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Pacer International, Inc. (NASDAQ:PACR)

Q2 2009 Earnings Call

August 5, 2009 5:00 pm ET

Executives

Brian C. Kane – Chief Financial Officer & Executive Vice President

Michael E. Uremovich – Chairman of the Board & Chief Executive Officer

Daniel W. Avramovich – President Retail Intermodal Services

Analysts

Jon Langenfeld – Robert W. Baird & Co.

Alex Brand – Stephens, Inc.

Scott Group – Wolfe Research

Todd Flower – KeyBanc Capital Markets

John Larkin – Stifel Nicolaus

Analyst for Thomas Wadewitz – JP Morgan

Keith Schoonmaker – Morningstar

Operator

Welcome to the second quarter earnings conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session with instructions being given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Mr. Brian Kane.

Brian C. Kane

Thanks for joining the Pacer International second quarter earnings call. By now you should have received our press release which was issued after the market closed today. In the press release you’ll find a statement of operations reflecting our second quarter and six months results compared to the same periods last year. Also included in the release is a balance sheet as of the second quarter and a statement of cash flow for the first half of 2009. In addition to the normal financial data in our press release, we have included a reconciliation of GAAP financial results to adjusted financial results excluding the goodwill impairment that occurred in the first quarter to provide greater clarity with respect to our ongoing operations.

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 provision of the Private Securities Litigation Reform Act of 1995 and are based on management’s beliefs or interpretations of currently available information. These statements and assumptions involve certain risks and uncertainties which are described in our SEC filings and the actual events may differ from expectations as specified from time-to-time in filings with the Securities & Exchange Commission.

Except as required by applicable law, we assume no duty to update these statements as of any future date. As information, a reply of this earnings release conference call will be available through September 5th on our company’s website www.Pacer.com. Also, we will be filing our 10Q with the Securities Exchange Commission on or before August 10th.

Now, I’d like to discuss the second quarter financial results and then I’ll turn it over to Michael Uremovich, our Chairman and CEO along with Dan Avramovich, our Chief Operating Officer to talk more about our progress implementing our strategic objectives in the current business environment. As you can see from our press release we reported a loss for the second quarter of $7.3 million or a loss of $0.21 per share as compared to income of $0.39 per share in the second quarter of 2008.

Revenue for the second quarter was $376.7 million, a decline of $139 million from the prior year quarter. For the six month period our earnings per share without the impact of the goodwill impairment was a loss of $0.65 as compared to income of $0.77 per share in the comparable period of the prior year. Revenues for the first six months were $735.3 million as compared to $1.02 billion last year. Our results reflect the continuing difficult economic conditions that existed in the second quarter. Industry volumes have not noticeably improved and the pricing environment remains difficult.

However, as I will discuss further, we have seen improvements in our retail domestic volumes and in some of the benefits of our cost reduction efforts. Looking at our intermodal segment we reported an operating loss of $5.7 million in the second quarter as compared to operating income of $31.6 million in the comparable quarter of last year. Overall, intermodal revenues were down $125.3 million to $278.6 million in the second quarter of this year. A significant portion of the decline in the revenue was as a result of lower fuel surcharge.

Our average fuel surcharge percentage was 13.8% in the second quarter of 2009 as compared to 39.4% in the comparable period last year. As I discussed in the first quarter call, due to the time lag on some of our underlying rail contracts, our cost attributable to fuel fell during the second quarter and by the end of the quarter were in line with our revenue surcharge. However, because of the decline in cost occurred during the quarter there was still some negative impact on results from fuel although not nearly as significant as its impact in the first quarter.

In addition to the negative impact of the fuel surcharge and price competition, intermodal segment revenue was also adversely affected by lower volumes. We saw lower volume in all three wholesale intermodal lines of business, third party domestic, automotive and international. Our retail domestic product however did show volume growth in the second quarters compared to last year. Total wholesale volumes excluding the retail business which utilizes our own containers declined by 25.7% while retail domestic volumes improved by 7/10ths of a percent in the second quarter last year.

If we take out our small box domestic repositioning moves, our big box retail domestic volumes actually grew by 4.4% in the quarter. Consequently, our retail operation grew its overall market share as compared to the first quarter of this year. The improvement is due primarily from the new customers we gained in the first quarter. On another positive note, almost 80% of our retail domestic business in the second quarter was shipped in our own equipment as compared to 70% in the second quarter 2008.

Our wholesale domestic volumes declined by 13% as compared to the second quarter last year principally from the effects of the economy. Also, as we had previously stated, we were impacted by reductions in volumes by two wholesale customers who last year made arrangements direct with other railroads and wholesale providers or who utilized their own equipment fleet. Wholesale automotive volumes continued to be affected by the financial stress affecting the automotive industry.

Second quarter volumes fell by 38.2% as compared to the second quarter of 2008. While there has been some recent improvement in the automotive volumes as some of the OEMs come back on line we anticipate the third quarter will continue to show a decline from the prior year. Wholesale international volumes declined by 34.2% in the second quarter as compared to last year. Approximately half of this reduction is attributable to a loss of a customer as we previously discussed in the fourth quarter. The remainder of the volume reduction was attributable to our ongoing customers who have also seen significant volume declines as compared to the same quarter of last year.

As with our other sectors, we expect to see volume reductions continuing in the third quarter of 2009. Again, on another positive note our initiative to utilize our own cartage trucks for pickup and deliver for our retail domestic intermodal business was 60% of the retail volumes in locations where cartage has a presence were [inaudible] by our own cartage operation. This was up from 45% for the second quarter 2008. Overall, our transportation margin percentage for the intermodal segment was 18.7% as compared to 22.3% in the second quarter of 2008.

