Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Con-way Inc. (NYSE:CNW)

Q4 2012 Earnings Call

February 7, 2013 8:30 a.m. ET

Executives

Patrick Fossenier - VP, IR

Douglas Stotlar - CEO, President

Stephen Bruffett - CFO and EVP

Gregory Lehmkuhl – President, Con-way Freight

Bob Bianco – President, Menlo Logistics

Analysts

Ken Hoexter - Bank of America/Merrill Lynch

David Ross - Stifel Nicolaus

Chris Wetherbee – Citi

Brad Delco - Stephens

Bill Greene - Morgan Stanley

Todd Fowler - KeyBanc Capital Markets

Scott Group - Wolfe Trahan

Tom Kim – Goldman Sachs

Tom Wadewitz - JP Morgan

Chris Ceraso - Credit Suisse

Justin Yagerman - Deutsche Bank

Ben Hartford - Baird & Co.

Operator

Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to Con-way Inc.'s Fourth Quarter Earnings Review Conference Call. (Operator Instructions) Thank you.

I would now like to turn the call over to Patrick Fossenier, Vice President of Investor Relations. Please go ahead, sir.

Patrick Fossenier

Thank you, Brandy. Welcome to the Con-way Fourth Quarter and Year-End 2012 Conference Call for shareholders and the investment community. In a minute, I'll turn it over to Con-way President and CEO, Doug Stotlar.

Before we get into the call, I'd like to offer a few reminders. First, certain statements in this conference, including statements regarding anticipated results of operation and financial condition, constitute forward-looking statements and are subject to a number of risks and uncertainties. Actual results of operation and financial condition might differ materially from those projected in such forward-looking statements, and no assurance can be given as to future results.

Additional information concerning factors that could cause actual results and other matters to differ materially from those in the forward-looking statements and the inherent limitations of such statements is contained in our Forms 10-K, and 10-Q and other filings with the SEC.

Second, today's prepared remarks contain non-GAAP financial measures. Reconciliations of GAAP to non-GAAP financial measures are found within the financial tables of our earnings release, which is available on our website at con-way.com.

We understand that there are other industry calls today, so we'll be sure not to go over an hour on this call. I'd also like to note that we have a lot of people on this call, so we'd appreciate it if you'd could limit yourself to a question or 2 then return to the queue.

Now, without further ado, I'm pleased to turn it over to Doug Stotlar.

Douglas Stotlar

Good morning. On the call today, I'm joined by members of our senior leadership team, including Con-way's CFO, Steve Bruffett; Con-way Freight President, Greg Lehmkuhl; Menlo Logistics President, Bob Bianco; and Con-way Truckload President, Saul Gonzalez.

Steve will provide some commentary on our financial picture, and Greg, Bob and Saul will participate in the Q&A portion of the call.

The fourth quarter results reflected good cost controls, strong productivity. This helped us mitigate the effects of weak business conditions which were dampened by several macro factors, including an uncertain political environment in Washington and the market disruption caused by Sandy.

Turning to our financial results for the fourth quarter of 2012, Con-way reported consolidated revenues of $1.36 billion, a 3.4% increase over last year’s fourth quarter revenues of $1.32 billion. On an operating income basis, we earned $37.8 million in the 2012 fourth quarter compared to $49.9 million last year. The 2011 fourth quarter included a $10 million gain from the settlement of a dispute related to Chic Logistics.

Diluted earnings per share were $0.21 compared to $0.41 per share in the prior year period. On a non-GAAP basis, earnings per diluted share in the 2012 fourth quarter were $0.26 compared to $0.27 in the prior year. The 2012 period included the effects of certain tax items while the 2011 fourth quarter included the gain from the Chic settlement as well as other tax adjustments.

Looking at the full year for 2012, Con-way reported revenue of $5.58 billion, a 5.5% increase over 2011. Net income for 2012 with a $1.85 per diluted share were $104.5 million compared to $1.58 per diluted share or $88.4 million in 2011. Full year 2011 results included the $10 million gain from the Chic settlement and $6.7 million of discrete and other tax adjustments. On a non-GAAP basis, 2012’s full year earnings came into $1.86 per share compared to $1.54 in 2011.

Moving now to a review of our business segments, I will start with Con-way Freight, our LTL company. Con-way Freight posted fourth quarter operating income of $21.5 million, a 9.9% increase over the $19.6 million earned in the fourth quarter a year ago. While we did improve operating efficiencies and increase yield, these results were affected by accelerated decline in daily tonnage at the close of the fourth quarter that exceeded normal seasonality. Revenue was $824.7 million, a 3.6% increase over the last year's revenue of $796.2 million. The increase was mostly attributable to improved pricing and higher fuel surcharge revenue, partially offset by a 3.5% decline in tonnage.

Con-way Freight’s operating ratio this period was 97.4 compared to 97.5 in last year’s fourth quarter. Revenue per hundredweight, or yield, increased 5.1% in the quarter compared to the prior year. Excluding fuel surcharge, the increase in yield was 4.2%. A portion of the yield increase was attributable to higher length of haul.

Comparing tonnage for the three months and the 2012 four quarter on a year over year basis, October tonnage was down 3.1% and November declined 2.1% and December was down 5.7%. Through January we saw tonnage bounce back a bit. On a year over year basis, January’s tonnage this year came in at 1.2% below January of 2012. Entering 2013, we continue to execute our three year strategic plan at Con-way Freight. I’d like to remind you that the work we are doing has been extensive and represents hundreds of employees putting in thousands of hours of development over the past year.

As we outlined last year, our teams have done a heavylifting to develop the framework and the models for two transformative initiatives, lane based pricing and dynamic line haul optimization. We are on track with implementing the process improvements and their underlying technologies on a network wide basis.

