performance and logistics where the record has been very mixed at best. We enumerated in earlier calls the difficulties in our Flatbed division, so I won't repeat them, except to note that third quarter performance was much improved and they seem to have begun the road back to traditional levels of profitability. As a matter of fact, they were profitable in the third quarter.

Brian took you through some of the details, but I want to emphasize that we remain committed to these businesses and believe they're an important part of our future. Our truck brokerage operations, international freight forwarding and NVOCC services, combined with transloading and warehousing, are all strong adjuncts to our core intermodal product.

Our final major strategy is to improve our productivity by implementing new integrated IT systems across the company. We have taken several important steps in that direction as well. As Brian mentioned, we're now on a common financial platform that will enable us to improve productivity, visibility and consistency across all units.

This transition went well. Though we had some of the usual expected initial hiccups, they were caused mostly by the change in procedures and the intended training of staff and did not occur because of any changes in the software.

We'll begin seeing savings in 2009 as a result of this, and some major cost reductions during 2010. Early next year, we will begin migrating some of the operating systems. The design phase of most of the systems is nearly complete.

While I wish we were doing these things in a better economic climate, we don't get to choose the timing. Pacer has a strong balance sheet and is a cash generator, and thus we are somewhat insulated from the liquidity crisis.

We have available resources to take advantage of opportunities and with our highly variable cost structure, can weather a significant economic downturn. We are not immune to economic downturns, and recent volume levels cause us considerable concern. Volumes did soften late in the third quarter, and there is a palpable sense of unease and concern across the entire customer base at the moment.

I've experienced at least a half a dozen economic disruptions during my career, and I cannot recall any six week or eight week period where things ever changed as quickly as this experience. These are very strange times and we have even less ability to predict next year or next quarter than usual.

While we may be in uncharted waters and no one can predict what the next 12 months to 18 months will hold, Pacer is a strong company with excellent employees and a product it's vital to our economy in both good times and bad. We know what we need to do, and we're making good progress despite these market conditions.

As many of you know, our situation is also affected by movement in fuel costs. During the fourth quarter, as Brian mentioned, we expect our fuel surcharges to be much lower than earlier in the year, and yet we will have some timing issues in that our fuel adjustments with the railroads are typically adjusted quarterly. This means we won't have the full advantage of lower fuel costs in the fourth quarter and its impact will be exacerbated by lower fuel surcharges assessed customers.

Given the steep decline in fuel and the rapidly softening market, we think our prior guidance may have been slightly aggressive, though it's certainly still possible depending upon how rapidly this market changes.

Last quarter I expected to end – I indicated we expected to end 2008 between $1.70 and $1.80 a share. Today, we believe this is still a realistic range including the recent tax benefit. Things have changed so rapidly and so dramatically in the last six weeks. It's very difficult to predict what will happen in the final quarter of the year. I think it would be very premature to offer any outlook for '09 at this point.

Today, at the board of directors meeting, they did authorize the payment of the regular dividend of $0.15 a share to shareholders of record on 12/22/08 and it will be payable 01/12/09. That's two days off the normal schedule as a result of a week-end interruption, but it was the normal dividend process.

I'd be happy to entertain questions, and to the best of our ability, Brian and I will try to answer them. Ricardo, you can go ahead and start, if you like, with the question queue.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Tom Wadewitz, JP Morgan. Please go ahead, sir.

Tom Wadewitz – JP Morgan

Yes, good afternoon.

Mike Uremovich

Hi, Tom.

Tom Wadewitz – JP Morgan

One – I guess one just clarification, first, before I get into more questions. On the earnings guidance – so essentially you including the $0.10 tax benefit now, but keeping a range, so effectively taking the range down to $0.10, is that (inaudible) the tax benefit. Is that the right way to read that, or am I interpreting that incorrectly?

Mike Uremovich

That's the right way to read that.

Tom Wadewitz – JP Morgan

Okay. What's the key driver in that? Is it just the way fuel has played out or – and that you're going to get – or it sounds like you'll get headwind from fuel in fourth quarter. Or is that more your concern that volumes would fall off sharply in the fourth quarter given the weakening in demand?

