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Pacer International, Inc. (NASDAQ:PACR)

Q4 2008 Earnings Call

February 11, 2009 5:00 pm ET

Executives

Brian Kane - EVP and CFO

Mike Uremovich - Chairman and CEO

Analysts

Ed Wolfe - Wolfe Research

Jon Langenfeld - Robert W. Baird

Tom Wadewitz - JPMorgan

Alex Brand - Stephens

Todd Fowler - KeyBanc Capital Markets

John Larkin - Stifel Nicolaus

David Campbell - Thompson Davis

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Pacer International fourth quarter earnings call. (Operator Instructions).

I would now like to turn the conference over to our host, Executive Vice President and CFO, Mr. Brian Kane. Please go ahead, sir.

Brian Kane

Thank you, Cary, and good evening everyone. Thanks for joining the Pacer International fourth quarter earnings call. By now, you should have received our press release which was issued at 4 o'clock Eastern Time today.

In the press release, you'll find a statement of operations reflecting our fourth quarter results compared to the same period last year, as well as year-to-date 2008 compared to last year as well. We've also included in the release a balance sheet as of the end of the year and a statement of cash flow for the year 2008.

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 and 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 March 13 on the company's website, www.pacer.com. Also, we will be filing our Form 10-K with the Securities and Exchange Commission next week.

Now, what I'd like to do is discuss the fourth quarter financial results, and then I'll turn it over to Mike Uremovich, our Chairman and CEO, to talk more about the business and the current environment we face.

As you can see from our press release, we reported a loss for the fourth quarter of $65.1 million or a loss of $1.87 per share. For the full year, the loss was $16.6 million, which is a loss of $0.48 a share. The loss for the quarter and the year is attributable to an $87.9 million pre-tax non-cash goodwill impairment charge for our logistics segment.

While we still believe we are working through the underperformance issues within this segment, these issues and the economic downturn impact our ongoing estimates of future cash flows. This, in addition to the sustained decline in our market capitalization in the fourth quarter, caused an impairment of the carrying value of our logistics segment when we conducted our annual impairment tests. There was no impairment of our intermodal segment.

In addition to the normal financial data in our press release, we have included a reconciliation of GAAP financial results to adjusted financial results for greater clarity with respect to our ongoing operations.

Without the impairment charge, our EPS for the fourth quarter was $0.24 a share versus $0.59 a share in the prior year. For the year, our adjusted EPS was $1.63 as compared to the 2007 EPS of $1.51.

Revenue for the fourth quarter was $503.7 million or a decline of $36.5 million from the prior year quarter. For the year, revenue was $2.087 billion as compared to $1.969 billion in 2007, which represents an increase of $118.3 million.

Clearly, the results are not what we would have liked to report. The fourth quarter of 2008 was particularly challenging given the quickly changing economic environment.

In our third quarter earnings call, we spoke about the short peak and the softness in the freight volumes. I don't think anyone imagined that we would see continuing sustained declines in volumes at these dramatic levels. Also, as I stated in the third quarter call, we faced headwinds with the lag in fuel surcharge in some of our underlying rail contracts. The recent dramatic decline in fuel has exacerbated that headwind in the fourth quarter and this will continue into early 2009.

Having said that, we are operating in the same environment as our competitors and we know that we must react to changing circumstances. Part of this reaction is to quickly control or reduce costs in the face of declining volumes. We are making changes in workforce levels, which I will discuss in more detail a little later.

The second part is we continue to execute against our strategy for the long-term. We have repeatedly talked about our strategic initiatives and we continue to make progress in several of these areas.

Looking at our intermodal segment, overall revenues were $390.8 million as compared to $435.1 million in the fourth quarter of 2007. This is a decline of over $44 million or approximately 10%.

Our fuel surcharge percentage was 27.4% in the fourth quarter of 2008 as compared to 25.1% in the comparable period last year. Again, as I said in the third quarter call, due to the time lag and some of our underlying rail contracts, our costs attributable to fuel continued to increase in the fourth quarter while our customary fuel surcharge has rapidly declined.

Much of the revenue decline in the intermodal segment is attributable to lower volumes. We saw volume declines in all three lines of business; third-party domestic, both wholesale and retail, automotive, and international.

Our domestic wholesale volumes declined 7.6% and retail domestic volumes declined 11.7% in the fourth quarter as compared to last year. While some of the retail volume decrease can be attributed to the lapping effect of lost customers earlier in the year, the recent economic impacts are the significant issue in the volume declines, both wholesale and retail.

The percent of Stacktrain business that is from retail was 27.6% in the fourth quarter, the same as the fourth quarter of last year. Looking from the retail point of view, 78.8% of the retail domestic business in the fourth quarter was shipped in Stacktrain equipment as compared to 71.9% in the fourth quarter of 2007. We continue to drive at this strategic initiative to capture multiple margins on the same transaction.

Our automotive volumes continued to be affected by the economy. Fourth quarter volumes declined 16.4% as compared to the fourth quarter of 2007. While this is slightly better than the 20.4% decline we saw in the third quarter, it still demonstrates the significant weakness in this sector and we do not anticipate any meaningful increase in volumes in the first quarter of this year.

The international volumes declined 18.8% in the fourth quarter as compared to the prior year. Much of this decline is attributable to the loss of a customer, as we previously discussed in the third quarter. Of our ongoing customers, the volume decline was 3.2% as compared to the same quarter of last year. As with our other sectors, we expect to see volume pressure continuing at least through the first quarter of 2009.