The reduced margin is due primarily to higher costs from increased traffic on the BN, lower pricing to match market competition and maintain equipment flows and increased rail costs in both contract lanes pursuant to contract rate adjustments and rate increases in non-contract lanes. As I noted earlier, the in balance in fuel costs as compared to the fuel surcharge largely abated in mid second quarter and the cost and revenue were comparable by the end of the second quarter.

Our logistics segment had an operating loss of $1.4 million in the second quarter as compared to a loss of $1.7 million in the same quarter last year. Revenues in this segment declined $14.2 million year-over-year. This revenue decline was driven largely by declines in our transport heavy haul and highway brokerage business units. The transport unit has been impacted dramatically by the slowdown in the economy. As this unit did not strategically fit in the primary focus on our core intermodal business, we made the decision to sell the assets of this business to UTSI which is scheduled to close this month.

On an annualized basis the revenues for this unit are less than $100 million and the unit had incurred an operating loss in 2008 and in the first half of this year. The highway unit provides services to the automotive sector and revenues have been negatively impacted by the weak automotive industry. The reduction in the logistic segment operating loss was driven primarily from improvements in the warehousing distribution unit and reduced losses from the transport unit. The warehousing unit showed an increase in operating income through continued strong performance and the transport unit had a smaller loss than the prior year as a result of reduced personal injury and cargo claims during 2009.

These improvements were partially offset by a decline in the highway unit operating income principally from lower revenues and increased personal costs from the regionally focused [steams] added last year. As we discussed on the last call, while we continue to focus in the development of highway brokerage business, we have deferred the addition of future teams to our highway brokerage unit pending improvement in the economy. We have also taken reductions in personnel where productivity levels have not been achieved.

Overall, SG&A expenses were lower by $4 million as compared to the second quarter of the prior year. Included in the current quarter is $1.2 million of severance costs for the staff reductions that occurred in the second quarter. Severance costs for the intermodal segment was $1 million and $200,000 for the logistics segment. The 2008 SG&A amounts include $3.1 million performance incentive expenses. Excluding these severance costs incurred in 2009 and the prior year performance incentives, second quarter SG&A declined by $2.1 million. The majority of the improvement is attributable to the reduced employment levels and the salary benefit reductions that we discussed on the last call. As of the end of the second quarter, our overall employment level was 86 people lower than at the end of the second quarter in 2008.

Comparing our second quarter SG&A levels to the first quarter of 2009 our SG&A expenses declined by $2.7 million. We had a reduction of over $3.5 million in salary and wages based on our actions taken this year partially offset by increased consulting and legal costs. As of the end of second quarter, our overall employment level was 100 people lower as compared to the first quarter of this year. Overall, our employment level was down by 172 people from the end of the year.

We are continuing to streamline our organization and lower our SG&A expenses. Last Friday we reduced our work force by an additional 30 people and we have planned to eliminate additional positions and consolidate offices in the second half of this year so that we can exit two leases by the end of the year. Interest expense for the quarter was $900,000 as compared to $800,000 in the prior year quarter reflecting higher debt levels. We do expect our interest expense to be higher for the remainder of the year as a result of the increase spreads under the terms of our recent bank facility amendment and the anticipated permanent financing.

We had a tax benefit of $5.4 million as compared to an expense of $8.7 million in the second quarter of 2008. The tax rate was 42.5% in the second quarter of 2009 as compared to 39.3% last year. We used $28.7 million in cash from operations for the first half of 2009 as compared to generating $27.7 million in the comparable period last year. The decrease in cash from operations is driven largely from the operating loss incurred in the first half of 2009. The use of cash from operations in the second quarter was $1.6 million.

We continue to monitor our accounts receivable and our DSO remains consistent with prior years. Capital expenditures were $5.5 million in the first half of 2009 as compared to $9.1 million in the first half of 2008. The capital expenditures were due primarily to our SAP project. During the quarter we completed the implementation of SAP financials in all of our domestic business units. On the first quarter call we indicated we were slowing the SAP project with respect to the operating system. Since that time we entered in to an amendment to the software license agreement with SAP which limited the license agreement to the financial applications. We received a payment of $22.5 million and wrote of $22.4 million of costs associated for a gain of $100,000. Our capital expenditures for 2009 which we previously expected to be in a range of $10 to $15 million will be lower as a result concerning SAP.

Our debt level at the end of the second quarter was $78.9 million as compared to $44.6 million at the end of 2008 and $79.5 million at the end of the first quarter 2009. We had net borrowings of $34.5 million on our revolving credit facility during the first half of 2009. All of this net borrowing occurred during the first quarter of this year. As outlined in our 8K filing on June 29th of this year, we entered in to an amendment of our credit facility. Among other things, the amendment waived compliance with our leverage ratio covenant for the period June 20, 2009 through August 31, 2009 and it increased the margin on our bank borrowings.

We are currently in discussion with the lead arranger to amend the existing facility with acceptable longer term financing package before August 31st. We remain confident that we will conclude an agreement by that time. Under generally accepted accounting principles, our bank debt has been reclassified as a current liability until such time as our long term financing is secured.

Our weighted average stock outstanding for the first half of 2009 was 34.747 million shares and the stock outstanding at the end of the first half was 34,907,000 shares. The second quarter continued to be challenging. We have taken and will continue to take significant actions to streamline our organization and eliminate costs. In accordance with our strategy and direction we have seen increases in our retail volumes and utilization of our own cartage network.

We expect to continue to make strides in all of these areas as we face the challenges that we expect that will persist through the remainder of 2009. With that, I’ll turn it over to Mike Uremovich, our Chairman and CEO.