Mike Uremovich

It's a combination of both, Tom. And it's probably about 50-50 frankly. We have a problem with rapidly declining fuel, and yet we're going to be – we're going to have a fuel adjustment from the third quarter that was much higher. But I will tell you that volumes have softened depreciably. And we get such week-to-week variations that it's very, very difficult to build a prediction or a trend on what's going to happen to the rest of the year. So, I guess the direct response would be it's about evenly split.

Tom Wadewitz – JP Morgan

About evenly split? Okay. In terms of giving us a framework for thinking about the fuel impact in the quarter, from an earnings perspective year-over-year, do you think fuel was a greater impact in first quarter? Second quarter? Third? Was it kind of comparable across the three? Or if you look at with that kind of a framework, what – how would you characterize the fuel impact to earnings?

Mike Uremovich

We indicated in several of our earlier calls this year that there would be a lapping problem in the fourth quarter of '08 compared to '07 because of the behavior of fuel, and that's still the case. We just – I just don't know what it is. Brian, if you want to add anything to that --

Brian Kane

Just in terms of the fuel surcharge percentage, the biggest ramp up occurred in the first quarter, the second quarter of this year. The ramp up between the second quarter and the third quarter wasn't quite as great. So sort of consisting a little bit better in the third quarter than it was in the second.

Tom Wadewitz – JP Morgan

So, are you – Brian, are you talking about the earnings impact, so ramp in fuel surcharge net of the increase that you're paying for the railroads in fuel or are you just talking about the change in the surcharge?

Brian Kane

Specifically, I was referring to the change in our fuel surcharge, because as I mentioned, there is a lag in terms of the timing that the railroads come at us.

Tom Wadewitz – JP Morgan

From an earnings perspective, would the third quarter benefit year-over-year have been similar to second quarter?

Brian Kane

Yes, I think that's pretty fair. Maybe a little bit more in the third quarter, but they're not real inconsistent.

Tom Wadewitz – JP Morgan

Okay. Can you talk about order of magnitude what that fuel benefit was? Was it $0.05 or $0.10 or what kind of ballpark you be in?

Brian Kane

No.

Mike Uremovich

No.

Brian Kane

We've been reluctant to isolate one particular issue pretty consistently because of the timing and the impact varies widely across the units. So we have similar situations with other competitors in that a lot of our fuel surcharge ultimately. As I mentioned, our third party domestic product, a lot of that is sold through our retail channel, and there is a variety of fuel surcharges that get passed on to the customer. Some are better than others. There are timing issues with that as well. So it's a moving target.

Tom Wadewitz – JP Morgan

Okay. And then one more and I can pass along to someone else. In terms of the business you're doing with Burlington Northern, what is the volume look like in third quarter compared to second? Was there a further significant ramp? And, can you characterize how – what that would look like in terms of percent of your total volume – in the Intermodal.

Mike Uremovich

Yes. The answer to the first question is volumes have stepped up with the BN as we indicated we would be ramping those up. And as we've said previously, we're really not in a position to talk about specifically how much traffic is routed on which individual railroad.

Tom Wadewitz – JP Morgan

Did – are you making money on the BN business or is that still premature?

Mike Uremovich

The answer to that is yes.

Operator

Thank you, sir. Our next question comes from the line of Jon Langenfeld from Robert W. Baird. Please go ahead, sir.

Jon Langenfeld – Robert W. Baird

Good afternoon.

Mike Uremovich

Hi, Jon.

Jon Langenfeld – Robert W. Baird

Can you talk a little bit about the fuel and how it impacts kind of the customer discussions you're having? You alluded to a bit on the call in your prepared remarks about impacting shorter length of haul more than kind of traditional longer length of haul. So could you just go into that a little bit and tell us what you're hearing from your potential customers?