In the fourth quarter, our Cartage revenues were essentially flat as compared to the prior year, although we saw improvement in operating income. Equally as important, our Cartage business continues to grow its share of pickup and delivery for our retail intermodal business.

For the fourth quarter, 55% of the retail volumes in locations where Cartage has a presence were drayed by our Cartage operation. This was up from 45.8% for the fourth quarter of 2007.

Overall, our transportation margin percentage for the intermodal segment was 20.5% as compared to 24.2% in the fourth quarter of 2007. The decline is due primarily to higher costs from increased traffic on the BNSF, lower pricing to maintain equipment flows, and increased rail cost in both contract lanes pursuant to contract rate adjustments and rate increases in non-contract lanes. These increases include higher fuel costs, as I discussed earlier, and we do expect the fuel cost headwind to continue into the first half of 2009.

Our logistics segment, before the impairment charge, had an operating income of $516,000 in the fourth quarter of 2008 as compared to $592,000 in the same quarter of last year. Revenues in this segment increased $8 million over the comparable quarter in 2007. This was driven largely by strong revenue growth in our international unit.

Our supply chain unit saw a $2.9 million revenue decline, principally from the loss of a customer in the fourth quarter of 2007. This unit also provides services to the automotive sector and revenues have been impacted negatively due to deterioration in the automotive industry. The slight increase in the logistics segment operating income was, again, driven primarily from international, and also our warehousing unit, offset largely by the decline in the supply chain unit for the reasons I just mentioned.

While our highway brokerage unit had a loss, this was largely due to the continued expansion of regionally focused (inaudible) we discussed in the third quarter. The additional resources take time to reach full productivity, but we believe this is a significant long-term investment in growing our business for the future. However, given the current economic environment, we have elected to defer the addition of a new team that was scheduled for the first quarter of '09. We want to make sure that we invest wisely as there seems to be a pullback in the truck brokerage market.

Our corporate expenses were lower by $5 million as compared to the fourth quarter of the prior year. This decline is due primarily to the inclusion of a $1.6 million in restructuring charges and the accrual of a special incentive for all employees in the fourth quarter of 2007. In the fourth quarter 2008, we incurred $1.8 million in expenses associated with our SAP project as compared to $254,000 in the fourth quarter last year.

We continue to monitor our SG&A expenses closely and we just recently downsized our business with a forced reduction of over 50 people. The severance costs associated with this reduction is approximately $900,000 and we expect in annual savings of approximately $2.5 million. Most of the affected employees were in the intermodal segment, although there were reductions in the logistics segment as well.

Our interest expense for the quarter was $400,000 as compared to $1.4 million in the prior-year quarter, reflecting our lower level of debt and lower interest rates. We also capitalized $300,000 of interest in the fourth quarter of 2008 related to our SAP software project.

Tax expense, without the impact of the goodwill impairment was $4.3 million as compared to $13.2 million in the fourth quarter of 2007. The decline in taxes is due to the decline in operating earnings. The tax rate for the fourth quarter was approximately 35% as compared to 39% in the fourth quarter of 2007. We expect the tax rate to be approximately 39% going forward. We generated $59.6 million in cash from operations in 2008 as compared to $108 million in 2007. The decrease in cash from operations is due to a combination of the 2007 settlement of the Del Monte arbitration case, and the impact on receivables and payables from lower traffic volumes in 2008 as compared to 2007.

In addition, we had increased volume incentive payments during 2008, due to a change in our incentive program, and we incurred higher tax payments in 2008 compared to 2007. We continue to monitor our accounts receivable and our DSO remains consistent with prior periods.

Our capital expenditures for the year were $24.8 million as compared to $14 million in 2007. The increase is due primarily to our SAP project. We have implemented the general ledger modules in all of our business units, with the last implementation occurring in January of this year. We expect to implement the operational elements in 2009 and 2010. Our capital expenditures for 2009 are expected to be in the range of $10 million to $15 million, the majority of which are related to the SAP project.

Our debt level at the end of the year was $44.6 million as compared to $64 million at the end of 2007. We repaid $20 million on our revolving credit facility during the first three quarters of 2008. Our debt level at the end of the fourth quarter remained at the same level as the third quarter. Our diluted share count for the fourth quarter 2008 was 34.768 million.

The fourth quarter was a challenging one and we expect those challenges to continue into 2009. We are continuing to focus on our strategic objectives for the long term and taking the necessary actions in the short term. With that, I'll turn it over to Mike Uremovich, our Chairman and CEO.

Mike Uremovich

Thank you, Brian. As Brian indicated, the final quarter of 2008 was very challenging for us. And 2009 is shaping up equally difficult. We were affected by both the financial and the freight markets during the quarter. The recent performance of the logistics segment and the rapid significant decline in market capitalization has required us to take the noncash impairment charge against our logistics segment in the amount of $88 million. While disappointing, this charge is a onetime event and it has no effect on cash flow. Our Company has traditionally been a cash generator, not a cash user, and thus access to the credit markets has not been a major issue.

In the freight markets, we saw substantial drops in volume levels across all of our businesses during the middle and latter part of the fourth quarter. Things seemed more or less normal up to early November, and at that point, it appeared as if many markets simply froze. Brian has provided you some of the details of the freight volumes in various segments, so I won't repeat what you already know.