Michael E. Uremovich

I’m also joined at this end by Dan Avramovich who is our newly appointed Chief Operating Officer and is heading the operating and commercial transition. For Pacer, second quarter was a big improvement over the first and we’ve seen signs of traction in our strategic initiatives. In spite of very challenging market conditions we made significant progress in the implementation of our four major objectives during the second quarter of ’09.

Recall, and I reviewed this with you earlier, recall that those objectives were first we were going to build a world class intermodal product, secondly we were going to get our costs down, we were either going to make the logistics profitable or withdraw from those segments where we had difficulty and we were going to solidify our rail relationships. First, as we moved to implement a world class intermodal service capable of competing with anyone in the field we saw our service metrics reach their highest sustained levels in Pacer history. We’re now delivering 95% of our retail shipments in accordance with customer expectations and picking up 97% of the shipments on time.

Based on customer feedback, our service is as good as any in the business. Our retail volume improvement demonstrates this. As Brian indicated, our overall volume of retail intermodal traffic was essentially flat, increased a little less than 1% in the full second quarter compared to the second quarter of ’08 but, our core transcontinental lanes grew 4.4% and we believe in light of current market conditions this is strong performance and it has resulted in a full percentage point increase in market share.

Retail revenue was down but this was almost entirely driven by lower fuel surcharges. Consistent with our performance in the first quarter, our overall yield net of fuel declined only about 3%. This is in spite of a very strong pricing environment, though by the way there are some indications that our environment may have begun to stabilize late in the quarter. We had said that a world class intermodal product was one of the lynchpins of our strategic direction and its clear our efforts are paying off in that regard. Some of this improvement is masked by the difficult market conditions particularly the bit of price erosion however, we do intend to remain competitive and will aggressively pursue new business and protect our current book of business.

Market conditions remain highly competitive an volatile. Volumes strengthened compared to prior year in mid quarter and tailed off a bit later in the quarter. They seem to have resumed some stability over the last several weeks but I’d hesitate to make any market predictions based on such short term conditions. Our wholesale market performance by contrast has been disappointing. Two major segments auto and international were particularly hard hit. While auto has begun to show some signs of life, it remains well below last year as Brian pointed out.

We have no greater visibility in to that market than any of you but we will continue to do everything that we can to protect and grow our position in the business. Wholesale international also remains very weak as imports remain well below prior year. Another major strategic effort of ours has been that of cost reduction. We told you that we intended to reduce our cost structure to competitive levels and we’re doing that through a major series of organizational changes. Overall, our SG&A declined about 10% in the quarter net of severance. We’ve told you that our target was roughly 20% to 25% reduction in overall SG&A. This amounts to $40 to $50 million on an annualized basis.

While not obvious in direct year-over-year comparisons today, actions we have already taken will get us to this objective by yearend. Just last Friday as Brian mentioned, we took another set of actions to ensure that we reach our goal. These reductions while very painful are necessary. Some of it comes from headcount reductions, some of it comes from works amplification and a significant factor has also been our move to a functionally organized highly simplified structure. As many of you know, Pacer’s legacy came from the acquisition of over a dozen companies and we were left with far too many separate profit centers and in some cases internally competing interests.

That has now been simplified and centralized under Dan. We’ve created a functional organization dividing operational, commercial and financial functions under single key executives. At the same time we’re beginning the process of centralizing most functions in Dublin Ohio and concentrating field activities in three major regional centers eliminating unnecessary facility expense. This will result in some offices closings and I suspect some onetime charges over the next couple of quarters as we close offices.

We are also simplifying and concentrating our businesses. As you know, we’ve reached an agreement to divest most assets of our flatbed division and we expect to close that transaction during August. We’re concentrating our focus on the intermodal and truck load markets and all of our current businesses participate in those segments. Our logistics segment should show significant improvement with this divestiture.

I’d like to sort of digress on one subject for a moment. I’d like everybody to understand that these changes are very hard on our people. It’s nice to point our cost reductions but I think too frequently in earnings calls and public pronouncements we don’t recognize the hardships that are entailed in these kinds of actions. We should recognize those and I’d like to do that here. While we all recognize our responsibilities to shareholders, please remember that there are other stakeholders in these companies and they often pay a price for improved financial performance. At the very least they deserve recognition for their sacrifices and the response to the increased demands placed on them.

As to our rail relationships we continue to maintain positive relationships with our rail partners both presently and looking to the future. I’d really like to emphasis a couple of points that Brian made. We had a very bad first quarter. We burned cash and took major write downs as faced the rapid and unprecedented deterioration of the economy. The second quarter was much improved, our cash usage from operations was modest, less than $2 million as Brian pointed out, we have already or soon will receive nearly $30 million in cash from the SAP settlement and selling of transport assets. We will also be cash positive in the second half from operations.

We remain confident of restructuring the bank facility though clearly costs will go up. We have made significant progress in improving our retail position and this is the market on which Pacer will flourish in the future. We are getting our costs competitive. The economic storm is still blowing and we don’t know when it will end but we are weathering the storm and expect to come out of it positioned for a strong future. Now, operator I’d like to go ahead and open the floor for questions. Dan and Brian will join me in helping to respond to those.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jon Langenfeld – Robert W. Baird & Co.

Jon Langenfeld – Robert W. Baird & Co.

Mike, when you think about kind of the path to get back to profitability, of the things that you can control and costs is obviously a big piece of it but what about the sales side and when should we expect to see some benefits from kind of your internal structural reorganization on the wholesale business?

Michael E. Uremovich

The wholesale business as you know Jon, that’s a derivative market to some extent so, that a lot of that demands on what the end user market is doing. Our ability to capture margins in that business obviously get squeezed when the end user market is as competitive as it has been. I don’t know about the visibility on the wholesale side particularly since so much of that is attributable to the automotive and the international side. Dan, I don’t know if you want to add anything to that?