Brian Kane

I think the – what we're talking about in terms of the shorter length of haul is the rate – mileage at which something that may have gone truck before now is a little bit more competitive on the rail intermodal environment. Typically, a short haul along the East Coast was really the purview of the truck environment. With the rapid rising fuel, we got much more competitive overall the intermodal business. So that was really what Mike was talking about.

Jon Langenfeld – Robert W. Baird

And have you seen the – I know you don't get involved with it as much as there's out there, but have you seen that already start to occur?

Mike Uremovich

Seen what already start to occur, Jon?

Jon Langenfeld – Robert W. Baird

In terms of the shift away from intermodal to truck because of fuel prices coming down or less interest by customers, I guess I should say, to pursue that route given that fuel has declined.

Mike Uremovich

I haven't seen any backing away from our perspective. I think the operative environment right now is from a cost standpoint. Lot of customers are looking at their supply chain from an overall cost standpoint. Some are looking at intermodal, may not have looked at intermodal before or expanding their intermodal percentage. Hard to say what's going to happen as fuel comes back down at this point I think.

Brian Kane

It's hard to tell, Jon, because, at the same time that intermodal has some positives there. We've got a truck environment that is very competitive at the moment. So shifts back and forth from mode to mode are really hard to pin on any particular aspect of the transaction.

Jon Langenfeld – Robert W. Baird

Sure. Yes, that makes sense. And then just shifting gears a little bit to the pricing side within intermodal. How is that trended in recent contract discussions? And then could you also give us the yields on each of your segments within the intermodal side? You talked about the volume growth. Could you also give us the revenue per load?

Mike Uremovich

We could, but we would prefer not to speak to the yield on the individual lines of business. We've stayed within in order to be consistent with our reportings with SEC and things like that we will stay consistent with the segments.

Brian Kane

We have seen increasing price competition in some areas. The railroads have not raised rates – underlying rail rates for the most part, but they sure haven't come down either. And we are seeing an aggressiveness in certain competitive situations. So the – everybody is scrambling at the moment, Jon. I think it's again I want to emphasize this that the conditions under which we are operating today are dramatically different than they were only six or eight weeks ago, so it's awfully hard to tell how much of this is a current disruption and that things will get back on track more or less or whether it's some permanent change we just don't know at this point.

Jon Langenfeld – Robert W. Baird

And on the (inaudible) and I appreciate it's hard to split it apart, but you kind of alluded to the fact that some of the issue in the fourth quarter is the comparison, some of it is fuel prices. But core earnings look like they would still be down even independent of fuel given the external environment. Is that a good – ?

Mike Uremovich

I don't think – yes, in general, Jon, I don't believe we provide quarterly guidance in situations. I don't believe we ever have. And obviously, most of the remarks that I'm focused on right now are dealing with the third quarter. I'm – we are all nervous as I suspect everybody on the call is nervous about the fourth quarter and what's going on. So again it's very, very difficult for me to predict, other than to say I do believe we will still be, including the tax situation, in the $1.70 range to $1.80 range.

Jon Langenfeld – Robert W. Baird

Okay. Fair enough. Thanks.

Operator

And our next question comes from the line of Alex Brand from Stephens. Please go ahead, sir.

Alex Brand – Stephens

Thanks. Good afternoon, guys.

Mike Uremovich

Hi, Alex.

Brian Kane

Hi, Alex.

Alex Brand – Stephens

Mike, with respect to the fuel coming down a lot and potentially narrowing the gap between intermodal and truck, are – is that gap still pretty big or has it narrowed enough that it might – you – I heard you say that you haven't seen anybody change direction yet, but how much that gap narrowed as a result?

Mike Uremovich

Alex, I don't know. Fuel has been cut in half in how many weeks? How long does it take this to ripple through? You folks are all asking me fundamentally the same question, and I don't have an answer to what – why fuel is where it is or where it's going to be three months from now. So we have not seen any migration of business as a result of this. If oil stayed at $63 or whatever it's at today forever, would there be some migration? I suppose over time, yes. But, certainly we have not seen that, and I don't know whether it's going to stay there or not.