Like many in business today, I don't have much confidence in our ability to predict the outcome of 2009. The freight market is a derivative one, and since there is no conviction about consumer behavior, or in the timing of retail inventory replenishment, we can't predict how the year will develop. I am very reluctant to make commitments about this year's outcome, and thus we cannot provide specific earning guidance for the year.

I am confident about our progress on our strategic plan and will report those to you as the year progresses. It is our intent to report specific metrics to you in each of our major strategic objectives. When evaluating our progress and creating a strong intermodal product, we will share service performance and market share in both retail and wholesale intermodal markets. Since we cannot predict actual market volumes in advance, we believe share numbers are a good indication of our progress in the intermodal segment.

We've instituted a rigorous and continuous set of measures of how well we serve our customers. During the last quarter of 2008, we exceeded our customer expectations 94% of the time. We track customer service in line with customer expectations, in capacity commitments, on-time delivery, damage-free transit, and rate compliance. The trend in all of these measures has been positive since they were instituted in late 2007, early 2008.

In the lanes serviced by Pacer, our retail market share in 2008 was roughly 5.9%, which is down slightly about 0.03% from 2007. This is in the face of several significant losses of major customers in late 2007 and early 2008, when we attempted to lead price up in a difficult market. Early indications for late 2008 and 2009 suggest our share is improving.

In the wholesale market, our share declined modestly as a result of shifting routings by several of our largest customers. Business was down over 4% in a growing market, with three major customers contributing over 70% of the decline in volumes. Without those specific customer losses, Pacer's overall wholesale volumes would've been up 3%, year over year. The diversion of these customers was a combination of aggressive competitive pricing that Pacer chose not to match, and strategic decisions made by these customers to reduce their use of Pacer assets in preference for something else.

We do not foresee any additional major customer volume declines in 2009.

Of the over 50 IMCs that we do business with, 57% grew their business with us and most grew faster than the market, some substantially faster. We are seeing some major shifts in where share is being carried in this market and we predict that this will continue in the future. We believe Pacer, with its diverse sales channels, is well positioned to continue to participate and grow share in this market through both retail and wholesale channels, as buyers shift their sourcing to seek out better value propositions, improve service offerings, or better pricing and capacity commitments.

In our efforts to capture more of the local trucking business, we'll report overall growth and the percentage of Pacer traffic handled by our own local trucking operations. Operating income in Cartage improved nearly 90% in the full year from 2007 to 2008. Our fleet is 15% larger at the end of 2008 than at the end of 2007 and is now at 900 trucks, up from just under 800. We think this is particularly impressive organic growth in this challenging market.

Share, obviously, increased significantly though it's difficult to quantify given the fragmented nature of this market. Helping this growth was a 30% decline in operator turnover.

As Brian said, where we have Cartage presence, our internal operation handled 55% of our retail moves in the fourth quarter, up from 48% in 2007. Our longer-term goal is to handle 80% plus of our own traffic where we have local trucking presence.

In expanding our logistics profitability, we will provide detail on the growth and profitability of our truck brokerage units, separate and report on progress in international, and report separately on our progress in Pacer Transport, our flatbed trucking division. Brian provided you a summary of that performance in the fourth quarter.

As he said, our international unit had a strong year delivering record operating income. While the export market was unusually strong early in the year and helped that performance, we have taken steps to ensure we continue our robust growth in this market. Our warehousing unit also had a good year and they are well positioned for 2009.

The challenges in the flatbed trucking market continue to be significant as this market is particularly hard hit by the slowdown in housing and wind energy markets. Among other things, we have moved to reduce the cost structure to counter this slowdown.

Truck brokerage continues to make progress, as Brian noted. We have slowed our investment given the state of the market.

We continue to improve productivity by integrating efforts across our operating units. Our SAP installation continues on plan and on budget with all units now on a common financial platform, and our planned migration to the new operating system is on-time and on budget.

As a result of these efforts, we will begin combining functions during 2009. The major productivity savings from this effort will begin to be more obvious in late 2009 and 2010. We did take some employee reductions outside the arena of this effort in order to bring headcount more in line with volumes. There may be more such actions, should volume continue to suffer. We are examining all areas in an attempt to reduce costs.

While times are difficult, we intend to remain focused on our strategic transition plan to position Pacer as a long-term premier intermodal and logistics company. We can't control the market or the economy, but we are convinced our strategy is the right one for the company and we intend to continue to pursue it.

I've told you repeatedly how we intend to position Pacer for the future and how, regardless of our current legacy rail contracts, we will move forward. Today's disruptive market does not alter our belief that our strategic plan is sound.

2009 is shaping up to be difficult and we have less ability to predict results than normal. Nonetheless, even in tough times, we intend to remain on our described strategic path. It would be better to do it in a robust economic environment, but we don't have that choice.

I know that many of you would like more detail about the specific outcome, but in today's environment, I simply don't have a crystal ball any more than any of you. I would not have predicted six months ago that our economy or the financial markets would be in these straits. None of us could have or did foresee what the last part of 2008 would hold. And we don't apologize for not being able to predict the future. We have reacted to the market by reducing costs and we will continue to do so.

In addition, at today's Board meeting, it was determined prudent to suspend the payment of our quarterly dividend given the uncertain nature of this year's economy. We will reconsider this action in our next Board meeting once we have better visibility to market conditions. However, we believe it's more important to remain focused on our strategic transition plan, conserve resources in these difficult times and do what's right for Pacer in the longer term. We will stick to our strategic plan and we will report progress to you each quarter.