Daniel W. Avramovich

I would just reiterate really that the biggest drop that we had in the wholesale side was driven by really two parties who decided to move a lot of their business directly with the railroads. If you kind of isolate kind of the rest of the IMC group in the wholesale channel, it was fairly consistent with what’s happened in the market.

Jon Langenfeld – Robert W. Baird & Co.

Then maybe a similar question on the retail intermodal services, what does it take to get that business internally to profitability? You struggled there and then the environment obviously hasn’t helped but with this recent signs of growth and you talked about the stabilization of pricing, can some of these other initiatives get you to profitability in that part of the business?

Brian C. Kane

I think we’re very pleased with our sales effort on our retail side as some of the numbers have indicated. We’ve added some new customers and as Mike pointed out in our customer service levels which is paramount for us, those numbers have been very good as well.

Michael E. Uremovich

I don’t think Jon in the past that we have typically broken out profitability by line of business. But, I can tell you that the retail business is profitable, we just don’t break out the specifics of the level of profitability. For us and for my point of view, folks should understand that retail performance in the intermodal market in this second quarter given what the competitive landscape looked like, I was very pleased with that both in terms of how we’re gaining share in that business and how we were able in large measure not to have the kinds of price declines that we’ve seen generally speaking. We had a 3% yield decline net of fuel which in this market place I think is really quite good.

Jon Langenfeld – Robert W. Baird & Co.

How did the volume progress in to July in the retail business?

Michael E. Uremovich

Well, it’s been spotty, it was a little soft in the first couple of weeks and we frankly couldn’t tell whether that was because of the timing of the holiday or what it was but the next couple of weeks looked to be okay.

Daniel W. Avramovich

Yes, the first two weeks were a little soft, it came back in the second two weeks of July and actually on another side of the equation, actually our automotive business both in the retail and wholesale side of the equation showed some marked improvement in July. The shutdowns, some of these factories are back up Jon.

Jon Langenfeld – Robert W. Baird & Co.

The last question I had for you just in terms of the BN business, can you quantify or just directionally give us some idea of how much business you have moving through BN at this point?

Daniel W. Avramovich

We’ve typically not broken that out. Part of when I mentioned increased costs that was in startup during the second quarter of last year so that was part of the reason but we typically haven’t broken that out.

Jon Langenfeld – Robert W. Baird & Co.

Any plans to in the near term?

Daniel W. Avramovich

No.

Operator

Your next question comes from Alex Brand – Stephens, Inc.

Alex Brand – Stephens, Inc.

I guess I want to take a little bit more direct shot at Jon’s question there, there’s a lot of moving parts on changes and Mike you said we’re going to hit these cost save targets by the end of the year. Do you expect to be profitable, squarely profitable in the back half of 2009?

Michael E. Uremovich

Well, we haven’t given any guidance for this year and have generally stayed away from that but we have said that we do expect to be cash positive in the last part of the year and you can draw whatever conclusion you like from that. Yes, there are a lot of things out of our control and a lot of things moving around but I guess I would have to answer that question as yes.

Alex Brand – Stephens, Inc.

Now, in terms of there’s restructuring going on, it sounds like you’re consolidating locations and taking out people at the same time, but I would think part and parcel of that is you’ve got to have a systems plan and it sounds like beyond the financial systems you’re not moving to a single operating platform in the near future. Can you just talk about how you’re thinking about putting all those pieces together.

Michael E. Uremovich

As a matter of fact, we do have a plan. Without going in to a lot of detail on it, it was presented to and approved by the board yesterday. We’re moving forward on that. Since things have become simpler, we didn’t feel we needed as complex a system as we initially might have. So, while it’s in the formative stage, we have received permission to proceed in developing that. We have chosen some systems that are currently in operation in other companies today so we don’t run the same level of risk that we might have had in our attempts in prior years to do that.

Alex Brand – Stephens, Inc.

Brian, just sort of a housekeeping question, I think you said fuel by the end of the second quarter was kind of a wash so it’s neither a headwind or a tailwind in Q3, is that fair?

Brian C. Kane

The problem that you run in with fuel is generally when things are gyrating either up or down you get a tailwind as things rise and you get a headwind as it comes back down. So, I think for our standpoint and everybody in the industry, kind of a stable fuel let’s people plan and do some things.

Operator

Your next question comes from Scott Group – Wolfe Research.

Scott Group – Wolfe Research

Can you talk about the bottom line and cash flow impact from the sale of the truck services business?

Brian C. Kane

We’ll get some cash out of that, we sold the assets, we’ll collect receivables and as I said revenues were kind of south on an analyzed basis of $100 million and we did have an operating loss last year and first half of this year.

Scott Group – Wolfe Research

Can you just put some numbers around that in terms of how much you sold that for and then what the kind of quarterly or annual loss was that is going to be coming out?

Brian C. Kane

We’ve never really broken that out Scott and I don’t anticipate doing that now.

Scott Group – Wolfe Research

Well I suppose we’ll see what the sale was in the third quarter cash flow. Then, are you going to be restating a year ago for discontinued ops, will we see it then?

Brian C. Kane

No, we won’t have a discontinued ops, it’s generally not that material.

Scott Group – Wolfe Research

Mike, did you say that it was about $30 million in the door from SAP and the sale? Is there more coming in from SAP besides the $22.5 or is it about $7.5 million from the sale?

Brian C. Kane

The sale and really a lot of that is collection of the receivables because we sold the assets.