Alex Brand – Stephens

Okay. It sounds like, in the long haul, Mark, it's – that's less of an issue right now, anyway.

Mike Uremovich

Yes, it would be, because, again, the longer the market – the longer the haul, the greater the intermodal cost advantage. So, it does have much less impact on the long lengths of haul.

Alex Brand – Stephens

And Mike, it sounds like things have sort of dramatically weakened in the last few weeks, and I don't feel like I've heard your competitors talking – at least, not quite so ominously as what I'm hearing from you. Is there something specific you can point to? Is it international – or?

Mike Uremovich

I can tell you – as Brian pointed out, auto is down dramatically.

Alex Brand – Stephens

Right.

Mike Uremovich

And that's a significant piece of our business, particularly to and from Mexico. Our retail store – our business with retail stores has softened significantly. And again, whether this is a current inventory adjustment, whether it's short-term caution or what it is we don't know at this point.

Alex Brand – Stephens

Okay.

Mike Uremovich

Clearly the retail guys have slowed down, and I think you would find that to be the case across all of the competition.

Alex Brand – Stephens

Right. And just one more question then. It sounds like, in many ways, kind of the wrong time to be investing in other parts of the business. It feels like you're kind of spreading yourself out thinner. Can you just sort of comment on --

Mike Uremovich

I don't understand the drift of the business. How do you mean investing in other parts of the business?

Alex Brand – Stephens

You're hiring sales people in other parts of the business. You're investing in IT, which I think everyone agrees you have to do. But I mean you obviously feel like you want to expand (inaudible) invest in other parts of the business. Are you comfortable that this is the right time to do that?

Mike Uremovich

The answer to that is absolutely yes. Remember that the fundamental of our strategy is to build a world-class intermodal product that requires the pickup and delivery and requires the sales force to be out in front of customers and requires us to be able to offer the Truck Brokerage option. And we don't think that – whether the economic situation is particularly strong or particularly weak, that should alter our fundamental strategy. So we plan to continue to do that.

Alex Brand – Stephens

Fair enough. Thanks for the time, guys.

Operator

And our next question comes from the line of Ed Wolfe from Wolfe Research. Please go ahead, sir.

Ed Wolfe – Wolfe Research

Thanks. Congratulations, Larry.

Larry Yarberry

Thanks, Ed.

Ed Wolfe – Wolfe Research

Congratulations, Brian.

Brian Kane

Appreciate it. Thank you.

Ed Wolfe – Wolfe Research

Mike, can you talk a little bit – I just want to first confirm. The annual guidance, Brian, if I add up the first three quarters and I assume 59 for a third quarter, I'm getting $1.36, which is in flying range of 34 to 44 for EPS for fourth quarter. I'm looking at that right?

Brian Kane

Let me take a look at. I got to do the arithmetic here. Just a second. But, I think you are generally correct. We did add $0.59 this quarter.

Ed Wolfe – Wolfe Research

$0.59 plus $0.40 and – I did it wrong, because I was looking at '09 quarters. So 40 and 41 is 81. What you have for the first two quarters, 40 and 41? $1.40? Either 40 --

Brian Kane

I believe that's correct, Ed. I don't have that right in front of me.

Ed Wolfe – Wolfe Research

Can you talk about – I know you don't want to talk specifically about the fuel surcharge impact quarter-over-quarter, but am I thinking about this right if I think that you levy a surcharge on your client that moves up your customer that moves up and down? Is that weekly and then you reset it with the railroads every – it gets reset every quarter?

Brian Kane

The Stacktrain surcharge does adjust weekly. The retail side, those fuel surcharges will reset periodically. It depends on the customer. Some are weekly, some are monthly, some do not have fuel surcharges, so it – that's a mixed bag.

Ed Wolfe – Wolfe Research

What would you say the average is in retail? It sounds like it's less than quarterly. Is that fair to say?

Brian Kane

I would say it's less than quarterly on average, but I'd be hazarding a real guess.