At this point, Brian and I would be happy to respond to questions. Cary, are you there?

Operator

Yes.

Mike Uremovich

Okay. We will open it up for questions at this point.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from Wolfe Research in the line of Ed Wolfe. Please go ahead, sir.

Ed Wolfe - Wolfe Research

Thanks. Good afternoon.

Brian Kane

Hi, Ed.

Mike Uremovich

Hi, Ed.

Ed Wolfe - Wolfe Research

First of all, the dividend suspension. What's your sense of the timing of this? Is this, we should assume for now, all of 2009, and maybe the world gets better by the end of the year and it's back for 2010, or is it quarter-by-quarter? How are you thinking about this?

Mike Uremovich

Well, as you know, the dividend decision is made by the Board on a quarterly basis. So it would be hard for me to predict what it's going to look like. We re-examine it every quarter and will continue to do so. And the decision will be made at that time. I can't predict what that decision is going to be at this point.

Ed Wolfe - Wolfe Research

I mean, I'm guessing that there is still significant free cash next year. What are you going to do with the cash instead? What's the thought process?

Mike Uremovich

Well Ed, until we have better visibility to how the year is going to come out, we're going to be prudent and conserve the resources. So, I can't give you specifically what application of cash is going to look like over the next couple of months. Things are simply not clear enough out there, and we want to be particularly prudent given the fact that nobody knows where this economy is going to go at this point.

Ed Wolfe - Wolfe Research

Just directionally, I mean, if I assume $50 million or so from operations and $15 million of CAPE X, there is going to be free cash, I'm not missing something directionally, am I?

Mike Uremovich

Ed, the only thing I can tell you for certainty, is that we're going to spend our $10 million to $15 million on the SAP project primarily. That's the only thing I have certainty on at this point.

Ed Wolfe - Wolfe Research

Okay. When I look at the margin pressure and the big change in profitability, how much of that, if you just kind of directionally think about it, is fuel and how much of that is much lower volume and you get caught with that? And then, how much would be pricing outside of fuel?

Mike Uremovich

To give you a sense, and I don't have a breakout in detail, but it is all of those things. From a fuel standpoint, while our number in the fourth quarter averaged 27.4%, that's just a simple average of the three months in there. I think we are down currently to around 13%. So the last month of the year was particularly low compared to where we were in September and October.

The flipside, as I said, is under our rail contracts, the legacy contracts, and the fuel number, there is a two quarter lag. So our costs were going up in the fourth quarter as our revenue fuel surcharge came down.

Ed Wolfe - Wolfe Research

I mean, your costs should have been coming down too, but obviously, didn't come down as much as the revenue because of the legacy contracts?

Mike Uremovich

Costs went up on the legacy contracts because of the lag.

Ed Wolfe - Wolfe Research

So, you're saying both the surcharge and costs, both sides of that equation worked against you in the quarter?

Mike Uremovich

The revenue fuel surcharge was coming down in the quarter as our cost side was going up.

Brian Kane

Simply put, Ed, we were paying third quarter fuel base and not being able to collect that high a percentage from our customers.

Ed Wolfe - Wolfe Research

Directionally, I'm going to guess then it's going to be worse in the first quarter. Should I think about it that way?

Mike Uremovich

Yes.

Ed Wolfe - Wolfe Research

And second quarter will be probably similar to fourth?

Brian Kane

It will start coming back down, but we're probably won't work it through until after the first half. And again, I can't predict what fuel is going to do either. But generally, you've got the sense of it.

The other things you've asked about. One, volume, certainly as Mike said, October, I think we talked about it on the call, we started seeing some signs that things weren't great. It wasn't a great peak, maybe two weeks at most. But clearly, volumes declined much more dramatically in November, December. And we have not seen a rebound. I look back on our auto volumes and I was actually surprised that we weren't down on the same percentage level as the third quarter. I think that's just somewhat of a lapping because the absolute volumes were not that great.

The other thing we are seeing and you mentioned on the pricing side, there is a lot of competition out there. We're seeing it from other wholesalers who are putting out some rates, and we're seeing it from the trucking community as well as they are trying to keep their trucks moving. So we're hitting on all cylinders, so to speak.

Ed Wolfe - Wolfe Research

How far down is pricing in December and January versus a year ago?

Mike Uremovich

I don't have a specific number, but I can tell you that we're starting to see some very low rates in some core lanes.

Ed Wolfe - Wolfe Research

The wholesale business or in the retail business or both?

Mike Uremovich

Yes, both. Customers are also being very aggressive on their bids in terms of pushing the price down.

Ed Wolfe - Wolfe Research

Just a quick little one that doesn't make sense to me. Interest expense went from $100,000 to $400,000. Why would that go up in the quarter?

Mike Uremovich

If that was off my earnings remarks, I may have misspoken. Interest expense in the fourth quarter was $400,000 for the quarter 2008 and they were $1.4 million last year.

Ed Wolfe - Wolfe Research

But in the third quarter, what…

Mike Uremovich

In the third quarter we had the capitalization of a large amount of the SAP, so there's a little bit of a catch-up there. We have capitalized $300,000 this quarter.

Ed Wolfe - Wolfe Research

Should we expect that to be going forward?