With respect to our line haul initiative, we have built new capabilities to dynamically adjust the operation of our network to adapt as freight flow rate is changed. This is a multi-staged project, we are on schedule and deploying the initial stages this stage. We expect to see incremental improvements build as each stage rolls out. Under our lane based pricing initiative we are applying new measurement analysis tools to better our customers’ freight profile and how they impact our network. As we work through our book of business and employ these new methodologies with more of our accounts this year we are incenting our customers to use our network where we can best leverage our operating cost structure.

What will sustain these technology and process based improvements is the ongoing development of our lean-based culture, respecting our people, tapping into their knowledge and helping them develop eyes for waste are the keys that will drive our long term success. Our lean based culture is the key to continuously improving after these initiatives are implemented. We remain focused on our strategic initiatives and we continue to be excited about the opportunities they’re creating for our LTL company.

Now we’ll move to our logistics segment. For the 2012 fourth quarter Menlo Worldwide Logistics, our global logistics and supply chain management operation, posted higher revenues and net revenues but saw an operating income decline. Menlo’s operating income this period was $8.6 million which was below last year and included a $2.3 million increase in reserves for international bad debt. In the 2011 fourth quarter Menlo’s operating income of $21.3 million included the benefit of the $10 million gain related to Chic Logistics.

Revenue for the quarter was $431.2 million, an increase of 5.5% over the prior year revenue of $408.9 million. Net revenue or revenue minus purchased transportation came in at $161.8 million, a 2,7% increase from $157.6 million in the previous year period. Net revenue grew at a lower rate than gross revenue as some of Menlo’s larger warehouse management customers saw reduced activity as a result of the weak economic environment.

Moving into the new year, January concluded in a more positive manner as volumes with some existing customers began to rebound. We also are encouraged by the strength of Menlo’s new business pipeline as well as the quality of the prospects we are pursuing.

Now I will review the results of our truckload segment. For the 2012 fourth quarter, Con-way Truckload had operating income of $8.5 million compared to $9.5 million last year. The fourth quarter operating income was lower primarily because of $2.2 million in additional costs for vehicular claims from accidents most of which occurred in prior years. Revenue of $155.2 million was essentially flat with last year’s fourth quarter revenue of $155.6 million. Last year Con-way Truckload experienced a surge in business late into the fourth quarter whereas this year volumes reflected weaker demand patterns.

In January after a slow start, we saw a rebound in load count in the second half of the month, a trend which has continued into early February. Revenue per loaded mile, excluding fuel surcharge, increased 2.3% over the previous year. The operating ratio ex fuel surcharge was 92.9 compared to 92.1 in the year ago period. Con-way Truckload benefitted from consistent operational execution in the fourth quarter as well as low driver turnover in a stable rate environment. With its focus on delivering premium service, while effectively managing costs Con-way Truckload is well positioned for further margin expansion this year.

Now I will turn it over to Steve

Stephen Bruffett

Thanks Doug. Good morning everyone. I will begin with our full year 2012 cash flows. Our cash generated from operations totaled $311 million which compares to $345 million in 2011. On a year over year basis, operating cash flows benefitted primarily from higher net income and depreciation, and the main items that more than offset this benefit included cash impact of income taxes and employee benefits.

Net capital expenditures were $281 million in 2012 which was slightly below our guidance as some of the cash outflows for tractor acquisitions that were originally planned for late 2012 occurred in early 2013. Financing activities consumed $54 million in 2012 primarily related to payments of the capital leases and cost dividends. In total this cash activity resulted in the balance of cash, marketable securities totaling $433 million at year end 2012 which compares to $451 million at the prior year end.

Moving now to the balance sheet, the funded status of our defined benefit pension plans improved slightly from the prior year end valuation. The liability increased as a result of the lower discount rates, however the combination of asset returns and cash contributions grew the assets more than the liability. And this resulted in the improved funded status for accounting purposes.

On the income statement, there are a couple of additional items to highlight. First, healthcare expense for the fourth quarter was $49 million which was close to our expectations. This compares to $48 million in the fourth quarter of 2011. For the full year healthcare expense was $193 million in 2012 compared to $172 million in 2011. As we noted on the last call, we implemented program changes for 2013 that are designed to mitigate inflationary pressure on healthcare expenses.

Next, our effective tax rate for the fourth quarter was 50% which is unusually high. That’s due to discrete items and adjustments to state, international tax provisions. For the full year, the effective rate including discrete items was 38.8% compared to 40.3% in 2011.

I’d also like to reiterate comments we made last quarter regarding an upcoming change in how we report income or expense related to our defined benefit pension plans. Our practice up through 2012 has been to allocate this income or expense to the business unit. Beginning in 2013, we will retain pension related items at corporate level and report them in the corporate and elimination section of our financial statements. Defined benefit pension plans are fully frozen and therefore have no service costs associated with them. The income or expense related to these plans is predominantly driven by long term discount rates and to a lesser degree corporate decisions regarding pension funding and asset allocation. As such our legacy pension plans have little to do with the ongoing operating results of our business units.

On our website, we posted a schedule of historical quarterly information showing the amount of pension income or expense that was allocated to our business units over the past three years. So you have full visibility to the impact of this change.

Before I turn it back over to Doug, there are few forward looking items for your modeling purposes. First, we expect that our defined benefit pension expenses will be approximately $4 million for 2013 compared with $10 million in 2012. The decrease in annual expense is the result of improved funded status that I described earlier.

Next, we expect depreciation and amortization expense to be approximately $233 million, that’s up from $216 million in 2012. Also, we anticipate that our 2013 effective tax rate excluding discrete items would be approximately 37.5%. Including discrete items our all-in tax rate is expected to be even lower than that. But since there are few moving parts within our tax rate and that we anticipate in 2013 merits a brief overview.