Scott Group – Wolfe Research

Can you just give an update on the conversations with the banks and what the timing is and at this point are you talking about kind of permanent covenant relief or just still temporary negotiations? What’s the plan B if you can’t reach an agreement by the end of August?

Brian C. Kane

Well, our goal is to reach an agreement. We’re working constructively and the banks are working constructively with us. As is stated, we’re shooting for a permanent solution by the end of August.

Scott Group – Wolfe Research

Outside of the sale of truck services, are there other businesses within logistics that you’re thinking about or would look in to selling?

Brian C. Kane

Not at this time. Our primary focus is to continue the good things that are going on on the intermodal side so no.

Scott Group – Wolfe Research

So if we look in the K there are kind of five key businesses within logistics. You said truck services was a loss in ’08, were the other four profitable or did you have losses from those as well?

Michael E. Uremovich

We had some, warehousing, international were both solidly profitable. Truck brokerage was not and again, we don’t provide breakouts of each of these. In truck brokerage, as you’ll recall there, and in retrospect and given the kind of market, the timing of our aggressive step up of that business was not good. We had anticipated moving rapidly in to that market because at the time we made the decision in roughly early ’08, it was a very robust and attractive market place. By the time we got up to it was just got our critical mass where we needed to be at precisely that moment in the later part of ’08 of course that market kind of came apart on us. So, no we had some losses in highway brokerage both in the first and second quarter.

Brian C. Kane

I think the biggest thing again is looking at it from a standpoint of single operations accountability up and under Dan to drive those things in a coordinated effort.

Daniel W. Avramovich

Scott, we’ve essentially right sized a lot of the brokerage side of the equation so we’re looking for positive results in the second half on that piece of business.

Scott Group – Wolfe Research

Can you say in the second quarter excluding truck services if you were profitable or not in retail?

Brian C. Kane

No, we’re not going to go there.

Scott Group – Wolfe Research

Just a couple of real quick ones, I guess you talked about being EPS and cash positive in the back half of the year, can you talk about July whether you were still in losses or if you were positive?

Brian C. Kane

Number one, I’m not closed and number two is no we’re not going to get in to number reporting.

Scott Group – Wolfe Research

Just one last quick one, just a quick liquidity update in terms of what’s left on the revolver or where do you think the liquidity is after the close of the truck services business?

Brian C. Kane

The only thing I’m going to tell you is as of the second quarter I think we had what $78.5 in bank debt. There was a small chunk of capitalized leases but that was roughly the same number as where we were at the end of the first quarter.

Operator

Your next question comes from Todd Flower – KeyBanc Capital Markets.

Todd Flower – KeyBanc Capital Markets

Mike, I do appreciate the context that you put around the cost savings and obviously the impact it can have on employees but I do want to talk a little bit about where you’re at on the $40 to $50 million. I think at the end of the first quarter you talked about $15 million that had been identified, it sounds like some additional costs coming through or some additional areas identified here recently. Where does that put you then kind of on just a ballpark number of that $40 to $50 million at this point?

Michael E. Uremovich

You mean on a run rate basis?

Todd Flower – KeyBanc Capital Markets

That’s right.

Michael E. Uremovich

Right now we’re about half or two thirds of the way there.

Daniel W. Avramovich

Right now but by the end of the year we’ll be probably towards the low end of the $40 million and by midyear next year we’ll be at kind of the $50 million run rate basis.

Todd Flower – KeyBanc Capital Markets

Getting to the other half obviously some of that is coming from consolidation of locations, does some of that come from exiting the flat bed operations or what are kind of the biggest buckets that are still remaining?

Michael E. Uremovich

Flat bed operations will have an impact on that.

Daniel W. Avramovich

Right, some of it is a consolidation and we’re doing a roll out of changes to the regional structure that both Mike and Brian had alluded to and kind of continued cost savings on the IT side as well next year.

Todd Flower – KeyBanc Capital Markets

I thought that some of the costs was coming from the IT side, so you’re still going to get some of those savings even with the change in the SAP implementation?

Daniel W. Avramovich

Yes.

Todd Flower – KeyBanc Capital Markets

What’s the magnitude of the IT savings at this point?

Brian C. Kane

It’s part of the whole package and I don’t want to parse out particular pieces.

Daniel W. Avramovich

But, I’d say we’re fairly confident it’s not something – we’ve got identified programs that we’re highly confident we’re going to be able to get that costs out.

Todd Flower – KeyBanc Capital Markets

Then I guess maybe at just a high level to come back to the profitability in the second half of the year, thinking about where we were in the second quarter, obviously we’ve talked about the cost savings, there’s another piece in getting back to profitability, does that come from just having the fuel headwind subside in the intermodal business in the back half and really getting beyond that and having a normalized fuel environment or is there something else in there either from a share gain or from automotive picking up or stabilizing? What’s kind of the other big pieces that get us besides the costs to profitability?

Brian C. Kane

I think it’s all part and parcel. It’s nice to have the fuel headwinds behind us. We think again, we’ve had some fairly positive results that we want to continue to build on, on the retail, the cartage conversion. Early indications are now that automotive has improved from the second quarter numbers, continued benefit from some of the cost reductions although as we talked about, offset by some continuing restructuring costs associated with that. There’s a lot of things, we’re working hard on the ones we can control.

Todd Flower – KeyBanc Capital Markets

Two last ones, I’ll try to get what I can out of these, from the standpoint of where you’re at with the credit facility, what seems to be the sticking point? I was a little surprised when you had the waiver that it was only through the end of August. Was that just a matter of the banks wanted to see the final second quarter results and get the financial statements?

Michael E. Uremovich

Let me make it clear, there is not an individual sticking point at all in the discussions. Obviously we went to the bank well in advance of what we thought was going to be a difficult time because of the first quarter performance. It just takes time to get these things done and we were unable to get all of the legal niceties and everything else around it completed in time for the second quarter.