Mike Uremovich

Yes, there will still be some as we start putting it into play. The financial piece is done. The capitalized interest should probably come down a little bit.

Ed Wolfe - Wolfe Research

All right. Thanks, Brian. Thanks, Mike. Hang in there.

Mike Uremovich

Okay.

Brian Kane

Appreciate it. Thanks, Ed.

Operator

Thank you. And our next question comes from Robert W. Baird's Jon Langenfeld. Please go ahead.

Jon Langenfeld - Robert W. Baird

Hi. Good afternoon, guys.

Mike Uremovich

Hi, John.

Brian Kane

John, how are you?

Jon Langenfeld - Robert W. Baird

Good, thank you. Just on the fuel piece, just so we understand it, so essentially if we think of the gross margins on your intermodal, do you see pressure near-term because of that, but all else being equal that that pressure lightens simply because you catch up? The amount you're paying and the amount you're getting reimbursed basically comes back to equilibrium, I guess, by the second quarter, right?

Mike Uremovich

You're right on the assumption that you have a relatively flat fuel market. It's when we get the real wild significant fluctuations, both up and down, that causes timing issues.

Jon Langenfeld - Robert W. Baird

Got it. So if we look at the roughly 400 basis point compression on the gross margins in intermodal, is all of that or most of that related to fuel or is there something else going on there?

Mike Uremovich

No. As I mentioned, we really had no significant volume presence in fourth quarter of 2007 on the BN. That was something that ramped up earlier this year. So that certainly has an impact because those are clearly market rates. And again, we are seeing some price pressure.

Jon Langenfeld - Robert W. Baird

Okay. And then, why would the direct operating expense not be going down here with volumes off double-digits?

Mike Uremovich

The direct operating expense really is our equipment cost. I think I failed to mention equipment at the end of the year was [28,681]. So we typically will off-hire towards the end of the year into the first quarter and we are aggressively doing that to take our equipment down and try and size it back to the volumes that we have.

Jon Langenfeld - Robert W. Baird

Okay. And what would be your expectation for box counts in 2009?

Mike Uremovich

Box counts probably about 2,500 by the end of the year.

Jon Langenfeld - Robert W. Baird

Okay.

Brian Kane

We had Board authority to acquire boxes this year. We had not pulled the trigger and expectation, if I was a betting man, would be I probably wouldn’t do that.

Jon Langenfeld - Robert W. Baird

And Hub and some of the others out there have idled boxes or put them in temporary storage, have you done that at all?

Brian Kane

We always have some around this time of the year, just because of normal slowdown after your peak season, Christmas holidays. We had a higher number than we have had historically, but the trend line is starting to come back down again.

Jon Langenfeld - Robert W. Baird

Right, and then the corporate expense line, the part that is unallocated was about 2.6 million, and I know you had some puts and takes in there with incentive comp, but what is a good run rate to think about for that in 2009 on a quarterly basis?

Brian Kane

The fourth quarter of last year we had I think it was a 1.8 million the restructuring charge and the $3 million in special incentive.

Jon Langenfeld - Robert W. Baird

Yes.

Brian Kane

I can probably say, you can probably look towards the fourth quarter of 2008 as being a better indicator.

Jon Langenfeld - Robert W. Baird

I mean that number includes your bonus reversals I am assuming?

Brian Kane

Small amount, about a million.

Jon Langenfeld - Robert W. Baird

Because your run rate for the last three quarter has being closer to the $6.5 million to $7 million range. Now you had 2.6 in fourth.

Mike Uremovich

The bonus was accrued typically in the first three quarters as we were measuring against our target. So, those numbers were pretty much almost at the full level, and we took that back down little over a million dollars in the fourth quarter because of the decline in earnings.

Brian Kane

And, just so that everybody knows, here in Ohio, we are in the midst of some very violent weather and so if everything goes dark all of a sudden, it’s not because we pulled the plug.

Jon Langenfeld - Robert W. Baird

One more and then I'll let you go. The charges that you talked about for the severance, the headcount reduction, is that a first quarter event?

Brian Kane

Yes. That occurred last week.

Jon Langenfeld - Robert W. Baird

Okay. Very good, thanks guys.

Brian Kane

Thanks.

Operator

Thank you. And our next question comes from JPMorgan’s Tom Wadewitz. Please go ahead.

Tom Wadewitz - JPMorgan

Yes, good afternoon.

Brian Kane

How are you, Tom?

Tom Wadewitz - JPMorgan

Good. I think you talked a little bit about the volumes, the progression in the quarter, but I don’t know if you gave it by months and if you are willing to do that in terms of maybe total intermodal volumes in October, November, and December?

Brian Kane

We typically don’t give that out, but generally speaking, it was certainly more affected in November and December.

Tom Wadewitz - JPMorgan

And did you comment on January versus December? January got a little bit weaker or is it at the same level as December?

Brian Kane

Probably around the same level, we are certainly not seeing any huge uptick.

Tom Wadewitz - JPMorgan

Okay.

Mike Uremovich

And we are seeing weakness across our customer base. It's not that we are loosing accounts. We're just saying that a lot of them are affected as well.

Tom Wadewitz - JPMorgan

So you asked a little bit about pricing. How do you think the bid season will come out in terms of pressure on pricing on the bid activity? Do you think rates could be down a couple percent or do you think that there's a chance that it's so aggressive that it is more of a decline than a couple of percent? Could it be down 5%, 6% or, what do you think the magnitude might be as a decline in the intermodal pricing?

Brian Kane

We are early into it, but we are also seeing some people renew early. So, if I had the crystal ball, I would say 3% to 5%. It’s a very difficult market out there.

Tom Wadewitz - JPMorgan

Is there much of a way to offset that? Or, is that pretty much something that, at the end of the day, you end up just losing that from your margin?

Brian Kane

Well the offset will be from the SG&A reduction and any furthers, but it is difficult on the margin side to do anything.

Tom Wadewitz - JPMorgan

And do you take the approach that there is a certain level where you would give up business just because its not worth to protect the margin, I guess, or is it just not worth taking the bad pricing, or is this a type of market where you really have to be pretty defensive and aggressive about keeping your customers and keeping your business?

Brian Kane

I would say it's probably going to be case-by-case. In general, we believe that we have done a good job in providing good service to our customers, and we will continue to do that. I mean, at the end of the day, that's what it’s all about. So we are going to have to look at things on a case-by-case basis. There are probably sometimes when we hold our nose and go for it, and there maybe other occasions where you get to the point and say, I can't go that low.

Tom Wadewitz - JPMorgan

Right. Okay. I guess longer term, I think, part of the strategy is to try to get the margin up in retail given that you would expect some pressure from, as the UP contract expires on the wholesale side. So, did you make any progress on that in 2009 and what might be the timing when you think you would be able to make some progress in terms of really seeing the retail margin expand?

Brian Kane

Well, you know as Mike mentions, we have several of those strategic objectives out there. One of which is to increase the actual volumes on a retail book of business and capture that incremental margin. Can I expand the margin? That may be difficult to do. That's why Mike had mentioned that trying to watch our market share, I mean I can't predict what volumes are going to do this year, but I have to maintain my market share.

Mike Uremovich

Yes. And from a practical point of view Tom, I think at this particular point , conditions in the market place are probably overwhelming any individual pricing strategy that any individual company has out there. You know, everybody scrambling. There are a whole bunch of things that we would like to do and that we would like to see certain things occur. But I will tell you the tsunami that's out there now in the market place is difficult to deal with and we just have to be flexible there. So our wishes, I am afraid, are not going to prevail.

Brian Kane

Yes. The other thing is, as we talked about again trying to maintain or grow margin, it is again through the utilization of our own cartage unit and we continue to push that effort.

Tom Wadewitz - JPMorgan

Yes. That's fair in this type of a market. It's pretty tough to think about expanding margins on a kind of a specific program itself. Anyway, all right. Thank you for the time. I appreciate it.

Brian Kane

Thanks, Tom.

Operator

Thank you. And our next question comes from Stephens, Alex Brand. Please go ahead, sir.

Mike Uremovich

Alex, how are you?

Alex Brand - Stephens

Good, guys. Thanks a lot for taking my questions. Can I just start? I want to make sure Brian that I understood on the accruals. Is Q4 just reflecting no accruals or do you have some credit back from earlier quarters?

Mike Uremovich

In terms of the bonus?

Alex Brand - Stephens

Right.

Brian Kane

Yes, it has an adjustment back from earlier quarters.

Alex Brand - Stephens

Now was that the $1 million that you mentioned?

Brian Kane

Yes, round numbers.

Alex Brand - Stephens

Okay. Now with respect to the dividend cut. It sounds like cartage is still a focus. There is growth in that area, if maybe the only area right now. Would you use some of the cash you are preserving to maybe make some acquisitions?

Brian Kane

I would say, you know from a longer term strategic objective, we would always consider that. I can't say I have got anything that I would look at right now.

Mike Uremovich

That's husbandry resources to be able to act on opportunities. It is obviously something that we want to do, but we don’t have a situation at the moment where we are going to directly apply the additional cash from the dividend decision to a specific acquisition at this point. We are just trying to be prudent about the whole thing and trying to keep our powder dry.

Alex Brand - Stephens

Fair enough. Can you comment Mike? In the past you have talked about your BN agreement being profitable, but I assume that there are volume commitments and volume is certainly under some stress now. Do you still feel like you can make money on that in the current environment?

Mike Uremovich

Yes.

Alex Brand - Stephens

And just one more question from me then. I think last quarter you had talked a little bit about some of the shorter hauls in the east where there had been a lot of growth and that you guys were looking into that as a potential growth avenue. Are there any further thoughts on that front?

Mike Uremovich

Well, we are still looking at it. We don't have anything in our hands at the moment that would suggest anything major over the next quarter or two in that area. But we are trying to examine how to do that.

Alex Brand - Stephens

Okay. Thanks for the time guys.

Operator

All right, thank you. And, our next question comes from KeyBanc Capital Markets, Todd Flower. Please go ahead.

Todd Fowler - KeyBanc Capital Markets

Hi, Mike. Hi, Brian.

Brian Kane

Hi, Todd.

Mike Uremovich

How are you?

Todd Fowler - KeyBanc Capital Markets

I'm okay. How are you guys?

Mike Uremovich

Well, we could have had a better weather.

Todd Fowler - KeyBanc Capital Markets

We used to get some warm weather. On the cost side, or on the pricing side related to your underlying rail contracts, it really sounds like there's going to be pressure with what you are able to receive from your customers. Excluding fuel, can you talk a little bit about the magnitude of what you're seeing with the underlying rail rates right now, and what your expectation is? If you see top-line pricing come in 3% to 5%, would you expect to see rail pricing come in, at least a 1% or 2% in this environment?