The fiscal cliff legislation included the extension of the propane tax credit for both 2012 and 2013. However given the timing of the legislation, we’re required to recognize the benefit of both years in 2013. Since the law was enacted in early 2013, the 2012 benefit of $3.3 million will be recognized as a discrete item in the first quarter of 2013 and as such our all-in tax rate including discrete items is expected to be unusually low in the first quarter.

However the 2013 benefit from the propane credit is not a discrete item and therefore will be recognized ratably throughout the year. And that’s the primary reason that our guided rate for 2013 is 37.5%. That’s slightly below what we would consider to be our normalized tax rate of 38.7%.

So moving on to our share count, we expect fully diluted shares for 2013 to be 56.9 million and we also expect 2013 capital expenditures to total about $300 million. This amount is consistent with multi-year capital plan established in 2010 and we are making steady progress toward the fleet ages that are most efficient for operation. Also the 50% bonus depreciation was available once again as it was in 2012 for these 2013 capital expenditures.

Finally, we expect to fund the pension plan with a steady contribution level of between $50 million and $60 million in 2013. This amount which approximates the pension benefits that are paid annually beneficiaries of the plan could vary depending on a variety of factors.

So with that, I will turn it back over to Doug.

Douglas Stotlar

Thanks Steve. We made steady progress developing our lean based culture and preparing for the deployment of our key strategic initiatives at Con-way Freight. As we have outlined previously we expect to see the benefits of these initiatives start to accrue in the second quarter and then build throughout the second half of the year. We are focused on those areas of business that present the highest leverage opportunities. We have validated our ability to impact operating metrics through lean and we have a workforce that is engaged and motivated to succeed. All this gives us confidence in our plans and the opportunities ahead to improve our financial results.

And with that, operator, we’re ready to open up the phone lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ken Hoexter with Bank of America/Merrill Lynch.

Ken Hoexter - Bank of America/Merrill Lynch

Doug, can you talk a bit more about the process here on the lane based pricing and the line haul optimization? It seems like there is I guess a potential for – I guess what rate should we expect the improvement as we move into 2013? Is this something we're going to see some step functions on the gains here and eventually onto the operating ratio or is it something that will come in on a progressive basis?

Douglas Stotlar

Ken, we expect the benefits to accrue on a progressive basis throughout the course of the year but I am going to turn it over to Greg to provide a little more color on these initiatives.

Gregory Lehmkuhl

Sure. So on the pricing side as we discussed last quarter, we’re using a lane based price process to (inaudible) our customers to use our network where it makes sense and where we can be more profitable. We’re focused on our largest 360 accounts which constitute a little bit more than half of the company's revenue. The account negotiations are spread fairly evenly across the year. So for example, so far year to date we have negotiated 35 of 360 and so far they are on track with both from a timing perspective and from a results perspective. So as the year goes on they will bear more fruit and you can see the progress accrue.

Ken Hoexter - Bank of America/Merrill Lynch

If I can just follow up with that on the optimization, should customers expect as you change the routes and the structure, should they expect any impact to service, or I just want to understand the process as you roll this out what the expectations should be in terms of the service levels and the like?

Gregory Lehmkuhl

I would say the service levels would not be impacted. We continue to provide a very high level of service to our customers. Both of these decisions are internal and happen really kind of behind the scenes from the customers’ standpoint. So we should not see an impact to service.

Operator

Your next question comes from the line of David Ross with Stifel Nicolaus.

David Ross - Stifel Nicolaus

Greg, why is the LTL business picking up more long-haul freight, length of haul jumped up 4% year over year in the quarter. Is that on purpose – that these customers coming over, can you explain that?

Gregory Lehmkuhl

Sure. So we did see an increased length of haul in Q4. It was primarily driven by a few major accounts that decided to utilize our network a little bit differently and use this in longer lengths of haul lanes. That trend did moderate a little bit in January. Without the freight mix changes our yield increase would have been closer to 3%. So we did have an impact on yields. But I do want to be clear we're not targeting any specific length of haul or freight type, each lane in the account is different based on the commodity, the pricing and the lane characteristics like that balancing capacity.

David Ross - Stifel Nicolaus

And then just a couple of questions for Bob on Menlo. The reserve for bad debt, was that in a specific region? And then also, some of the larger warehouse management customers had lower activity in the quarter which hurt margins. Can you give a little color on what industry those might have been in? And he last question is tighter margins on new business, was that due to a change in mix, different kinds of logistics business coming your way, or was that due to tougher pricing environment competitively?

Stephen Bruffett

Dave, this is Steve Bruffett. If I can handle the bad debt one and then Bob can step in on the remainder of your operational questions there. The bad debt reserve does involve a specific internationally-based account that we have assessed indeed through the poster reserve based on the facts that we had at the time. Some progress has been made since that point in time, but we're going to continue to monitor that situation and adjust accordingly just like we would with any other account. It is related to one specific account outside of North America.

David Ross - Stifel Nicolaus

Is it in Asia, is it in Europe?

Stephen Bruffett

We don't really comment on specific regions but it is outside the US.

Bob Bianco

Dave, this is Bob. So the volume declines in our existing business that was – we really saw it across the board in our industry groups. And as far as the new business and the tighter margins, in our project-based business when we start up projects we’re usually under fixed budgets. And so as we go into the startups, we do the systems integration, we do the training, hiring all of that, and sometimes we exceed those budgets. So it will have an impact on margins. So our start-up activities usually come in at lower margins until the account of the project is up and running and stabilized.

David Ross - Stifel Nicolaus

Bob, is there an opportunity for you to go and recover some of those extra costs?

Bob Bianco

Yes, sometimes but it varies by account and by project.