Brian C. Kane

Basically we looked at it as a two step process, one get the amendment and the wavier in place so we can do the permanent facility.

Todd Flower – KeyBanc Capital Markets

I understand, I guess I was just getting at was it something that was just more procedural at this point now that you have the second quarter release, the Q filed and the sale is it something that should be automatic now to get the new credit facility?

Michael E. Uremovich

I hope you can appreciate we’re not going to go with all public details on it. As I said, we are working constructively with our bank to get a permanent solution.

Todd Flower – KeyBanc Capital Markets

Just one last one here, any update or anything you can talk about with the outstanding arbitration claims that have been in the recent SEC filings? Any change in the amounts or any change in developments related to those claims?

Brian C. Kane

There’s really not a whole lot of significant change and that will be updated in the Q.

Todd Flower – KeyBanc Capital Markets

No significant change with the amounts of where you’re at with the whole process?

Brian C. Kane

In the process.

Operator

Your next question comes from John Larkin – Stifel Nicolaus.

John Larkin – Stifel Nicolaus

If you took your wholesale volumes and adjusted out the two big wholesale customers that decided to go direct to the railroads what would the number have looked like then just sort of round numbers? And, are you worried that there are other wholesale customers that may go direct to the railroads in the future?

Michael E. Uremovich

Well, if you took those two out, and Dan is checking those numbers now to be specific but, as I recall if you took those two out the volume is essentially flat. It’s down a little bit relative to market given the market conditions I think but not significantly.

John Larkin – Stifel Nicolaus

That’s reasonably encouraging with the customers that have stayed with you?

Michael E. Uremovich

Yes. Again, sometimes it’s hard to predict, we don’t know right now of any of the other IMC accounts that are considering that. Recall that the two that made the largest move were very, very large customers in one case combining their international volumes with their domestic and in another case making a different kind of strategic decision for their equipment and things like that. I don’t see that as a major risk. I can’t predict that it would never happen but I don’t see it as a major risk downstream.

Daniel W. Avramovich

Jon, we were down 1% excluding them.

John Larkin – Stifel Nicolaus

Pretty solid performance.

Daniel W. Avramovich

Then I’d just reiterate what Mike had said on others, I think we’ve got a fairly solid footing with the rest of the IMCs and I would think that the volume, kind of the business that they’re doing, is a clear indication of that.

John Larkin – Stifel Nicolaus

Now, you said that you’re going to be profitable and cash flow positive in the second half, that implies that there still could be losses in the third quarter that would be offset by profits or positive cash flow in the fourth quarter. Do you care to comment as to whether that’s the right way to look at it or whether there in fact would be a more positive outlook for the third quarter?

Brian C. Kane

Given the environment that is out there and as we talked about, it’s a difficult environment. Again, we believe we have some positive traction in some of the things that we can control. I wouldn’t want to break it down by quarter.

Michael E. Uremovich

I’d be reluctant to do that.

John Larkin – Stifel Nicolaus

The debt level has been discussed, was just shy of $80 million and you did mention that there would be $30 million coming in from the sale of what I’ll call the truck load operation for lack of a better name and then the SAP payment –

Brian C. Kane

The SAP payment came in.

John Larkin – Stifel Nicolaus

It already came in, that’s not a question mark for the future plus you should have positive free cash flow during the second half, plus reduced cap ex mostly due to scaling back the SAP. That sort of implies that perhaps you might be able to pay down as much as half of that debt by the end of the year. Is that an outrageous thought at this point?

Brian C. Kane

I think if you look at the balance sheet we had indicated the SAP money came in very late in the quarter so we had $21.6 million in cash.

John Larkin – Stifel Nicolaus

So that’s not netted out against the $78 already?

Brian C. Kane

That is correct. Again, I don’t want to try and parse out specific numbers and where we’re going to be at a specific point in time.

Michael E. Uremovich

Debt will clearly be lower.

John Larkin – Stifel Nicolaus

But this is still a asset light business at worst and if you can continue on with your current momentum there’s a reasonably good chance that over the 18 to 24 month horizon you could be completely out of the woods with respect to your debt. That’s not an outrageous scenario?

Michael E. Uremovich

Directionally that’s correct. Whether it would be zero in 24 months or some modest amount I’d hate to predict but the logic is absolutely correct.

John Larkin – Stifel Nicolaus

I’m trying to reflect the types of questions that we get all the time and they tend not to be too similar to some of the questions that have been asked already. They tend to relate to things like one of your competitors/customers has just moved all its business over to Union Pacific and the implication is that could potentially be negative for you from a competitive point of view but it seems to me that you’ve always competed with a HUB group and the fact that they happen to buy their line haul transportation from somebody else doesn’t necessarily change things.

Michael E. Uremovich

I would agree with that. As you know, we have always had and continue to have a high regard for HUB and the way they run their business. They do a nice job and they’re a formidable competitor but, they made a decision that was in their best interest relative to the management of their own fleet and I don’t believe that alters the competitive dynamics at all.

John Larkin – Stifel Nicolaus

Are they still a customer of yours?

Michael E. Uremovich

Yes.

John Larkin – Stifel Nicolaus

Also, just the obvious question here with respect to the contract with Union Pacific which I guess expires a little over let’s call it two years from now, just hypothetically almost every investor I talk to that’s the main issue and under a worst case scenario let’s say that whatever reason there is no agreement and the two parties cannot agree. By then do you think there’s enough business on the BN and enough business in Mexico, enough business in the east, enough business in your logistics operation so that Pacer is a viable model going forward?