Mike Uremovich

Maybe on some outside SAPs possibly, we might be able to do something, but on the base contract, it's pretty well locked.

Todd Fowler - KeyBanc Capital Markets

Okay.

Mike Uremovich

We haven't seen a lot of aggressive rail pressure.

Todd Fowler - KeyBanc Capital Markets

I'm sorry, what was that?

Mike Uremovich

I just said, we have not seen a whole lot of aggressive rail pricing

Brian Kane

Coming to us.

Todd Fowler - KeyBanc Capital Markets

Okay.

Mike Uremovich

Coming to us and if you look at the numbers for the railroad, their volumes are down very significantly obviously, so.

Todd Fowler - KeyBanc Capital Markets

Okay. And then Mike, at this point, how much is moving underneath the contractor lines versus moving on to spot lines? How much of you are in the intermodal business?

Mike Uremovich

I don't have those numbers. Generally speaking, I don't think it has moved significantly from what we talked about.

Todd Fowler - KeyBanc Capital Markets

So still like the 16% type level?

Mike Uremovich

Yes, and that's off the top of my head, so please don't hold me to that.

Todd Fowler - KeyBanc Capital Markets

Okay.

Mike Uremovich

Our order magnitude. That maybe all right, but I don't know.

Todd Fowler - KeyBanc Capital Markets

Okay.

Brian Kane

Again, as we have put some business on BN, that obviously changes that number a little bit.

Todd Fowler - KeyBanc Capital Markets

Okay, sure. On the cost side with the operating expenses, you obviously identified some flexibility here early in the year. How much more can you cut or how deep do you think you'd have to go if you see volumes continue at these levels? If you get into an aggressive pricing environment, you don't have as much leverage. How do you look at the business model, and basically where we're trending if things don't improve in the next two or three quarters?

Brian Kane

As I've talked about before, we understand that we do have a cost side issue and we are trying to deal with that. One of the ways to do that is to improve our productivity through the SAP project. Our three, I'll say, operations systems within the intermodal segment, don't talk to each other and that creates some problems in terms of your cost structure.

So that was one of the key reasons why we embarked on the SAP project. And as we've mentioned, once that's implemented we expect to achieve certain savings. Having said that, we're going to keep everything on the table as Mike mentioned. You don't want to do something too soon that damages the business, but you also have to reflect the current realities.

Todd Fowler - KeyBanc Capital Markets

Okay. Brian, on the SAP side, how does the depreciation start to ramp that? Will we see incremental depreciation expense during the first part of 2009 or does the depreciation start in the back half roughly around the same time that you start to get some of those cost savings?

Brian Kane

It will start ramping up in the first quarter. We have hit the implementation of the GL and all the business units. So we'll start ramping it up in the first quarter, and then, obviously, it will increase some more.

Todd Fowler - KeyBanc Capital Markets

And what was the incremental year-over-year expense going to be in the first quarter?

Brian Kane

Off the top of my head, I apologize, I do not have that.

Todd Fowler - KeyBanc Capital Markets

Like a couple of hundred thousand or is that going to be more than that?

Brian Kane

It's a hazard to guess at this point, I apologize.

Todd Fowler - KeyBanc Capital Markets

That's okay. We can follow up off-line.

Brian Kane

Yes.

Todd Fowler - KeyBanc Capital Markets

Okay. No big deal there. Just one last one on the logistic side, just to make sure I'm understanding correctly, it's still the biggest drag with regards to overall profitability in that segment. Is that still pretty much the flatbed operations and how much of that's related to external factors within the flatbed market and how much opportunity is there within that business? It sounds like most of the cost reductions made here earlier this year or early this year were in the intermodal side. Is there anything you can do on the cost side on the logistics business?

Mike Uremovich

Yes. The issue is still highly concentrated in the flatbed operation and that has not yet been sized the way it needs to be and it's something that's very high on our agenda over the next several weeks actually.

Todd Fowler - KeyBanc Capital Markets

Just as far as taking a closer look at the cost structure of that business or taking a look at that business in its entirety.

Mike Uremovich

Both because this is a situation where we can't afford to continue to run a business that doesn't make a contribution to the company, and we don't plan to do that. So, if we can't figure out a way to get it done, we have to take some more drastic action.

Todd Fowler - KeyBanc Capital Markets

Okay. Sounds good, Mike. Thanks a lot, Brian. Talk to you later.

Mike Uremovich

Thank you.

Operator

Thank you. And our next question comes from Stifel Nicolaus' John Larkin. Please go ahead, sir.

John Larkin - Stifel Nicolaus

Good afternoon, gentlemen.

Brian Kane

Hi, John.

John Larkin - Stifel Nicolaus

I had a question about the volume declines that you saw pick up steam as the quarter worked its way through. How much of that do you think was due to customers beginning to conserve cash themselves and de-stock their inventories? How much of it do you think might have been due to extended holiday plant shutdowns? Is there any feel from your sales people on that?

Mike Uremovich

The feel from the sales people on that is the fact that it doesn't appear to be a directly credit-driven thing where the customers are concerned. It's just that people stop buying stuff, so our customers stop shipping it. And they didn't need to replenish inventories because nobody was buying. That's fundamentally where we are at this point.