Operator

Your next question comes from the line of Chris Wetherbee with Citi.

Chris Wetherbee – Citi

Maybe just back on the pricing side a little bit, not sure if I caught it if you said it, pricing in January just wanted to get the rough trend, it sounds like length of haul was fading little bit too. Just wanted to understand kind of how we should think about pricing in the first quarter?

Gregory Lehmkuhl

So length of haul did moderate, it was up about 3% in January. From a pricing perspective we continue to see the same trend continue. We're getting low to mid single digit increases from our national accounts. And we don't see that slowing down.

Chris Wetherbee – Citi

And when I think about the – I think you laid out the cost picture for ‘13 pretty well. Are there anything else we should be thinking about from either an IT cost perspective or implementation cost around some of the initiatives whether it be lane based pricing or some of the line-haul initiatives?

Stephen Bruffett

This is Steve. I’ll jump in on the IT question. We do expect that there will be occasional pockets like I tried to describe last quarter of implementation costs as we rolled out some of the new technologies. They should be limited to a few million dollars of extra expense at certain points throughout the year. So it’s not like there will be tens of millions of costs hitting a quarter in additional IT costs but there will be occasional pockets of costs as we replace old technologies with new which requires some transition and implementation costs. But I think that it should be extraordinary, we may speak to it to provide additional context around a given quarter. But I don't think those amounts will be abnormally large.

Gregory Lehmkuhl

And outside of IT there's no real incremental cost on the lane based pricing side. On the linehaul initiatives we do have premium expense -- for that training expense in the first half should be more than offset by gains in productivity.

Chris Wetherbee – Citi

And just when you think about the productivity and the potential benefits that you may accrue in ‘13 from your initiatives that you’re working on, can you give us some rough kind of margin guidelines to think about when we look at the freight division? Any kind of help to try to quantify what maybe some of these benefits should look like as we get into the second quarter and the back half specifically as they start to occur?

Douglas Stotlar

Chris, we’re not giving any real guidance or targets around these improvements. But I can tell you that we truly expect our margins -- our expanded margins to really progress as we go through the year. As we look at this first portion of the year, we're just getting rolling with these new initiatives. Recall last year that we had virtually no winter weather to speak of, this winter we’re already experiencing a little more of that. And then, we had a tonnage surge last year at the beginning, the first half of the year that provided some lift for the whole industry and we don't know how the first half of this year's going to work out from a tonnage standpoint. But we are being successful in implementing our initiatives, we are starting to see that the results that we want to get from these initiatives are starting to come to fruition. And we expect the margin improvements to continue as we said, really getting some traction in Q2 and then progressing as we go through the year as we work through the entire 360 accounts that’s really targeting our lane based process and the linehaul initiatives are able to optimize our cost structure for moving that tonnage.

Chris Wetherbee – Citi

That 35 on the account that you’ve touched so far, do we get a sense of how that looks like best year to date through January and maybe how we should think about that through the first quarter or two?

Gregory Lehmkuhl

That’s a year to date through today. And as I said they’re fairly evenly spread throughout the year.

Operator

Your next question comes from the line of Brad Delco with Stephens.

Brad Delco - Stephens

First question on these initiatives that you guys are trying to roll out, I guess what I'm trying to understand, what type of environment do you need, i.e. is this a process in which, as you're going to these 35 customers, are you bidding on different lanes so we could see length of haul kind of shift throughout the year, are you targeting different types of freight? Just what I am trying to get at it is do you need tonnage growth in order to achieve some of these margin targets or is it really just a selection of freight within your network?

Gregory Lehmkuhl

So the simple answer is, we don’t need tonnage growth and it is the flagship freight within our network. Our lane based approach is laser focused on profit improvements and every single lane in every single account is different. So for example, there will be some lower length of haul lanes that are very profitable where we may lower the price to grow the business and that will lower our yield but increase our profits. And there could be lanes or there will be lanes where we are asked to be removed from certain business because of unprofitable and those could be longer length of haul lanes. Again that could lower yield but increase profits. So with so many variables going into the yield calculation, length of haul, specific density, pricing it’s really difficult to say how our yield metric will trend in ‘13. Revenue could be flat or could even decline slightly and we’d be fine with that because revenue and the yield metrics aren’t the game here, our profit is.

Brad Delco - Stephens

So I guess with the accounts that you have been going through thus far, do you feel like the customers are understanding the process you’re going through and you haven’t necessarily seen a lot of churn in the freight i.e. there -- that you are happy with what you are keeping in the network.

Gregory Lehmkuhl

Yes, I think your last statement is right on. So far we are very pleased that we are actually right on target on what we thought would happen. There are some accounts where we shed some business, there are others where we have grown the business. And in just about everyone the mix has changed favorably for us. And so the sales and pricing teams are going into the customer 120 days before the contract expires with a very clear picture of how the business operates for us and what the options are for renegotiation and mix change. So it’s a very proactive collaborative approach with the customers and in aggregate they have been very receptive. And I think a lot of that is just because we have been so transparent and clear on what our goals are.

Operator

Your next question comes from the line of Bill Greene with Morgan Stanley.

Bill Greene - Morgan Stanley

Just following up on this, in the past we’ve sort of talked about this effort to get pricing up. And I just want to understand is the way we’re going to perceive these changes to your pricing dynamics such that it’s going to appear to us that you may be sort of making trade-offs more often here, tonnage versus price where it seems like for the last few quarters at a minimum and maybe even a bit longer there’s really been – look, we will shed some business if we get price and that’s okay because we’re trying to get the margins higher. Do you see I mean -- are we walking away a little bit from that discussion and focus more on just mix even if that means what will perceive as lower yield?