Michael E. Uremovich

Let me respond to that in two ways, number one I think we have consistently said that irrespective of the outcome of any discussions with our railroad partners, what we have to do with our business from a business strategy point of view and from an execution point of view is exactly the same with or without an early arrangement with Union Pacific or expiration on time. What we need to do for our business is exactly the same.

Secondly, I will add a note of caution here that we have respected our obligation with Union Pacific not to discuss publically anything that’s going on between the parties if you will and they have been very, very rigid and disciplined about maintaining the same situation from their perspective so we’re not in a position to go in to any details on any of that.

Operator

Your next question comes from Analyst for Thomas Wadewitz – JP Morgan.

Analyst Thomas Wadewitz – JP Morgan

A quick question on pricing, you seem to be pretty aggressively pursuing new business and you had mentioned you want to maintain your book and it sounded like on some of the other calls that there was an indication that pricing would get worse in the second half than it was in the second quarter when your competitors also said pricing was down 3%. So, they were looking at like a down 6% level, is that something that you’re concerned about, deteriorating pricing in second half?

Michael E. Uremovich

Well, I’m always concerned about deteriorating pricing.

Brian C. Kane

We haven’t seen it though. I mean really the major bid season is generally in the spring time in May and based on what we’ve seen consistently between some of the bids that we’re involved in and have won we see pricing fairly stable between the first and second quarter.

Analyst Thomas Wadewitz – JP Morgan

You had mentioned that there was another 30 employees that were let go last week, or there was an additional reduction of 30 employees, what was that related to?

Daniel W. Avramovich

As part of the functional realignment that Mike had indicated and it really was focused around consolidation of like functions as well as migrating to a three regional operational center concept. We will be migrating really through the end of the year in that regard. It was just kind of an initial migration to that concept.

Michael E. Uremovich

As you identify opportunities for improvements, streamlining, we try and implement those and we want to do it in a fashion as Dan pointed out in the last quarter and what Mike was emphasizing in the call is we’re very cognoscente of maintaining our service product for our customers and so it’s not going to be just a mass change, it’s going to be in a controlled fashion.

Daniel W. Avramovich

One thing that we’ve done is we’ve looked out over the next 12 months in terms of actions that we anticipate taking and we’ve shared that with our employees so they know exactly what we’re doing and why we’re doing it and making sure that they’re on board with that.

Analyst Thomas Wadewitz – JP Morgan

With the 30 heads here does that include the ability to recognize an opportunity with real estate at that point or is there more room to go with that facility?

Brian C. Kane

We don’t own real estate it’s all leases. We have two that we think we can exit by the end of this year.

Analyst Thomas Wadewitz – JP Morgan

So you’ll go from five to three?

Brian C. Kane

No, there were a couple of smaller offices, there will still be some. We have a lot of field offices with cartage locations and things like that but we’re trying to shut down the offices.

Analyst Thomas Wadewitz – JP Morgan

I guess if you’re realizing some opportunity to lower your SG&A costs here, is there more room to go in the third quarter, is that like the bulk of it and then we’ll see like another batch of cost savings in the fourth quarter to reach your full year run rate at the end of fourth quarter? How does the timing profile work for the rest of the year?

Brian C. Kane

Probably again in the fourth quarter.

Analyst Thomas Wadewitz – JP Morgan

Okay so probably not much more expected in third quarter at this point?

Daniel W. Avramovich

There will be some. Clearly, when we go to the three regions, that will be over time. It’s not going to be all at once. That will be throughout the second half.

Michael E. Uremovich

Obviously, what we try to do here is we try to do this as driven by the business not by the calendar. So, right now it would be very hard for us to tell you what comes out in the third quarter and what comes out in the fourth.

Daniel W. Avramovich

One thing that we’ve said to our customers, said to our people is that we will not jeopardize any service progress that we’ve made. In fact, we’re looking at and as Mike had indicated, we’re looking at continuing our progress on getting a world class intermodal service. We continue to make progress in the second quarter, we anticipate we’re going to continue to improve upon that in the third quarter.

Analyst Thomas Wadewitz – JP Morgan

Switching gears for a moment, if we look at the auto business, how much of your business today is really auto related?

Daniel W. Avramovich

16% from probably a revenue basis, from an overall intermodal volume perspective it’s about 20% to 25% depending upon –

Michael E. Uremovich

A lot of it depends on how you define auto [inaudible] there is some suppliers, primary suppliers but it’s significant. Choose a number between 15 and 20.

Analyst Thomas Wadewitz – JP Morgan

Even with the volume decline.

Michael E. Uremovich

It use to be higher.

Analyst Thomas Wadewitz – JP Morgan

What was it before? Around 25% or even more?

Michael E. Uremovich

If you took intermodal volume if you will total, last year it was probably 25% and this year it’s about 19%.

Analyst Thomas Wadewitz – JP Morgan

Then I think last year you started to see the significant drop off in auto start to have an impact on third and fourth quarter, how should we look at it this year seeing as how there’s a lot more anticipation of a ramp up in auto production?

Michael E. Uremovich

I don’t know, you tell me what the auto production is going to be and we’ll be able to give you an idea of that. I haven’t the foggiest notion.

Analyst Thomas Wadewitz – JP Morgan

Well I’ve heard as much as 30% to 40% depending if you include the cash for clunkers.

Michael E. Uremovich

I don’t know, you have more transparency in to that business than we do.

Operator

Your next question comes from Keith Schoonmaker – Morningstar.

Keith Schoonmaker – Morningstar

I recognize your progress in one of your key goals is growing retail during a pretty turbulent market with intense truck competition but can you comment on the type of business you’ve won in retail? Are you targeting particular markets?