John Larkin - Stifel Nicolaus

So, the implication of your answer is that the drop in volumes is not sort of temporarily exaggerated by a de-stocking or temporary plant shutdowns or anything of that nature.

Mike Uremovich

I doubt that we had some of that.

Brian Kane

Well, if you parse it domestic business, we probably had some of both, clearly, in the automotive sector.

Mike Uremovich

Yes.

Brian Kane

I mean the shutdowns were extended significantly so they are fairly substantial. Going back to the domestic side, we were down 1.3% in the third quarter year-over-year, and these are the on the Stacktrain domestic, the wholesale domestic volumes. And we were down 7.6% in the fourth quarter. It was a fairly substantial decline later on in the quarter and it was across a variety of businesses.

John Larkin - Stifel Nicolaus

As fuel costs dropped during the second half of the year, do you think it got to the point where some customers were hitting the bid from desperate truckers who perhaps were coming in with highly discounted backhaul rates, and certainly did you see any traffic leaving as a result of that in your opinion?

Mike Uremovich

There is probably a two edged sword there. We have some more feedback on the retail side in that fashion. I think the decline in fuel certainly is perhaps some of that should play to the truckers. And, then maybe there is some conversion back but some of the things we're hearing from our customers is that they are also looking at, there is still a differential between truck and rail in general. In some lanes, it may be unique and as you mentioned backhauls. But I think there are some people still looking at intermodal as an overall cost savings. And again, you're going to get some lane backhaul things of that nature. But it's…

John Larkin - Stifel Nicolaus

And one final question. I know you've danced around this with a couple of other questions that have been asked by other analysts earlier in the call. But, it seems to me that at some point the volume decline gets to the point with the underlying rail service providers that perhaps they feel like they need to get into the pricing action themselves. They have actually heard some fairly specific examples of that particularly in the East. Over the last two or three weeks it just seems that its got to be awfully difficult if a third party community in general and Pacer in particular has to take entirety of the margin compression? So at what point do you go to the railroads and try to sit and work with them on this? Because the last thing in the world they need is to lose some intermodal marketing companies I would think.

Brian Kane

Well, I don’t know when it comes to that point. We certainly try, and particularly around the SCQ process, the special commodity quote setter in non-contract lanes, we try and work with them as much as possible.

John Larkin - Stifel Nicolaus

But they are standing firm on their pricing in general as far as you know?

Brian Kane

I think there is such a dramatic fall-off in the volumes and you see it in the rail numbers. We have seen some other wholesalers with some very aggressive pricing and it’s not just in the east, there are again some selective lanes. So, we will just have to keep slogging through the best as we can.

John Larkin - Stifel Nicolaus

Okay. Maybe one additional final question as it were. The Senate apparently got together with the House and they have hammered out a stimulus and a package was presumably voted on the next couple of days and signed into law. If you had a chance to sort of comb through that and get a sense for whether that could begin to help the volumes turn around a bit in the second…

Mike Uremovich

Actually, we have been in a Board meeting all day and getting ready for this, so I apologize I haven’t looked through it. I think there is a confidence issue at the consumer level and hopefully something like this will start instilling some confidence. But I don't know if there is anything specific for us. And I understood there were some discussions about incentive for the rail from an infrastructure standpoint which ultimately is good for us. We certainly want this. We have seen, as I mentioned earlier, over the course of last couple of years, some really good improvement in our underlying service providers. So anything they can do to continue to improve that, we would think is a good thing.

John Larkin - Stifel Nicolaus

Thank you for your time.

Brian Kane

Thank you.

Operator

Thank you. And our final question today comes from Thompson Davis', David Campbell. Please go ahead.

David Campbell - Thompson Davis

Yes, thank you and I understand from your answers and questions that cost savings in the intermodal operations will be primarily related to this severance actually in January, and perhaps some reduction in containers, but there isn't anything else that you can do to reduce those costs. I mean, it didn't look like there were any cost reduction at all in the fourth quarter compared to previous quarters, and I just want to understand that in the future, the SAP implementation is the principle way to reduce those costs.

Brian Kane

We are running a real balancing act, David. Clearly we took the actions here recently, none pleasant, but that's what we have to do. We will continue to look at it, and we are trying to balance between looking at opportunities to improve things from a process standpoint where I can take additional people out. We know that we are going to get a fair amount of that out of the SAP, so you try to balance between the two and not damage the business. But everything is on the table.

David Campbell - Thompson Davis

But you don’t see any SAP benefits until may be the fourth quarter?

Brian Kane

Yes, we will start to implement from an accounting perspective, second and third quarter. So we’ll start pushing that aspect of it, but the bigger pieces will come later on this year.

David Campbell - Thompson Davis

Okay. Thank you very much.

Brian Kane

All right everybody, we appreciate it and as I said earlier, we will have the replay on until March 13th and I think the AT&T will have a replay. We appreciate your time and your effort, and we look forward to the next call.

With that, operator.

Operator

All right, thank you. Ladies and gentlemen, this conference will be available for replay after 7.30 pm Eastern time today to midnight March 11, 2009. You may access the AT&T replay centre at any time by dialing 1800-475-6701 and entering the access code 976637. International participants may dial 320-365-3844. Again those numbers are 1800-475-6701 and 320-365-3844, access code 976637 and that does conclude our conference for today.

Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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Source: Pacer International, Inc. Q4 2008 Earnings Call Transcript
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