Gregory Lehmkuhl

Yes, and again it may or may not be lower yield. I don’t think it will be. Tonnage is probably the thing that could be most impacted this year. But again, before we would look at overall account, say it’s operating at call it 115 and (inaudible) 6% or 7% rate increase and we take kind of across the board approach. Now we're being much more strategic and dissecting that customer lane by lane in understanding the lanes that operate at 130, the lanes that operate at 80, all the additional business that the customer has that we could potentially grow with and try – and coming up with a collaborative solution to the customer that impacts our margins in a way that is more positive than across the board increase would be.

Bill Greene - Morgan Stanley

And then on the comments you made on truckload, if I might have not gotten this exactly but it sounded like you said that you’re seeing some good trends in January, that’s continued into February. Can you comment at all on early indications on LTL in February, did we get a sort of continued improvement throughout Jan that would suggest that is getting better on tonnage or how is the quarter sort of shaping up from your perspective?

Gregory Lehmkuhl

I don’t have the exact number for the first three days in front of me but it’s on a year over year basis it’s a little bit worse than January, call it about 2% down from depreciation (ph).

Bill Greene - Morgan Stanley

And then if we look at the historical sequential change that occurs on your operating ratios during the first quarter, a lot of moving parts here. So is seasonality a good rate to be thinking about trend here or will these changes result in something better?

Stephen Bruffett

This is Steve. On that one as we’ve indicated the benefits of these efforts will show up as we move through the year, later in the year, second half in particular. So first quarter I would not anticipate big sequential differences as a result of the initiatives themselves and how the first quarter in particular turns out, there’s still a lot of that game to be played, you may know that March is a disproportionately large portion of the first quarter. If you look at the composition of months in each of the quarters throughout the year first quarter is unique in that March plays a very significant role in how things look. And so there’s still a lot to be determined about the first quarter yet but off to a decent start I would say.

Operator

Your next question comes from the line of Todd Fowler with KeyBanc Capital Markets.

Todd Fowler - KeyBanc Capital Markets

Just a couple of questions on the cost side within the freight segment, I think if I understand the remarks correctly, is the way healthcare set up is that you change the plans to mitigate any inflations so the expectations should be that healthcare is relatively flat, number one, if that is right. And then number two, there was some comments on the linehaul costs and it sounds like there are some training initiatives in the first half of the year but do you have any directional comments on what we should expect for linehaul rates – linehaul costs in 2013?

Stephen Bruffett

This is Steve again. I will handle healthcare, Greg can tackle the second half of the question. On healthcare to be clear the actions we have taken are intended to help mitigate cost increases but not necessarily eliminate healthcare cost increases. So we would expect some degree of medical inflation to occur but no above normal or above market inflation in those cost sides.

Todd Fowler - KeyBanc Capital Markets

Is it fair to think about mid single digits from market cost inflation to healthcare side?

Stephen Bruffett

Yes.

Todd Fowler - KeyBanc Capital Markets

And the linehaul piece?

Gregory Lehmkuhl

And the linehaul piece, we certainly have some incremental trading expense in the first half of this year. However given our results in January we anticipate that those trading expenses will be more than offset by productivity gains.

Todd Fowler - KeyBanc Capital Markets

And so Greg, does that mean that you think that linehaul could be relatively flat on a year over year basis or is there also just some a normal rate pressure on the linehaul piece of the business?

Gregory Lehmkuhl

There certainly is rate pressure, we will give wage increase in April and we do give our external carrier, our purchase transportation hardware spare increase and those all have been negotiated. But even though despite those cost headwinds, we anticipate that our total linehaul expense per million pound miles or unit measurements of total linehaul expense would be down year over year.

Todd Fowler - KeyBanc Capital Markets

And then just for a follow up, Doug, can you just frame up how you are thinking about the three year plan that you laid out within the press release? Is this something that we’re entering the second year of the plan and is the ultimate outcome of that to get back to the historical operating ratio within freight, is that kind of the target that we are moving towards?

Douglas Stotlar

So we just completed the first full year of this three in three plan this year, in 2012. And we are now entering the second year. The first year was really putting all the foundational steps in place, to be able to move on the big leverage initiatives like linehaul, like inflation pricing, our local account pricing, et cetera. And so we’ve put all that in place, we already have all the projects lined up for the latter part of this year as well as going into 2014. When we get to the end, it won’t get us back to what historical peak was. That was never our design but we intend to continue to expand the margin each year.

Gregory Lehmkuhl

Yeah the only thing I would add is that after first year we increased our operating income 20% year over year in a pretty tough economic year. And that was directly in line with what our internal targets were for the first year.

Todd Fowler - KeyBanc Capital Markets

So is the message there maybe to think about improvement in operating income and a close there, and it sounds like the best part of the yield initiative and then as the operating ratio falls into place, based on how you are growing operating income to back into that way?

Gregory Lehmkuhl

I would say we are focused on both margin and operating income.

Operator

Your next question comes from the line of Scott Group with Wolfe Trahan.

Scott Group - Wolfe Trahan

Just a couple follow ups on the linehaul and then pricing initiatives, can you give us a sense of how much implementation costs that were ahead of that in 2012, and what you are expecting in 2013 and when do you think we see the – when are we on the run rate where you are realizing full benefit of that? Is that in the beginning of ’14, or is it beginning of ’15?

Gregory Lehmkuhl

So from a cost standpoint, I would say in 2012 we probably put $5 million investments into those initiatives and this next year that number will probably be similar to that incremental parts, medical resources and training and it’s an external consulting partners primarily. As far as the run rate certainly, the maximum run rate would be implemented by the end of this year. That said, we are not going to stop working on linehaul with this initial phase to complete, we already have our next phases of linehaul design being worked on. On the pricing side, we continue to refine our message lane based pricing. Like I said the initial rollout across 35 accounts is on track from both a result standpoint and a timing standpoint. We will get better at that, so as the year goes on until we improve results even more. So by the end of the year you’re going to see those results get better and better and then we’re not done at the end of this year, not a one year thing, we’re going to continue to get more strategic and more sophisticated on how we manage our customer mix and how we manage the cost structure of our network to maximize profit and increase our return on capital. So we’re going to run this plan again next year and running it even better than we did this year.