Daniel W. Avramovich

Yes we are. Obviously, as we talked about on the prior question, a big piece of our business in the past has been automotive so a lot of what we’ve been focusing is more on the consumer products than the retail side of the equation. That’s where the growth has been.

Keith Schoonmaker – Morningstar

That makes sense, diversifying away a little bit from the historical automotive market?

Daniel W. Avramovich

Correct.

Keith Schoonmaker – Morningstar

Also, you mentioned your plan to operate the Dublin Ohio center of operations and three regional centers, could you give us an idea of the number of facilities the firm operated maybe at the start of the year presently and target for end of year? A lot of different brand names in there, it’s kind of hard to understand how many facilities there are.

Michael E. Uremovich

It is Keith and I’m not quite sure how to address that because in many cities we have physical operations so we would have a facility in the sense that you would have a yard, a dispatch office and some trucks and things like that. Most of those are going to remain, particularly in the dispersed locations because you have to be able to physically service the customer. What we’re talking about here is major offices and things like customer service centers and accounting and billing operations and things like that that we would be bringing together. So, it would be relatively few but it would be significant from our cost perspective.

Daniel W. Avramovich

Part of this initiative is really looking at how do we optimize our entire network and consolidating a lot of the network planning and dispatch activities together so we can be more responsive as it relates to opportunities in given markets.

Keith Schoonmaker – Morningstar

I recognize this is easy to say from the analysts chair not having to do the execution but I think Mike you mentioned to me that there are a number of for example redundant facilities in LA and Chicago that might be able to be taken out but I guess what you’re saying is it’s hard to put a number of that at this point?

Michael E. Uremovich

Yes, because at this particular point you don’t know and believe me for any of the employees that are listening I’m not sending a message or saying anything specific here, but you don’t know when you’ve got four locations in Southern California or five locations in Southern California which one is going to be the center and exactly how you’re going do it and would you leave the one in San Diego alone because it’s far enough out, those kinds of questions we really haven’t gotten resolved at this point. As Dan said, we’re trying to migrate this through region by region because it’s not the kind of thing that we can decide what we want to do and turn a switch and have it happen nationwide all at once.

Keith Schoonmaker – Morningstar

And closed facilities don’t necessarily mean terminations just a different location.

Daniel W. Avramovich

That’s right. In fact, a lot of what we’ve done has offered some of the people that are in the smaller local offices where we’re consolidating those activities relocation to kind of a more consolidated center approach.

Keith Schoonmaker – Morningstar

I guess just a quick one, I wanted to confirm what I think I heard earlier that at the moment you’re not mentioning if there are any additional business units for sale such as freight forwarding?

Michael E. Uremovich

That’s correct.

Keith Schoonmaker – Morningstar

I guess final question, we’ve heard management of other businesses like railroad integrators indicate they believe freight demand may no longer be deteriorating? Would you say the same at this point that we’re in the flat part of the trough not yet climbing upwards or can you give a general statement? I recognized you commented on July but just even one step back would you say that we’re at the bottom of the trough in your opinion?

Michael E. Uremovich

In my personal opinion, and this I would emphasize is a personal opinion, I think that’s probably accurate. I don’t see things continuing to deteriorate, I don’t see any evidence of that but on the other hand I don’t see any sharp point of inflection at the moment either. My personal view is that we’re likely to look back at this thing and say that the first quarter or first third of 2009 was the absolutely major of the whole thing.

Daniel W. Avramovich

I think the only area that we have seen uptick in is in automotive and that’s been as of late in July and hopefully that continues.

Operator

Your final question comes from Scott Group – Wolfe Research.

Scott Group – Wolfe Research

Just a real quick follow up, I don’t know if you mentioned it, when does the two international customers, when do you grandfather those?

Brian C. Kane

When will we lap them do you mean?

Scott Group – Wolfe Research

Yes.

Michael E. Uremovich

The international customers should be third quarter.

Scott Group – Wolfe Research

At the end of the third quarter.

Michael E. Uremovich

Yes, there was only one of those.

Brian C. Kane

One international customer.

Michael E. Uremovich

The international customer was third quarter was the start of the wind down. On the domestic side some of it was somewhat gradual but it was second half of the year.

Scott Group – Wolfe Research

So there was one international and one domestic and both second half of ’09 is when they will lap?

Brian C. Kane

Yes.

Scott Group – Wolfe Research

Then just sorry to keep going back to this I’m just not understanding it entirely, understanding that there is field offices out there that are going to remain open, when you talk about going to three operating regions, how many operating regions are we at now excluding the smaller field offices which you said are going to stay open? Is there a way to think about that?

Michael E. Uremovich

Maybe just in large numbers there’s 26 different terminal locations of which we’re looking at in most cases having a skeleton crew there if you will but the majority of those 26 will be consolidated in to three.

Scott Group – Wolfe Research

So you’re going from 26 terminals to three.

Michael E. Uremovich

No.

Brian C. Kane

The terminals will be still out there.

Michael E. Uremovich

You’re consolidating some of the activity out of the terminal location but you still need to interface with your drivers and make sure loads are picked up on time, paper work is turned in, etc.

Scott Group – Wolfe Research

Then the two leases that you talked about exiting this year, can you just put some numbers around what the savings are from that?

Brian C. Kane

No.

Brian C. Kane

Again, thanks everybody for joining us. It’s a tough quarter but we think we are making some positive strides in terms of what we can control particularly around the areas of growth in our retail and cartage consolidation as well as service product and we continue on our effort to streamline our costs. We look forward to talking with you at the third quarter and hopefully we’ll have continued good news.

Operator

Ladies and gentlemen that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Pacer International, Inc. Q2 2009 Earnings Call Transcript
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