Mike Uremovich

(inaudible).

Brian Kane

Yes, certainly, not weekly on average.

Ed Wolfe – Wolfe Research

And with the railroads, is it – which railroads is it quarterly, and which railroads, if there are some, is it not quarterly?

Brian Kane

I don't want to get into the specifics --

Mike Uremovich

Yes, we --

Brian Kane

on that.

Mike Uremovich

Yes.

Ed Wolfe – Wolfe Research

That's an average, again, quarterly with the railroads?

Brian Kane

No. I think it's a little bit different than that. There are some that are monthly and some quarterly.

Mike Uremovich

Yes, the rail fuel surcharges vary by railroad, and both the timing and the amount vary.

Ed Wolfe – Wolfe Research

Okay. What percentage of the volumes currently on Stacktrain are moving on UP?

Mike Uremovich

Ed, I said we wouldn't comment on that.

Ed Wolfe – Wolfe Research

I thought maybe you weren't listening (inaudible).

Mike Uremovich

Guys are all testing the new guy.

Ed Wolfe – Wolfe Research

Can you talk a little bit about direction of yields and margins on P&I versus UP?

Mike Uremovich

As we've indicated before, we certainly are paying higher rates on the BN than our legacy contract. We're not – we are bound by confidentiality agreements in both cases, so it's completely inappropriate for us to talk about margin differential.

Ed Wolfe – Wolfe Research

Is it fair to assume that the revenue that you achieved on one versus the other would be similar and assuming a similar lane, or is one where you can achieve a higher revenue?

Mike Uremovich

Generally speaking, as we said last time, we felt early on that we could get an increase – that we could get more money on the BN between the same two points as we could on the UP. And we price that way and discovered that that was not the case, that the market would not support the kind of differential that we wanted. So that today our view would be that both railroads are about the same where that's concerned.

Ed Wolfe – Wolfe Research

That's helpful. Thank you. One last one. On the IT systems, how do we think about Intermodal versus your Logistics unit? Is it one system that's going to do both, or is there a separate system? How do you have a Chinese wall with those two systems?

Brian Kane

From the financial side, everybody will be on the same general ledger package, AR, AP. The Intermodal – excuse me, the transportation or operation system will be primarily focused on the Intermodal leg first, but where we can make use of it in the other segments, we will. It's really a question of how fast can we implement.

Ed Wolfe – Wolfe Research

And again, the timing for the financial versus the transportation or operational side implementations are when?

Brian Kane

Yes, we'll have the financials done by the end of this year. There obviously is a little bit of learning curve from the user side, but we'll expect to start implementing some savings in the first quarter of next year. The transportation or operating system will be phased over in 2009.

Ed Wolfe – Wolfe Research

Thanks a lot, everybody, for the time.

Mike Uremovich

Thank you, Ed.

Brian Kane

Thank you.

Operator

And our next question comes from the line of John Barnes from BBT Capital Markets. Please go ahead, sir.

John Barnes – BB&T Capital Markets

Hey, good afternoon, guys. Real quick on the Cartage business, your investment there, is that investment increasing the asset intensity of your business?

Brian Kane

No. We use an owner-operator model. So we are out aggressively trying to increase our owner-operator fleet. But our investment is minimal in that. It's really trying to grow that piece of business via conversion of business that we already have and growing the fleet so we can add incremental business.

Mike Uremovich

Yes, and the – I'm not sure that even – our investment is in growing the fleet. It isn't a matter of us absent an acquisition in Cartage, it's not a matter that we're deploying cash resources to invest in equipment or those sorts of things.

John Barnes – BB&T Capital Markets

Alright. I just wanted to make sure that we hadn't seen any change there, especially given the – let me ask you the next question then. Success at recruiting owner-operators, obviously, smaller truckers, smaller owner-operators are the ones that have primarily gotten hit with the higher fuel costs and that type of thing? I think the data is fairly well understood that the sheer number of carriers that have gone out of business. So, any concerns about your ability to recruit additional owner-operators and having to change the strategy a little bit in terms of building that more through asset ownership than having a third party bring the asset to the table?

Mike Uremovich

At this point, there's no real change. Again, given the situation, it's hard to predict downstream. As you know, many of the people in our business, including our major facing competitors, have a mix of owned or company driver situations and owner-operators. We have tended to be much stronger in the owner-operator area and at least so far have been able to grow our business adequately in that using that model.

John Barnes – BB&T Capital Markets

Okay. Given the competition for the owner-operators, have you seen any major change in the cost of recruiting them into your network?

Brian Kane

No.

Mike Uremovich

No, really haven't. If you look at the glass being half full, we have freight available to us so hopefully that's an opportunity for us to continue our recruiting.

Brian Kane

One thing that we do see that was just pointed out to me by Dan Avramovich, who is the executive to whom the Cartage ultimately reports is, one of the things we have seen is that turnover has declined. Now, it's hard in those situations to say, did it decline because we're doing the right things, or did it decline because the market soft, but it's a little bit of both I'm sure. But the good news is the turnover's down.

John Barnes – BB&T Capital Markets

Okay. Very good. In terms of the competition, you made a comment earlier in the Q&A, conditions are much different versus six weeks or eight weeks ago, you have seen an increase in competition. Can you describe a little bit, what type of competitors? And I think this also goes to Alex's question on modal conversion. Have you seen – is it more from your intermodal competitors? Are you seeing the truck carriers get more aggressive? Is it – is the competition from carriers that are just out of balance on their lanes? Can you just give us a little bit of color where that's coming from?

Mike Uremovich

You don't know. I mean, you see the price in competition, and whether one of your direct intermodal competitors is responding to a perceived truck thing and you see it from the intermodal guy the truck guy is very hard to say.

Brian Kane

No, there is certainly some activity in the truck side that we've seen some aggressive pricing going on. And to some extent, in some areas you may be – maybe it's just reducing price, or it maybe that they have a back haul opportunity they need to fill in and they're lowering the price from that perspective. So it is hard to see.

John Barnes – BB&T Capital Markets

Okay. Can you give us an idea – I think there's still a portion of your business on UP that you're moving via the legacy contract, but there's also some business on the UP you're not moving, that's moving not on the legacy contract. Can you give us that breakdown?

Brian Kane

That mix remains the same as – I think we've communicated previously.

Mike Uremovich

I'd have to go back and look exactly what we said where that's concerned. We typically don't break all those down in great detail. I think we indicated that about 40% of the business is currently moving under the legacy contract.

John Barnes – BB&T Capital Markets

Okay. That's 40% of the UP business?

Mike Uremovich

That's – excuse me, about 40% of the business is not on the legacy contract. About 60% of the UP business is.

John Barnes – BB&T Capital Markets

Alright. So that is all the UP business. That's 100% – talking about 100% of the UP, 40% is non-legacy, 60% is still legacy?

Mike Uremovich

Round numbers, yes.

John Barnes – BB&T Capital Markets

Okay. Alright. That's close enough. And then, lastly – sorry, I wrote it down here and I misplaced it, I apologize. Alright, I'll get to the last one offline. I appreciate your time, guys. Thank you.

Brian Kane

Thank you.

Mike Uremovich

Alright.

Operator

Our next question comes from the line of Mr. Todd Flower from KeyBanc Capital Markets. Please go ahead, sir.

Todd Flower – KeyBanc Capital Markets

Hey, good afternoon, everybody.

Mike Uremovich

Hi, Todd.

Brian Kane

Hi, Todd.

Todd Flower – KeyBanc Capital Markets

Mike, or maybe Brian, can you directionally give us an idea of what net revenue margins in the Intermodal business could look like in the fourth quarter given what's happening to fuel? I mean, my guess is that they're going to be down probably pretty sizably on a year-over-year basis as well as sequentially. I mean, are we looking at net revenue margins in the mid-teen levels or still in the 20s, but the low 20s?

Brian Kane

At this point, I'd be hard pressed to speculate it. I don't think it would be in the mid-teen levels, but to be honest with you, I haven't really done that analysis yet. We --as Mike has indicated, there has been a significant rapid change in the price of diesel in our resulting index so.

Todd Flower – KeyBanc Capital Markets

--Yes. Just trying to brace a little bit for us so that's helpful. And then, I guess kind of along the same lines with the Logistics contribution for the rest of the year. Some of the softness that you saw at the end of the third quarter, what sort of run rate should we assume for Logistics during the fourth quarter given what we saw during the third quarter? Do we improve on that? Do we shrink a little bit from that? And give me a little bit of commentary about the kind of current environment for some of the Logistics offerings as gotten into the fourth quarter at this point?

Brian Kane

I'd say it probably won't go up substantially. I don't think it'll decline dramatically. We are seeing some – we have some good strength in our warehousing division. We're starting to see a little bit of softness in the export market from our international group. Highway Brokerage is still moving along nicely, although they're starting to get more calls from carriers seeking business at this point. But I don't think you'll see a dramatic change.

Todd Flower – KeyBanc Capital Markets

Okay. And then maybe just a little bit more specific on the timing of the UP – excuse me, the timing of the SAP implementation in 2009 as far as how the costs will ramp and when we should expect to see some of the cost savings from some of the personnel reductions. Will those mostly start to happen in the third and fourth quarter? And any sort of magnitude that we could start to think about related to headcount reductions as we see SAP become more functional?

Brian Kane

We will have the financials done by the end of this year, as I said earlier. And we'll start making some process changes as we get more comfortable with how that system runs and our comfort level is, our people have with it. So we'd probably expect to see those starting in the first and second quarter of next year. The operating system as Mike had mentioned, most of the design work is done on the configuration. We'll start implementing probably late in the first quarter, early second quarter. We're going to do the same thing on the operating side that we did on the financial side. We want to do it in a phased approach, so that we make sure that when we put something in, it goes very smoothly rather than doing a huge, big bang all across the system. So, I'd say, again, you want to keep one part moving – only one part moving. So we'll put the system in, make that change, get comfortable with it, and then we'll look at the process redesign on the back side.

Todd Flower – KeyBanc Capital Markets

And are the headcount savings larger from the financial implementation or the operation side of the SAP system?

Brian Kane

In a perfect world, what we want to do is we want to grow our business so that we don't have to cut headcount, but we can add the supplemental business without adding any headcount. That would be the best of all answers.

Todd Flower – KeyBanc Capital Markets

Okay.

Mike Uremovich

We don't look – productivity is not a matter just of flashing headcount, and I don't want to signal that we're looking at SAP as a way, necessarily, just merely to reduce headcount. We're going to alter processes and do better at what we do, but you can't – you got to do your business in the right way, we are committed to getting the savings, we will get them, whether they come from headcount reductions or not is far too premature to say.

Todd Flower – KeyBanc Capital Markets

Okay. No, that – that's fair enough, Mike. And then, I guess just lastly here, it sounds like there was a board meeting recently talking about, the balance sheet and certainly some capital and understanding what's going on in the credit markets. It certainly sounds like it's prudent to squirrel away a little bit of cash in this environment, but with the stock at these levels what was your thought process or what was the board's thought process or what would it be, I guess, if you saw a little bit of a normalization in the credit markets? Would it be to be more aggressive on the share buyback at these levels, or would it be to continue to pay down debt? And then, was there any discussion about continuing to pay the dividend on an ongoing basis?

Mike Uremovich

Obviously, it's inappropriate to talk about board discussions, but we think it is prudent to hold a little cash right now. And I think at this particular point, given the volatility of both the financial markets and the freight markets that it's only prudent of us to be careful, and we haven't come to any real conclusion as to how additional cash or the cash that we will generate will be used. It could be used in any one or a combination of ways in terms of paying down debt. It could be used relative to share buyback, it could be used for acquisition, it could be used for a number of different things. The dividend for this quarter was certainly reaffirmed in today's board meeting, as a matter of fact, as I said, and that's we are where we are I guess is the best way to put it.

Todd Flower – KeyBanc Capital Markets

Okay. Understandable. Thanks for the time.

Operator

Thank you, sir. And our last question comes from the line of David Campbell from Thompson, Davis. Please go ahead, sir.

David Campbell – Thompson, Davis & Co.

Yes, thanks very much. I want to ask you about the Cartage situation in the L.A. and Long Beach ports with the requirement that the tractors be a lot newer and your costs going up. Is there – can you pass on those cost increases to your customers?

Mike Uremovich

At this point, I guess we would not subscribe to the fact necessarily that costs are going up. It is true that there are new programs being introduced in Southern California that will require an upgrade to the owner-operator fleet, and we are examining how best to do that. We have a concession agreement with the port. The situation is still very, very dynamic. The ports are changing the rules virtually every day. They changed them as recently as yesterday. So again unfortunately David, this is a situation where I can't tell you how we're going to end up in that regard. For those of you who are not familiar with it, what it is a certain mandate relative to emission standards on vehicles that will gradually phase out older vehicles and replace them with new EPA-compliant vehicles. It's just – I don't know. It's just not clear how that's going to develop. We are in the midst of reacting to the situation. The whole imposition of these requirements is still in litigation. We don't know what the Ninth Circuit Court of Appeals is going to say to the most recent situation. So I wish I could be clear, David. I wish I knew, because it would make our job a lot easier, but right now, I honestly do not.

David Campbell – Thompson, Davis & Co.

Thanks. And with regard to business in general, I mean, the last conference call in July – I guess really August – you were saying some of the same things, how business fluctuated substantially from week to week and you really had a hard time figuring out, how the quarter would end up and so forth and so on, and then you ended up with a pretty good quarter. I mean, did things get better before they got worse or what happened?

Brian Kane

We stay focused on the tasks that we have, and Mike has outlined them, and we're trying to keep focused on those things that we can control and I don't want to say ignore those we can't, but stick to our knitting. We're always a little bit cautious I guess. We did see a very short – if you want to even call it a peak in late September/early October down in Southern California, and it started very quickly and it ended just as quickly, almost seemed like it shut off overnight. So, it's a difficult environment. We're just slogging through it as best we can.

David Campbell – Thompson, Davis & Co.

The last question is if the profits are down as much as you're suggesting in the fourth quarter, would the incentive bonus compensation accruals be the same as they've been (inaudible) about $3 million a quarter?

Mike Uremovich

What are you – down relative to last year you're talking about?

David Campbell – Thompson, Davis & Co.

Yes.

Mike Uremovich

Remember that the incentive plan is based upon goals and objectives that are established early in the year and for the entire year when we publish them. They are not established quarterly. And last year we had several unusual items in the fourth quarter that drove us to the – I recall, something like $0.60 level or something --

David Campbell – Thompson, Davis & Co.

Right.

Mike Uremovich

in that range. And we knew when we put the plan together, the incentive plan together, it would not occur in 2008. So, as far as we're concerned, our profit performance right now is on the track that we have established. And if the bonuses aren't earned based upon what was provided in the earlier disclosures, they will be paid.

David Campbell – Thompson, Davis & Co.

Okay. Thank you.

Operator

Thank you, sir. Please continue. There are no more questions.

Mike Uremovich

Okay. I want to thank everybody again for joining us. If any of you have a clear crystal ball and might be willing to tell me where to invest or how to do some of these things I would certainly be pleased to hear it. And – but, again, thank you for joining us. And you can feel free to call either Brian or myself, even Mr. Yarberry, I suppose, if – over the next 30 days or so if you like.

But, again, I want to express our appreciation to Larry, and I know all of you will join me in wishing him a very happy retirement. Thank you very much.

Operator

Ladies and gentlemen, this conference will be available for replay after 6 p.m. Central Time today through midnight November 28. You may access the AT&T Teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 960465. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844, access code 960465. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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