Scott Group - Wolfe Trahan

And you mentioned that even before you’re fully starting implementing these things you’ve got 20 million increase in LTL operating income in line with plan. Is it fair to think that, the thought is that, that 20 million build each year and each year is a bigger increase or do you have to take a step back in ’13 during the actual implementation?

Gregory Lehmkuhl

I think it was 20% is what I said. And it’s a little bit more than 20 million in operating income. So when we look at this year, I think Doug said it well, the first half of the year we have pretty tough comps given a no-weather and economic boom we saw at the end of first quarter until in the second quarter last year. So – and these initiatives are getting more phased-in, more implemented as the first half of the year goes on. So when we think about the year we are most excited about the second half when you compare it to 2012, and certainly we do expect to expand margins and operating income again for the full year ’13.

Scott Group - Wolfe Trahan

Last thing, so can you just give us your thoughts on how you think the truckload market shapes up this year from a pricing and utilization standpoint and maybe your thoughts about starting to grow the fleet again?

Douglas Stotlar

Well, we’ve already started some negotiations with some customers but quite honestly it’s too early to tell, we are expecting the gains from additional traction as we go on for the second quarter. But quite frankly it’s too early to tell right now. And the second part of your question was –

Scott Group - Wolfe Trahan

So in terms of – any thoughts about starting to grow the fleet?

Douglas Stotlar

As of right now we don’t have plans on increasing the fleet size. We are putting our focus right now on implementing our lean based initiatives, Con-way Truckload, improving our process, improving our fleet efficiency there and improving the return on investment capital that we have in that business. And as when we get comfortable that we’re utilizing assets to the extent that we believe we’re fully utilizing the assets and we will consider where we are in the cycle till we believe there is more likelihood of the economic recovery and we might start investing at that time but we have no timetable on that right now.

Operator

Your next question comes from the line of Matt Troy of Susquehanna.

Unidentified Analyst

(inaudible) in for Matt this morning. We talked a lot about lean on the LTL side of the business and you just mentioned it for truckload and also guided to further margin expansion. I was wondering if you could parse that between how much is going to be pricing driven and how much it will be driven by your lean initiatives and help us frame sort of what you are doing in the area and the timelines for when you see that really showing up in the results?

Douglas Stotlar

You want me to address it more on behalf of truckload and the other business units or –

Unidentified Analyst

Yes, truckload specifically.

Douglas Stotlar

So when we look at lean it’s really about engaging our employees and reviewing our processes, so we are always striving to continuously improve. And so we are right in the process right now of developing a continuous improvement roadmap for our truckload company. We think we have done a lot of rate work underlying that to value stream that in many of the functions, so we find out where the opportunities lie. We’re developing the strategy for how we are going to go about improving the internal efficiencies of the Con-way Truckload company. And getting of our employees involved and continuously improving beyond that point. One of the goals associated with lean is - umber one is engaging our employees or continuous improvement but number two is having the ability to – when you do take on projects or initiatives to be able to sustain the results because you have the process controls, you have the analysis in place to be able to drive sustained improved results. And so we are really focused – we are in the early innings of the implementation at truckload, we have put some resources in there last year, we did a lot of leg work to implement these changes. And these are just things we will expect to drive continuous efficiencies over time. It doesn’t take away the need to go out there and negotiate with our customers and look at our network and do lean based pricing in truckload which is really the way that business has been run. And that certainly is going to be a big driver of margin improvement over time but that coupled with how effective we can utilize the assets and how effective we will manage our processes within the company. That’s what we intend to drive.

Unidentified Analyst

So when you talk about further margin expansion in that business this year, are you thinking more cost efficiencies or are these going to be kind of a mix between pricing and costs?

Douglas Stotlar

It’s going to be a mix of both.

Operator

Your next question comes from the line of Thomas Kim with Goldman Sachs.

Tom Kim – Goldman Sachs

Can I confirmed that it took about a year to win over the 35 customers?

Gregory Lehmkuhl

35, we’ve negotiated in January, and the first couple of days in February.

Tom Kim – Goldman Sachs

And then from that basis, can we assume that it’s going to be – sort of what rate can we assume that will accelerate?

Gregory Lehmkuhl

I don’t think we will accelerate, we won’t accelerate. The 360 accounts that we are most focused on are spread evenly throughout the year and when I say spread evenly I mean that’s when their contract – their one year contract expires.

Tom Kim – Goldman Sachs

And then just with regard to other areas of inflationary pressure, can you just walk us through for example, just – outside of what we’ve already discussed, where do you see inflationary pressure on new cost basis and then also can you just give us an update on head count and drivers please?

Stephen Bruffett

On the cost side, this is Steve, we see a year somewhat similar to 2012 in that there is relatively moderate inflationary pressure on most cost items. There are some such as healthcare that will probably be above that 2, 2.5% range of inflation. But we feel like we’ve got things to contain that level of inflation. I have already guided depreciation expense, that will probably be up at a higher rate than number of items because of the investments we are making to renew fleet in particular through on year over year basis at Con-way Freight. And outside of that, I am not aware of anything (inaudible) on the cost structure.

Tom Kim – Goldman Sachs

And if I could just ask one last question on the price, it looks like the pricing initiatives have been quite effective and it looks like at least initially the pricing gains have been probably ahead of the market. Can you comment – is this really company specific with regard to your mix or is it a load base effect, and to what extent can you give us a little bit more color around the incremental faster pricing growth?

Gregory Lehmkuhl

So in the fourth quarter I haven’t compared us with all of our competitors yet but I think we are fairly well in line when you adjust for length of haul. We were about 3% year over year when you adjust for the mix change. Going forward I think our profit impact from pricing renegotiations should exceed the market and however it may be difficult for you guys to see that, when just looking at the yield mix metric because of all the components.

Operator

Your next question comes from the line of Tom Wadewitz with JP Morgan.

Tom Wadewitz - JP Morgan

First I wanted to ask you about how you would think about the performance in LTL margin in fourth quarter where a little more – a little challenging freight environment I guess but kind of flattish freight OR. How would you compare that environment to what you might expect in the first half of the year just in terms of thinking about freight environment relative to what OR performance might be?

Gregory Lehmkuhl

There is no doubt Q4 volumes suffered from economic uncertainty and Sandy but we accomplished a ton of freight in the fourth quarter. Once again we saw our broad based lean efforts positively impact our safety result, we sent more people home safely and their families than any other fourth quarter in our history, that result in our Q4 safety spend being $4.6 million less than last year, down again over 20% this quarter linehaul productivity despite pretty low tonnage 3.5% reduction in tonnage was an all-time high and up 2.2% versus prior year. Our customer performance across metrics was outstanding and we increased our operating income by 10% in a pretty tough economic quarter. I think when you compare that to Q1 and possibly Q2 I think the overall economic environment will be more buoyant, however the comparisons are a lot tougher.

Tom Wadewitz - JP Morgan

And do you think – I guess if we look at Q2 or maybe weather is not as much of an impact, do you think really the key driver might be with the freight environment is like or do you think if the freight environment is not much different that you could see some material margin improvement in the second quarter?

Douglas Stotlar

I think Q2 is going to be largely dependent on freight environment. We do have a tough comparison year over year and we won’t be that far into our new initiatives to have a huge amount of traction just yet. So I think Q2 probably is largely dependent on the external environment.

Tom Wadewitz - JP Morgan

And then just last one if I can, the second half for the year there is lot of optimism on improvement in – getting some traction on your initiatives, if the freight environment is flat, do you think you’d be talking about a reduction in I guess miles driven or reduction in employee count or how do we think about how that will flow through in terms of your productivity that you would expect from these programs if the freight environment is kind of flattish?

Gregory Lehmkuhl

Yes, all the above, you would see reduced miles, probably reduced purchase transportation on reduced wage and benefits expense.

Tom Wadewitz - JP Morgan

And that should flow through to the operating ratio then as well?

Gregory Lehmkuhl

Correct.

Operator

Your next question comes from the line of Chris Ceraso with Credit Suisse.

Chris Ceraso - Credit Suisse

Can you disaggregate the tonnage decline in freight in Q4 that was down 3.5%, how much would you say of that was from going back and adjusting contracts and maybe culling freight that wasn’t at the right price versus how much was Sandy, how much was general macro?

Douglas Stotlar

I don’t attribute any of it to culling freight, that activity we really haven’t done it and doing any wholesale culling really since end of 2010, beginning of ’11. So that activity has been over for a long time. I think it might just more to do with our overall freight mix and the industry segments that we serve, and tone of them.

Gregory Lehmkuhl

They may have been evenly split between Sandy and economy but we don’t focus here.

Chris Ceraso - Credit Suisse

So then for 2013 you expect to be up or down similar to whatever the industry is doing?

Gregory Lehmkuhl

In tonnage, not necessarily because of our lean based approach, again we’re not focused on the yield metric or revenue, we are focused on margin expansion and profit.

Chris Ceraso - Credit Suisse

I guess that’s what I was getting at for Q4, maybe culling is not the right word but just in your contract simply is the lean based focus, did that result in any tonnage decline?

Douglas Stotlar

It really did not because in December we – the activity involved in December was really determining the strategies for the first 50or so, lean based pricing negotiations that we were going to undertake, it really didn’t start until after the first of the year. So we really hadn’t even started that activity in the fourth quarter.

Chris Ceraso - Credit Suisse

But then in ’13, you may see tonnage growth that’s slower than the industry because you are making shift to your contract?

Douglas Stotlar

I think that could be a possibility, yes.

Chris Ceraso - Credit Suisse

And then lastly, can you give us a ballpark number of as you go – as you are thinking about these contracts that you are revisiting what portion of your business is operating let’s say something north of 100 operating ratio?

Gregory Lehmkuhl

We don’t think about being in those terms and I don’t know (inaudible) guess because when you say what portion business is it, are you thinking on account level, wage level, shipment level on the business, so we have different ways to look at that puzzle. I could say I will share a little more color on our – based on the overall operating ratio of individual account we have target for improvement internally, the higher that goes, the higher the target is. And depending on that, you’ve got to really determine how aggressive we are and the individual rate is up.

Operator

Your next question comes from the line of Justin Yagerman with Deutsche Bank.

Justin Yagerman - Deutsche Bank

If you’ve adjusted for the new pension accounting that you are talking about, what were the fourth quarter LTL it was like?

Gregory Lehmkuhl

Let me look here. I believe it’d be about $2 million better of operating income, let me find the number quick.

Justin Yagerman - Deutsche Bank

When you are thinking about margin improvement for next year, I’d assume that, that’s margin improvement above and beyond this pension accounting change and if you could kind of walk us through what you think of the $50 million to $60 million of pension expense that you’re going to incur would be allocated to LTL so that we can think about how much additive that’s going to be that would be very helpful in thinking further margin expansion?

Gregory Lehmkuhl

And it was almost exactly $2 million for freight in the fourth quarter. I want to distinguish between pension expense and pension cash contribution, these are very different numbers. Our pension expense in total in 2012 was $10 million. And that will be 4 million in 2013, so relatively small number. It’s what we are talking about. The schedule that’s on our website breaks out the expense, 8 million of the 10 million was at freight in 2012.

Douglas Stotlar

And to answer your other question, Justin, absolutely we expect to expand margin beyond what that differential would be.

Justin Yagerman - Deutsche Bank

Doug, in your comments when you were answering one of the questions earlier you talked about the three year plan being called at 3 in 3 plan. I never heard you use that terminology. So –

Douglas Stotlar

That’s our internal acronym, Justin, so it’s three years and it’s to focus on people, product and profit.

Justin Yagerman - Deutsche Bank

So it’s not like three points or something. When you think about the first half of the year you guys have obviously said it’s going to – your start-up cost is going to be difficult from a year over year comparison, a lot of these initiatives should accelerate in the back half of the year, are we talking about a down earnings in the first half, latter earnings in the first half, if you are thinking about it or do you think that you can still grow earnings but it just won’t be at pace that you are hoping to grow earnings for the full year?

Douglas Stotlar

Justin, I think the honest answer is we really don’t know for the first half right now. We’ve got all these new initiatives going in place, we still don’t know what the economic environment is going to provide for us. We have tough comparisons on a year over year basis but I will go back and say we do expect to expand margins over the full year and we certainly expect the second half of this year to be a lot stronger based on the traction from all the initiatives we are putting in place at Con-way Freight.

Justin Yagerman - Deutsche Bank

Last question is you guys have a lot of cash, and it would seem to me that today’s interest rates that cash isn’t earning a lot of money. And it doesn’t sound like you guys have excessive pension headwinds that would encumber that cash, I could be wrong but I don’t think you have a big debt maturity in the next few years. In terms of optimizing the cash structure at this company and driving more value for shareholders is a long couple of years in terms of operating improvement, hopefully we have a bright future ahead of us. What are you guys thinking of doing result as the cash is going to balance sheet?

Stephen Bruffett

That’s a good question, Justin and to your point, things are a bit different for us now than they were couple of years ago when we had a lot of uncertainty in the economy. We had (inaudible) the volatility of the company, we had large pension obligations that are still there but the line of sight has been banded in, so the range of variability is little tighter, so it does afford us the opportunity to begin stepping back and assessing where we are, where we are down on the path in our capital replenishment cycle, the renewal of our fleet. So it is something that generate thought stream as we move through this year about uses of cash, they will have the solution, or answer to the question, as we sit here today, I’d acknowledge that we are in a different place as we move forward and we are contemplating what the uses of cash are.

Operator

Our question is from the line of Ben Hartford with Baird.

Ben Hartford - Baird & Co.

Doug, can you tell us maybe in front of this I think lane based pricing and linehaul up in the business, what is the risk 2 or 3 that you foresee that would present you a year from now really having the cost of business changes define you and the bulk of the savings begin realized and really just focusing on the sale of the terminal productivity to complete the three year plan. So maybe give us a sense for what you view is the key risk in terms of the next few things that are upcoming?

Douglas Stotlar

When I think about the risk associated with this project, I don’t think in terms of having those risks or the downside of the risk if they do hit being on price this time next year. I think (inaudible) are in the immediate term as we implement these things and train to them are we going to get the traction as soon as the business – we expect. Some of them both the linehaul optimization changes and the lean based pricing changes will change the flow of freight and that means that our fontline operators have to adjust ours headcount that day, and that week in order to get the full benefit. So the biggest risk in my mind is that it’s going to take us a few more weeks and we’re planning to absorb the changes effectively and adjust the network as fast as we want to match the cost structure to the changing freight volume. That said, we are having daily calls, we’ve had extensive training, we’ve scorecard to measure this by building, we have mitigated as much as the risk as we possibly can, and we are confident that we will execute.

Ben Hartford - Baird & Co.

It would imply weeks, not months.

Gregory Lehmkuhl

I think about it in terms of the first half of the year as we kind of tamper the first half of the year that’s one of the reasons because we are implementing a lot of changes to do and again like we might not have done three years ago we piloted these changes, we’ve perfected the processes, better training we ever have but yet these changes are pretty big. I hope there will be no interruption and hopefully if there is it will be one week but I couldn’t see it running now a couple of quarters.

Douglas Stotlar

Thank you. I’d just like to make a few closing comments before we terminate today’s call. In closing, I just want to leave our ways with the fact that we are totally focused on execution to the areas that we have highlighted this morning at Con-way Freight in the areas of pricing and linehaul, several other initiatives that are underway. At Menlo, it’s execution and implementing the new business that we have already won as well as focusing on the real growth opportunities we have at Menlo with a lot of high quality prospects right now and at Truckload it’s implementing our lean based methodologies and continuing to improve our processes and implementing higher levels of execution. So it’s about focus, it’s about pace as being able to seeing the results we expect to achieve.

While we are implementing in these areas, behind the scenes we’re already hard at work on the strategic advantage that’s related for the second half of 2013 and for 2014. We’re already seeing result from some of our pilots that have been ongoing and they make us confident that we can achieve what’s needed for the later stages of our three year roadmap. There is no doubt that we will face obstacles along the way and it will not be a linear path of improvement of the reasons why we are still energized about our future are simple. Our strategy is clear and our teams are executing well against and across the enterprise. We have proven capabilities to move the needle on the metrics that added through our lean processes and we are currently implementing some of our most impactual initiatives as we speak. And we’re already working on the improvements that are going to move the needle in the out years.

So I want to thank you for your time today and we will talk to you next quarter. Thank you.

Operator

That concludes Con-way Inc.’s fourth quarter earnings review conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Con-way's CEO Discusses Q4 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts