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Con-way (NYSE:CNW)

Q2 2014 Earnings Call

July 31, 2014 8:31 am ET

Executives

Patrick J. Fossenier - Vice President of Investor Relations

Douglas W. Stotlar - Chief Executive Officer, President and Director

Stephen L. Bruffett - Chief Financial Officer and Executive Vice President

W. Gregory Lehmkuhl - Executive Vice President and President of Con-Way Freight Inc

Joseph M. Dagnese - Executive Vice President and President of Con-Way Truckload Inc

Robert L. Bianco - Executive Vice President and President of Menlo Worldwide Logistics LLC

Analysts

William J. Greene - Morgan Stanley, Research Division

Christian Wetherbee - Citigroup Inc, Research Division

Scott H. Group - Wolfe Research, LLC

Kenneth Scott Hoexter - BofA Merrill Lynch, Research Division

Thomas S. Albrecht - BB&T Capital Markets, Research Division

A. Brad Delco - Stephens Inc., Research Division

Jason H. Seidl - Cowen and Company, LLC, Research Division

David G. Ross - Stifel, Nicolaus & Company, Incorporated, Research Division

John L. Barnes - RBC Capital Markets, LLC, Research Division

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Thomas Kim - Goldman Sachs Group Inc., Research Division

Todd Clark Fowler - KeyBanc Capital Markets Inc., Research Division

Allison M. Landry - Crédit Suisse AG, Research Division

Matthew S. Brooklier - Longbow Research LLC

Operator

Welcome to Con-way Inc.'s second quarter earnings review conference call.

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

Patrick J. Fossenier

Thank you, Stephanie. Welcome to the Con-way second quarter 2014 conference call for shareholders and the investment community. In a minute, I'll turn it over to Con-way President and CEO, Doug Stotlar.

Before we get in to the call, I'd like to offer a few reminders. First, certain statements in this conference, including statements regarding anticipated results of operation and financial condition, constitute forward-looking statements and are subject to a number of risks. Actual results of operations and financial condition might differ materially from those projected in such forward-looking statements, and no assurance can be given as to future results. Additional information concerning factors that could cause actual results and other matters to differ materially from those in the forward-looking statements is contained in our forms 10-K and 10-Q and other filings with the SEC.

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

Also, certain financial and operating statistics of the company can be found in the Investors section of our website.

Also, we have a lot of people on this call, so we'd appreciate it if you'd limit yourself to a question or two, then return to the queue.

Now with that, I'm pleased to turn it over to Doug Stotlar.

Douglas W. Stotlar

Thanks, Pat. Good morning. On the call today, I'm joined by members of our senior leadership team, including Con-way's CFO, Steve Bruffett; Con-way Freight President, Greg Lehmkuhl; Menlo Logistics President, Bob Bianco; and Con-way Truckload President, Joe Dagnese. Steve will provide some commentary on our financial picture, and Greg, Bob and Joe will participate in the Q&A portion of the call.

All of our business units delivered improved results in the quarter led by the performance of Con-way Freight, which recorded a more than 50% increase in operating income compared to last year's second quarter. In conjunction with the release of our quarterly results yesterday, we also announced 2 initiatives designed to return meaningful capital to shareholders, along with an increased level of pension funding for 2014.

Regarding the shareholder initiatives, our Board of Directors authorized a $150 million share repurchase program and a 50% increase in our common dividend. Given the progress we have made toward our financial objectives, we have reached the point where we can redeploy a portion of our cash balance to fund these shareholder initiatives while maintaining a strong balance sheet. Steve will provide more detail around these actions during his commentary later in today's call.

Moving to the second quarter's financials. I'll provide an overview of our results. In the second quarter of 2014, Con-way reported consolidated revenues of $1.49 billion compared to $1.38 billion a year ago. On an operating income basis, we earned $102.7 million this quarter compared to $76.3 million last year. Diluted earnings per share were $0.93 compared to $0.75 in the prior year period.

On a non-GAAP basis, earnings per diluted share in the 2014 second quarter were $0.91 compared to $0.68 in last year's second quarter. Non-GAAP items consisted of tax-related adjustments and gains on sale of property from both years, and an increase in reserves for international bad debt in the prior year.

Moving to our business segments. I'll start with a review of Con-way Freight, our LTL company. Con-way Freight had second quarter revenue of $940.5 million, a 5.4% increase from last year's revenue of $892.3 million. Higher yield and higher daily tonnage in the quarter contributed to the increase. Operating income was $83 million, up 51.8% from the $54.7 million earned in the second quarter a year ago. Results this period benefited from revenue management initiatives that contributed to improved composition of freight in the network and included a $3.4 million gain on the sale of property.

Con-way Freight's operating ratio was 91.2 in this year's second quarter compared to 93.9 in the previous year period. Excluding the property gain, the operating ratio this quarter was 91.5. Revenue per hundredweight or yield increased 4.7% in the quarter compared to the prior year. Excluding fuel surcharge, the increase in yield was 4.1%. When adjusted for changes in length of haul and weight per shipment, the increase is 5.4%, excluding fuel surcharge.

For the second quarter, daily tonnage was up 1.3% over the second quarter of 2013. With respect to tonnage per day, year-over-year, April was up 3.4%, May increased 0.5%, and June was up 0.2%, while July is down approximately 1.5%. This recent year-over-year tonnage trend was expected and reflected the amount of -- the impact of our revenue management initiatives, which improved the composition and profitability of Freight in the network.

We experienced strong demand for Con-way Freight services in the second quarter. This reinforced the firming rate environment and supported solid profited growth as we continued to execute our lane-based pricing strategy and carefully managed our shipment mix to margin -- to improve margins.

We continue to benefit from the improved data and sophisticated linehaul planning and optimization tools we've developed. We're pleased with the progress at Con-way Freight and are focused on the next phases of our continuous improvement roadmap.

Now I'll move to our Logistics segment. In the second quarter, Menlo Logistics, our globally logistics and supply-chain management operation, reported increased revenues, net revenues and operating income. Revenue was $433.7 million, a 17.1% increase over the prior year's second quarter revenue of $370.4 million. The higher revenue reflected increased business in both Transportation Management and Warehouse Management Services. Net revenue or revenue minus purchased transportation came in at $186.7 million, a 15.7% increase from last year's net revenue of $161.4 million. The higher net revenue was primarily attributable to growth in Warehouse Management Services. Menlo's operating income this period was $6.4 million, an increase of 6.3% over the $6 million earned in last year's second quarter. The current period was affected by lower margins on Transportation Management Services and higher variable compensation expense.

Menlo grew revenue in the quarter, yet felt the effects of tight capacity and rising rates in the truckload market, which increased purchased transportation expense, negatively affecting operating income. Menlo remains focused on reducing costs and improving margins. Following the surge of new business we saw last year in Menlo's Warehouse Management Services, its pipelines has returned to typical levels and a more balanced mix of services. We are encouraged by an increase in bids for transportation management Projects, as well as growth opportunities in new industry sectors for us, such as oil and gas and healthcare.

Now I'll review results in our Truckload segment. In the second quarter of 2014, Con-way Truckload reported revenues of $164.1 million, slightly above last year's revenues of $161.8 million. Top line results benefited from higher other revenues and an increase in revenue per loaded mile, partially offset by a decrease in loaded miles. Truckload's operating income was $13.5 million in this year's second quarter, a 24.2% increase over the $10.9 million earned in the prior year. The year-over-year improvement was primarily the result of increased pricing and lower vehicular claims expense.

The operating ratio, excluding fuel surcharge, was 89.4 compared to 91.4 in the year-ago period. A consistently firm demand environment supported higher yield for Con-way Truckload in the second quarter. Pricing strengthened throughout the quarter as the market dealt with capacity constraints, exacerbated by the worsening driver shortage. We made strides reducing driver turnover, which spiked last quarter. At the same time, we are still above our fleet's normal level of unseated trucks adversely impacting revenue and profit. Improving recruiting and retention remains a focus for Con-way Truckload. As we discussed during our call last quarter, we're working on enhancements to our driver pay package, which we expect to announce later this quarter.

Now I'll turn it over to Steve Bruffett for some additional financial perspective.

Stephen L. Bruffett

Thanks, Doug, and good morning, everyone. I'll begin with the second quarter update, and then discuss our plan to redeploy a portion of our cash balance.

The second quarter operating cash flow was $126 million compared to $108 million in the second quarter of last year. Now on a year-over-year basis, the main items that drove this difference were higher net income and lower pension contributions, partially offset by increased working capital. Net capital expenditures were $39 million in the quarter as compared to $73 million in the second quarter of 2013.

For the full year, we are lowering our outlook to $275 million, which is down $10 million from our previous guidance of $285 million. This change is the result of slightly lower gross CapEx and higher proceeds from dispositions. Financing activities provided $6 million in the quarter, which was the net effect of capital lease repayments, common dividend payments and stock option activity.

In total, was cash activity resulted in a balance of cash totaling $499 million at June 30, which compares to $485 million at year-end 2013.

So now let me take a moment to discuss the redeployment of a portion of our cash balance. As we've described on previous calls, our cash balance was sized to accommodate several primary objectives coming out of the recession. These included the replenishment of our fleets, investments to support margin expansion at Con-way Freight and improving the funded status of our pension plans.

Over the past several years, we've made a lot of progress on each of these financial objectives. We've reduced the average age of our fleets to their targeted levels, and we provide our drivers and our customers as one of the safest and most technologically-advanced fleets in the industry.

We've ensured that Con-way Freight had the capital needed to fund strategic initiatives over the past several years, and we are now beginning to see the margin expansion we expected from these investments. There's more work to be done, but we have sufficient capital to fund the upcoming projects on Freight's continuous improvement roadmap. Most of these projects involve IT investments, which are not overly capital-intensive.

We've also improved the funded status of our pension plans. Pension funding has been our primary vehicle for leverage reduction since it addresses our most volatile form of debt. Our reduced leverage, coupled with Con-way Freight's margin expansion, has helped to solidify our investment-grade credit rating.

Importantly, we've also taken steps to de-risk these pension plans and reduced the likelihood that they'll become significantly underfunded in the future. So from a capital structure perspective, we've reached a point where it makes sense to redeploy a portion of our cash balance.

Our dividend increase brings our yield in line -- more in line with its historical average, and our stock buyback program is designed to return a meaningful amount of capital to our shareholders.

The incremental pension funding has the dual benefit of further strengthening our balance sheet while reducing our cash funding needs going forward.

So overall, we're pleased to have made significant progress toward our financial objectives so that we're in position to implement these uses of cash.

Now shifting gears, I want to provide some context on our near-term expectations for business unit performance. At Con-way Freight, we see continued strength in the LTL demand and pricing environments, along with steady progress on our margin expansion initiatives. As a result, we expect Freight's operating income to be approximately 25% over the $52 million that we earned in the third quarter of 2013.

As we consider Con-way Freight's 50% improvement in the second quarter of this year and the approximate 25% improvement expected for the third quarter, the primary difference between these 2 percentages is the wage increase that was implemented in July.

Now with respect to Menlo. For the third quarter, we expect modest sequential improvement in operating income over the $6.4 million earned in the second quarter of 2014.

Then at Con-way Truckload. We expect strong demand to continue supporting a price -- a firming price environment, and this benefit will be somewhat offset by the costs associated with driver availability.

In aggregate, we're expecting third quarter operating income to be up 20% over last year's $9 million.

There's another topic that I'd like to mention, and it involves the termination of a small pension plan. We normally discuss our large pension plan, but we have 2 others, including this small legacy plan, that we're terminating. This process will be completed in the fourth quarter, at which point we expect to make an incremental $5 million pretax contribution, as well as record a pretax charge of approximately $15 million. The exact funding and expense amounts won't be known until the fourth quarter, and they will be driven by lump sum take-up rates and annuity prices at the time of termination. I'd also note that the $5 million contribution is included in the incremental $80 million of pension funding that we discussed in the earnings release.

So lastly, here are some other items for your modeling purposes. First, we expect depreciation and amortization expense to be approximately $245 million for the full year. Also, we continue to anticipate that our 2014 effective tax rate, excluding discrete items, will be approximately 40%.

Regarding our share count, we continue to expect our fully diluted shares for 2014 to be 57.8 million, and that's prior to the effect of any repurchases.

Lastly, we expect to be modestly cash flow positive in 2014 before considering the impact of the cash redeployment initiatives we just discussed.

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

Douglas W. Stotlar

Thanks, Steve. Our second quarter results illustrate the progress we've made. We've upgraded our fleets, strengthened our pension plans and achieved margin expansion at Con-way Freight. Collectively, our business units are positioned with the resources and capabilities for sustained improvement.

Because of this progress, we've been able to take additional actions that will return meaningful cash to our shareholders through share repurchases and dividend increase. We continue to benefit from a strong demand environment and firm pricing for trucking services. At the same time, our strategic improvement initiatives have plenty of runway left to drive further cost efficiencies and profit growth.

Our focus remains on consistent execution, continuous improvement throughout the organization and expanding margins, while delivering safe, high-quality service to our customers.

That concludes our prepared remarks. And operator, we're ready to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Bill Greene with Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

I was hoping you can add a little bit more color around the third quarter trend, particularly as it relates to yield. I think if I heard you right, you said tonnage was running down about 1.5% this month. Is that sort of in line with your expectations? Or is that because of some big change on a contract side or something? And maybe you can add a little bit of color around some of the assumptions on yields that you're using on Freight for the third quarter.

W. Gregory Lehmkuhl

Sure. So we ended Q2 up 1.3% versus '13, as Doug talked about. And I think it's important to talk about the Truckload-sized shipments or over -- the shipments over 20,000 pounds when thinking about our yield trends. So we've been using our improved linehaul and pricing capabilities to ensure we're surgical about which of these shipments that we allow into the network. We're currently restricting about 3.5 million pounds of freight a day of Truckload-sized shipments. When we started this initiative back in March, it was about 1.5 million pounds a day. So without this initiative, our tonnage in Q2 would have been up about 5%, and we'd be up, per day basis in July about 3%. So this helps us maximize our use of existing assets and minimizes the need for purchased trans, especially in headhaul lanes, and obviously supports yield growth and ultimately, profit. And so when we couple that with our continued focus on lane-based pricing, we think we'll continue to see strong yield results for the foreseeable future.

William J. Greene - Morgan Stanley, Research Division

The yield results so far in July, have they been significantly slower than the second quarter?

W. Gregory Lehmkuhl

No, I would say in line. Another thing that's really driving our yield and just the composition of Freight and our network, we've talked about this on all the recent calls. In Q2, our national account tonnage was down about 1%, while our local account tonnage grew 8% year-over-year. And both of these segments were impacted by the heavyweight shipment restrictions. So I guess the point is our mix continues to trend in the right direction.

William J. Greene - Morgan Stanley, Research Division

Okay, fair enough. Steve, can I just ask you one quick question on the buyback? Are your intent to do this on a ratable basis or is this going to be totally opportunistic based on where the stock is?

Stephen L. Bruffett

Yes, it's a good question. We -- first, we're glad to be in a position to implement these initiatives. And our approach will be similar to how we've approached the pension issue, the fleet age issue and so on, which is steady progress toward an objective over time. So we see ourselves being steadily in the market, perhaps not in a linear fashion, but we expect to make progress towards this buyback program and steady fashion over time.

Operator

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

Christian Wetherbee - Citigroup Inc, Research Division

I guess maybe when you're thinking about some of the progress you've made on the LTL margins and the opportunity going forward, is there any way to sort of tease out what you're generating from the pricing side and really what's kind of being dropped to the bottom line from the initiatives you have rolling there? I know it's a bit of a circular argument because a lot of what you're doing is focused on improving pricing and the mix, but I just kind of wonder if you can give us a rough sense of how you feel like you're scoring yourself relative to your initiatives?

W. Gregory Lehmkuhl

Sure. So great, great question, and you're right. They're completely -- the revenue management side and the ops improvement side are very much linked. But I'd just like to start by saying thanks for recognizing Q2 was a solid quarter and I'd like to start just by thanking our 22,000 Freight employees for delivering $83 million in op income, 91.2 OR, and our most profitable quarter since 2006. The results were directly driven by their focus and hard work, and I believe provide further evidence that our strategic initiatives are working and that the demand environment remains soft. And so when you think about the contributions to the margin expansion, lane-based pricing was by far the largest single contributor of profit improvement, and we also had the benefit of the wage increase timing versus prior year in Q2. But Q2 was really the first clean quarter where we had a full year of lane-based pricing in place, if you consider the fact that the severe weather in Q1 skewed pretty much all of our operating metrics. And so as Doug said, our yield adjusted for length of haul and weight of shipment was up 5.4% versus 2013. And we're excited about the fact that given that we're only improving the process and getting more and more collaborative with customers as we do it, we would expect these results to continue. From an operation standpoint, in Q2, we did see some high points. We saw very strong fuel economy, up 5.4% year-over-year, and that's a direct result of our investment in EOBRs and trailer skirts. We saw reduced safety-related claims. We saw a strong pick up in delivery productivity up 4.5% from prior year. We also saw purchase trans as a percent of total miles drop from 39.6% -- from 39.6% last year to 37.5% in Q2. We also saw empty miles come down a little bit. Both of these things are clear signs that our linehaul optimization tools are working. That said, as you know in talking with our industry peers, the driver market definitely heated up in Q2 into higher-than-expected turnover, and therefore, higher-than-expected hiring. And this did lead to some network flow issues and some inefficiencies like higher cargo claims, a lower dock productivity and increased training expense. Most of these costs will continue into Q3 as we work to get our network back to maximum efficiency. And so while the hiring is still elevated today, we are seeing signs of network stabilization here in July. In fact, yesterday was our best on-time performance of the year. So I guess, the good news is we have a solid quarter and are comfortable with our guidance of a 25% operating income increased next quarter, yet we still have a lot of opportunity to provide increased improvement in operations as we get into the latter part of the year and in 2015, particularly on the cargo claims side and dock productivity. And so if you look at Q2, I'd say operations contributed, but the biggest single contributor was the revenue management initiatives.

Christian Wetherbee - Citigroup Inc, Research Division

Okay, that's helpful. And when you think about the context of the buyback and some of the things, Steve, you said about what you're doing with cash deployment, can we look at that as sort of an indication that some of the spending on initiatives, whether it be technology or training or otherwise, are in the ramp down phase here? So we shouldn't be expecting too much more to kind of crop up or be all that lumpy as we think about the next several quarters? Just want to get a rough sense and sort of what the messaging behind the buyback is in regards to the initiatives?

Stephen L. Bruffett

The good news is that we have a steady stream of initiatives lined up for the next several years. So there will be ongoing investments, and I can't sit here today and say there won't be any lumpiness in our IT expenses as we go through time, but we do see a steady pattern of investment as we -- as the technology really supports the initiatives that we're trying to do. It's not technology for technology's sake, but it's truly aligned with the strategic direction of Con-way Freight in particular that we're making these investments and recognizing the returns on. So it's not a statement that we're necessarily in a ramp down mode on those, it's a statement that we feel like we're able to fully fund all our obligations and opportunistic investments, as well as support the shareholder initiatives.

Christian Wetherbee - Citigroup Inc, Research Division

So the businesses has improved to a point where you, from a margins standpoint, where you feel comparable kind of being able to allocate cash to all the various initiatives that you're thinking about, as well as the buyback because that's the way I think about it?

Stephen L. Bruffett

Yes, sir, it is.

Operator

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

Scott H. Group - Wolfe Research, LLC

So I think there's a lot of focus on the third quarter and your commentary there, but maybe we can look out a little bit further. So you just had a 91.4 in the second quarter OR and you're kind of implying somewhere around the 93-or-so in the third quarter? What do you -- how should we start thinking about 2015? Can we get into this lower-90 range or is it just too early to know? Or are there headwinds to think about? What do you think the second quarter and third quarter mean for next year?

Douglas W. Stotlar

Scott, we're thinking about, as we look forward, and the environment has something to do with results, but we just expect continuous improvement as we go forward over time. We have a whole roadmap of initiatives, very similar to the initiatives we've played out over the last couple of years, lined up for the next several years, and they're all designed around continuous improvement and continuous margin expansion.

Scott H. Group - Wolfe Research, LLC

In terms of the plan that you guys have had, was '14 supposed to be a bigger year than '15?

Douglas W. Stotlar

Certainly we're happy with the market dynamics that have presented themselves in '14, but we're not forecasting '15 results at this time.

Scott H. Group - Wolfe Research, LLC

Okay. And then just on the driver side, so I'm not sure if you mentioned it. What is the driver pay there, cents per mile or percent increase you're planning to put in on the Truckload side? And then maybe, Doug, give us some perspective on the LTL driver issues and how this compares versus history? And do you think we need to start thinking about bigger than normal LTL wage increases, too?

Douglas W. Stotlar

So let me have Joe first talk about the Truckload industry and the driver market there, and I'll turn it over to Greg.

Joseph M. Dagnese

Scott, Joe here. On the driver pay side, we're working through what we need to do to implement our new driver pay package at Con-way Truckload. I'm not in a position to comment on any amounts or how the structure of that program will play out, because I firmly believe that our professional drivers need to hear it from me and our leadership team first. So once we get that pushed out, we'll be letting the balance of the community know what we're doing in regard to the pay package for our drivers.

Douglas W. Stotlar

But it will be a mix of mileage pay and incentives.

Joseph M. Dagnese

Correct.

W. Gregory Lehmkuhl

So on the LTL side, we are seeing increased demand for drivers. The wage increase that we implemented July 1 was greater than the one we did last year. It will be about $11 million a quarter, but we feel that puts us in a pretty good competitive position to recruit and retain growing forward.

Operator

Your next question comes from the line of Ken Hoexter with Bank of America Merrill Lynch.

Kenneth Scott Hoexter - BofA Merrill Lynch, Research Division

A couple of questions on that. You've been reviewing the accounts as part of the initiative here, are you done at least touching all of the accounts at this point? And I guess, how much now, that you've gone through that whole process, do you still think we have to back and touch the other accounts that's on the process in terms of your initiatives?

W. Gregory Lehmkuhl

So, we touched all the contractual accounts last year and we'll do it again this year. But there's still plenty of opportunity for further profit improvement with our current book of business us.

Kenneth Scott Hoexter - BofA Merrill Lynch, Research Division

So when you look at maybe some of the initiatives that you've made, is it still getting rid of businesses? Is it repricing? What is the -- when you go address the business, what's the largest ticking point as you revisit some of the customers from your first go around?

W. Gregory Lehmkuhl

Every customer's different, but it's mostly -- it's the composition of which shipments of their book of shipments that we handle. So we're changing the mix of shipments to better fit our network and better support our customers' needs.

Douglas W. Stotlar

And better leverage our cost structure.

Kenneth Scott Hoexter - BofA Merrill Lynch, Research Division

So is that part of why you're seeing the local business growing faster than the national you were talking about?

W. Gregory Lehmkuhl

Not necessarily. No, I think that that's a separate initiative where we're, our whole sales team, all of our account executives and directors of sales are incented to go out and get new business and new names, and that's working very well.

Kenneth Scott Hoexter - BofA Merrill Lynch, Research Division

I guess on that same vein, over at Menlo you've had a significant ramp up and you talked about some new initiatives. Can you maybe delve into that a little bit? Where are you seeing this new opportunity? And are we past the start-up cost that we've had the last couple of quarters? And will that lead to, I guess, continued operating improvement going forward?

Robert L. Bianco

Ken, this is Bob. Yes, we've been able to realize very good net revenue growth that, over the last few quarters, our profits have increased sequentially as a result over the last 2 quarters. Fortunately, we've been able to stabilize the operational issues we've had with some very large projects that we took on, that we mentioned on a couple of past calls. Our sales pipeline continues to be strong, and 2 things that we like about our sales pipeline: One is, it is -- we're seeing a high -- more projects that have Transportation Management in them. And that's a good thing because Transportation Management projects in our business come at a higher margin than Warehousing projects, so that opportunity's increasing. And we're seeing projects in new group areas, high growth areas like oil and gas and healthcare, and we're making a lot of progress in those areas, and we see that as a good growth opportunity for Menlo going forward.

Operator

Your next question comes from Tom Albrecht with BB&T Capital Markets.

Thomas S. Albrecht - BB&T Capital Markets, Research Division

As I look into the future and it's pretty clear you do have some nice momentum, I'm wondering that next round of OR improvement that would be maybe a little bit of a greater magnitude, do you need growth to accomplish that? I mean, you're tweaking the network, you're changing the mix of accounts, and that momentum will continue this year and into next year. But at some point, to accomplish the next thing, do you need more like 3% to 5% tonnage growth?

W. Gregory Lehmkuhl

So I don't think so in the next, call it, 18 months. I mean, with our internal initiatives, both on the revenue management side, the cost structure side and the operations side, can sustain steady improvement for the next, at least, year and a half. That said, we have retooled our sales force and are very focused on getting back into a tonnage growth position in 2015. So I think it'll come from both, but I don't necessarily think we need tonnage growth in the next 18 months for continued progress.

Thomas S. Albrecht - BB&T Capital Markets, Research Division

And then on the OR question, I mean, I think I can plug in the wage and all that. But would you expect the normal sequential change from Q2 to Q3, which has been an OR deterioration of about 60 basis points? Would you expect that to hold that deterioration, plus whatever we plug in for wage? Or is the environment such that maybe the sequential deterioration is a little less?

Stephen L. Bruffett

This is Steve. From what we can see, the normal seasonality is playing out. We've seen one month of the third quarter so far, and that would be our best estimation is that historical pattern would repeat itself, absent the item that you noted, the timing of the wage increase this year. Somewhere in that range. There's always some variation within there.

Douglas W. Stotlar

And Tom, 2 things. That the -- there is an extra holiday in Q3 than there was in Q2, and you have a higher wage increase than what we've seen in some time in Freight.

Thomas S. Albrecht - BB&T Capital Markets, Research Division

And your Truckload guidance, does that include some sort of a wage increase that you just haven't announced yet?

W. Gregory Lehmkuhl

Yes, it does.

Operator

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

A. Brad Delco - Stephens Inc., Research Division

I just want to ask sort of a bigger picture question. Looking back sort of in history, there's been a lot of focus on the yield side, and this is on LTL, and then the cost and productivity side, and commonly, always historically, has enjoyed a premium price relative to some of your peers. Where do you think you are right now versus the market with your yield, versus where you were on the cost side in your productivity initiatives? Are you 50% back to where you need to be relative to the market on yields? And are you close to being back to the costs and productivity measures that you've used to run at? I guess the point is, how much farther do we have to go on each of those focal points?

W. Gregory Lehmkuhl

So on the yield advantage side, I would say we're maybe 60% of the way to where we want to join. We're definitely gaining ground. On the operations side, we're more productive now overall in each segment of the operation than we've ever been. And yes, we have a lot of opportunities. I mean, if you think about Q2 and as we talk -- as I talked about last quarter, we accelerated our dock mix shift in Q2 to performing more of our dock workers -- with dock workers, versus what we traditionally done, which is rely on our drivers. And this helps us relieve the driving hiring pressure and enables us to utilize our CDL-carrying professional drivers where we need them most, and that's in front of our customers. But as we shift our mix as the year progresses, we'll reduce our cost structure by at least $10 million in '14 using this strategy. From the beginning of Q2 until now, we increased our dock workers 64% up to 2,200 dock workers throughout the company. So -- however, when we're bringing these new employees up to speed, not surprisingly, we've seen a dock efficiency drop. So the benefits of that cost for our reduction were actually masked in Q2 and will become more visible as the year progresses, and as we get into 2015. So that's one example of, even though overall our productivity is as good as it's ever been, this is a structural cost item that will benefit us starting in Q4 and going into '15.

A. Brad Delco - Stephens Inc., Research Division

That's good color. But in terms on the cost of productivity side, relative to where sort of your internal targets are, how close do you think you are to those targets? Is yield 50% of the way there? Where do you think you are on the cost and productivity side?

W. Gregory Lehmkuhl

I don't think about a destination when I think about operational improvement, I think about a journey, and we're making good progress. And we have a lot of near-term things where we can improve further. But there'll never be a point where we say, "Oh, we can't get better linehaul efficiency or P&D productivity or dock productivity or cargo claims until they're 0". So we think there's plenty of runway.

A. Brad Delco - Stephens Inc., Research Division

And then, Steve, I hate to have you repeat this, but the LTL guidance was to improve operating income, 25%. What was the base that you're using for third quarter? And then if it's the same as what I'd see in my model, it's about 170 basis points degradation from 2Q, is the big delta there just the timing of the wages? And did you say that was $11 million? I just want to make sure I have the numbers right.

Stephen L. Bruffett

I think you have all that correct. It sounds like the basis for the third quarter -- I'm trying to find it that quick here, $52 million is the number. I think it's $51.7 million to be exact from the third quarter of last year that we were basing that off of. And what was the rest of the question?

A. Brad Delco - Stephens Inc., Research Division

Yes, the $11 million, I guess, that implies sort of 170 basis points of sequential degradation. And to Tom's point earlier, you typically see, call it, 60 to 100 basis point of degradation. So it's a little bit worse. So I'm just trying to figure out, is it really just the $11 million of wage increases that's sort of the delta from to 2Q to 3Q?

Stephen L. Bruffett

That is predominantly. Yes, it is about $11 million of quarterly expense coming in to the run rate. And $51.6 million, it looks like in the third quarter of last year that we're basing that off of -- the 25% off of.

Operator

Your next question comes from the line of Jason Seidl with Cowen and Company.

Jason H. Seidl - Cowen and Company, LLC, Research Division

I just wanted to chat a little bit sort of about your mix of business between your national accounts and more of your local accounts. You say you reduced, I think you said -- or declined about 2% in the quarter. Is there a number you guys are looking to get to? Is there something you're going to continue to work on and sort of push the national accounts to pay more? And what is it -- what do you think we're going to end up in 3Q looking like?

W. Gregory Lehmkuhl

We were down 1% on national accounts in Q2, 8% on local. We don't have a goal on this. We're really treating each lane and each customer differently, and our focus is to improve our margin and profit. And so there's not a tonnage expectation. I mean, of course, we have a plan for Q3, but that's not the objective. The objective is improve network utilization, a return on capital and operating income.

Jason H. Seidl - Cowen and Company, LLC, Research Division

And as I look out for Menlo, obviously, you're showing a little improvement. There's been some other start-up costs and whatnot. As I look out to 2015, should we see some of these outsized start-up costs and the problem with that one international customers abate so we can see some margin expansion? What are your guys looking for?

Robert L. Bianco

Well, like Doug said, we're looking for continuous improvement quarter-over-quarter. The dynamic that we face in our business is we're a project-based company. So as projects come on, we can't control the timing of when we are awarded these projects so we do have to face some start-up costs. But right now, we're in a period where we're seeing a low level of start-up costs that we're absorbing, and so we expect to see some improvement going forward in our margin.

Jason H. Seidl - Cowen and Company, LLC, Research Division

And that one international customer, you think that those issues will be behind you in '15?

Robert L. Bianco

Yes.

Operator

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

David G. Ross - Stifel, Nicolaus & Company, Incorporated, Research Division

Could you, I guess, first, talk about Con-way Multimodal and where that fits into the portfolio, and then how that growth is trending?

Robert L. Bianco

Yes, Dave, this is Bob. Con-way Multimodal is in Menlo's book of business and we are seeing very good growth out of that unit, in excess of 20% year-over-year. And it's -- not only does business with the affiliates with Con-way Freight and Con-way Truckload, but also grows with outside customers on a very good rate in the 20%.

David G. Ross - Stifel, Nicolaus & Company, Incorporated, Research Division

And does that margin have a better margin than Warehouse Management or the Transportation Management function?

Robert L. Bianco

Yes, it does.

David G. Ross - Stifel, Nicolaus & Company, Incorporated, Research Division

Excellent. And then really quick on the Truckload side, and maybe for Joe. You've had 8 straight quarters of declining revenue per tractor per week, and then the tractor utilization has actually declined 13 of the last 14 quarters. What are your plans to reverse those trends? And kind of what's gone wrong? And what's going to be different going forward?

Joseph M. Dagnese

As we look forward, some of the key initiatives that are in place are to improve our yield and utilization through increasing our length of haul, which we've actually seen a fairly modest movement in the last 3 months on. Expanding our Mexico cross-border business, which we've also gotten some strong traction under as well. And then finally, looking to improve our Logistics and Brokerage business. Those are really the 4 key things that we're looking to do to drive that improvement rate.

David G. Ross - Stifel, Nicolaus & Company, Incorporated, Research Division

And you guys are already one of the dominant players in the Mexican cross-border business, what would you do differently to gain share down there?

Joseph M. Dagnese

Well, we're seeing quite a bit of activity in regard to the near-shoring activities in that marketplace. We see this is a great opportunity to enter or re-enter, I should say, certain market segments that are a small portion of our portfolios, specifically automotive. And we're looking to that as a possible revenue growth area in the Mexico cross-border business for us.

Operator

Your next question comes from the line of John Barnes with RBC Capital Markets.

John L. Barnes - RBC Capital Markets, LLC, Research Division

Two things. Number one, your comment earlier about the margin improvement this quarter was much more weighted towards the pricing contribution versus, I guess, the cost contribution. As you look at further improvement in the margin, would you expect the same, or at some point do those begin to balance out a little bit more and contribute a little bit more equally?

W. Gregory Lehmkuhl

I think it will balance out. Like I said, we've -- due to the driver turnover issues, we hired a whole lot of people in this last quarter, and we're training and getting those people up to speed. So we saw some drag on our overall operating performance despite the fact that we had all of our strategic initiatives like I talked about, fuel economy up 5.4%, pickup and delivery productivity up 4.5%, purchase trends down, empty miles down. So all the areas where we're focused are clearly working, but right now we're dealing with new employees. So once we get over that training curve, we would expect operations to contribute more significantly to the margin expansion.

John L. Barnes - RBC Capital Markets, LLC, Research Division

All right, very good. And then just a question around the networking capacity, with some of the things you've done, and especially the focus on productivity. As you further improve productivity, does it give you more opportunity to maybe right size the network down a little bit? Is there -- is the productivity in bigger facilities, does it mean that ultimately you can look to maybe reshape the network a little bit? And is there a big opportunity in some of the cost reduction perspective on that side?

W. Gregory Lehmkuhl

Yes, I don't think it's a big opportunity. We're kind of nipping and tucking each year and combining 2 or 3 into 2, or 2 into 1. But we don't have any plans for any broad-based network changes like we did back in 2008.

Operator

Your next question comes from the line of Jeff Kauffman with Buckingham Research.

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Just a couple of questions. Steve, you mentioned that you're going to put an additional $80 million of funding into the pension. I guess the question is which of the pension plans? And net-net, it's a benefit to income, the lower pension expense this year of about $2.7 million, I think. Does this $80 million imply that we're going to get a better benefit to earnings in terms of pension expense next year?

Stephen L. Bruffett

First of all, I'd reiterate, I'm just happy that we're at a point where we can be having this conversation. After numerous quarters of explaining where we were and where we're going, I feel that it's a nice benefit to the organization to have made the progress on numerous fronts to be able to be talking about it. So to clarify the incremental $80 million that we're talking about, $75 million of it will go into what we refer to as our large plan, the main one that has the roughly $1.5 billion of liability, and nearly that much of assets in it at this point in time. And then the remaining $5 million will go into the smaller plan, a legacy plan, that were referenced, that we're fully terminating, and getting that off of our balance sheet. So...

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

And the big plan's frozen at this point?

Stephen L. Bruffett

Yes. The big plan, the large plan, has been fully frozen since 2009. So it's been a strategic priority of ours to work our way out of that volatile form of debt on our balance sheet and put that in the rear view mirror. So with this contribution that we're making 2014, take a big step in that direction to band that in pretty tightly.

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

All right. And the big plan was about $80 million underfunded at the end of last year. So this basically makes you just about adequately funded in that plan right?

Stephen L. Bruffett

We're anticipating that we'll be at least in the mid-90s from a funded status when we end the year by the time all these contributions go in. Of course, that depends on discount rates and asset returns by the time we get there, but somewhere in that range. To your question about its effect on pension expense, one of the things that we've also been doing as we've improved the funded status of the plan, is we've been de-risking the plan. Along with that is the expected rate of return on those assets diminishes because you're less in equities and more in fixed income. So it has a bit of the opposite effect of what you were imagining might happen in that we could see slightly higher pension expense next year than this because of that.

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

All right, and then the follow-up. Regarding the increase in Con-way, the July 1 increase. I was on the impression that this was more of an annual increase. I don't know if we call it cost of living, but why was the increase in April last year and July this year?

Douglas W. Stotlar

Jeff, given the, obviously the difficult first quarter, we weren't quite sure how strong the demand environment was going into Q2. And so we deferred the wage increase, and really in hind sight I'm glad we did because what we learned during Q2 was the fact that the labor market was much more robust for -- to drivers, both Truckload and LTL, but LTL caused some issues for us and a higher turnover. And so, ultimately, we were able to calibrate it and make it, I think, a better wage increase for our employees. It also solved some of our turnover issues.

Operator

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

Thomas Kim - Goldman Sachs Group Inc., Research Division

I appreciate the nice addendum that we have going on here. And we would think that the environment looks favorable near-term, but I'm curious, what risks do you see that we should be mindful of outside of let's say, some of the driver issues that we're all well aware of?

W. Gregory Lehmkuhl

I think that what concerns me most is just the macro environment. I mean, if Russia does something even stupider or the Gaza gets more crazy, and there's big disruptions in the economic environment, that's our biggest risk. I mean, outside of that, things look very strong and steady, and we're confident about our future.

Thomas Kim - Goldman Sachs Group Inc., Research Division

If I could just sort of ask on the competitive side. I mean, clearly we've been in this benign competitive environment for a few years now. Are you beginning to see any signs or hints that, that behavior is changing. And if it does, let's say hypothetically, and this isn't our base case, but let's just say hypothetically, if it does, how would -- how do you anticipate responding to an environment where you begin to see 1 or 2 of your other competitors out there may be getting a little bit more aggressive to try to win back business?

Douglas W. Stotlar

Well, first, this is Doug. Let me clarify. I don't think we're in a benign competitive situation. I mean, every time we go into a customer, we're in a situation where you're bidding for the business, you're vying for the business based on your capability and your performance. So I wouldn't consider it benign. I would consider the fact that we're in a very firm demand environment to be a tailwind for pricing, but it's still a very competitive environment. At least from my perspective, I don't see where there's a situation in the near term that there is going to be aggressive -- an aggressive pricing environment to win market share. It appears that people are growing market share right now based on their product and based on the tailwinds of the firm environment. And if you look at in aggregate, across our -- the LTL industry, it's a good portion of the industry is still not earning their cost of capital. So I don't see what anyone's motivation would be to enter into any kind of aggressive pricing environment.

Thomas Kim - Goldman Sachs Group Inc., Research Division

Fair enough. And if I can just squeeze one more in here. As we look ahead, when you think about growing your daily LTL shipments again, do you anticipate a need to increase your sales and marketing efforts i.e. increase some costs to do that? Or do you think you can leverage your existing sales force to grow your volumes by, let's say, for example, building on your existing customers?

W. Gregory Lehmkuhl

So we restructured our sales force in the first quarter this year, and we don't think that we'll need to make any more significant investments to facilitate growth.

Operator

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

Todd Clark Fowler - KeyBanc Capital Markets Inc., Research Division

I guess I wanted to talk about growth as well. And I guess I'm curious as to maybe why this isn't the environment to be growing in and to understand. It sounds like maybe the growth won't be a focus for the next 4 to 6 quarters. Is that more of a function of getting the business back to an investable level before you think about growth? Is that there's more opportunity on the yield side? I guess how are you thinking about growth versus margin improvement right now?

W. Gregory Lehmkuhl

So we are thinking about growth. We're focused on profitable growth. So for example in our local segment, we could focus on growth, we've gotten 8%. On national side, we think there is more opportunity for margin expansion and profit improvement in the next, call it, 6 to 12 months than there is for an explosive growth. That said, we consider 3PLs and brokers as part of our national book of business, and we've just launched a strategic focus on growing that segment where we can be profitable. And we're starting to see good results here. So I think you'll see, in subsequent quarters and even the next 3 quarters, you'll start to see that segment growing, which represents about, call it, 17% of our tonnage. So I think, when it all nets out, it's hard to say how much tonnage will grow, but I do think you'll start seeing growth in tonnage per day in 2015.

Todd Clark Fowler - KeyBanc Capital Markets Inc., Research Division

So Greg, it's not a specific margin level or anything that you're looking at, it's more of the balance of as the more profitable accounts continue to grow and offset some of the accounts that you're weeding out once that mix starts to net out, that's when we should see the improvement in tonnage on a daily basis?

W. Gregory Lehmkuhl

Yes. I think so. And as we talked about earlier, the fact that we're restricting 20,000 pound and above shipments, is definitely masking our growth. We'd be up 5% for the quarter in tonnage if we didn't do that, but we felt it was the right decision for profit. So as we lap that position next year, we're not going to have that headwind in tonnage.

Todd Clark Fowler - KeyBanc Capital Markets Inc., Research Division

Okay, good, that makes sense. And then, I just can't help but ask, but on the purchase transportation side, again, another nice quarter of controlling the expenses. If I remember it correctly, I think you guys were out ahead of the curve and kind of locked in some multi-year rates. Can you talk about what you're seeing on linehaul capacity? And how you're positioned going into the back half of the year in the context of the tightness that we are hearing about in the Truckload market?

W. Gregory Lehmkuhl

Yes, especially with our restricting heavyweight shipments, we feel we're in very good shape. So our rates are locked for the year and in most cases, well into next year. And we're outside of some key areas that are always hot like out of Southern Cal, we're doing very well from a capacity standpoint. So not a huge concern at this point.

Todd Clark Fowler - KeyBanc Capital Markets Inc., Research Division

And no big movement in kind of PT as a percentage of revenue over expenses or anything like that?

W. Gregory Lehmkuhl

No, we think we'll continue to make progress.

Operator

Your next question comes from the line of Allison Landry with Credit Suisse.

Allison M. Landry - Crédit Suisse AG, Research Division

Just one quick question for me. I noticed on the balance sheet that your days accounts receivable has ticked up in each of the last few quarters. So I just want to -- was curious if there's been any change in how you manage working capital?

Stephen L. Bruffett

Yes, Allison, this is Steve. You're right. Working capital has increased, predominantly driven by the increase in accounts receivable, and part of that is seasonality and revenue growth. In fact, about 2/3 of that is attributable to revenue growth. But there has been some DSO deterioration that we're focused on. It's predominantly in the international space as we've had more wins there. The DSO tends to be higher in the international space, and that is contributing to that as well. Outside of that, our domestic DSO is very much in line with historical patterns. So revenue growth and international growth are the contributors.

Operator

We have time for one last question. Your last question comes from Matt Brooklier with Longbow Research.

Matthew S. Brooklier - Longbow Research LLC

Bit of a nit-picky question given the good quarter, but just looking at your Truckload pricing and the growth there, in yield, it looks like it's tracking a little bit below the market. And just curious as to what's the driver there? Is it mix? Is it the timing of contracts being repriced? And I guess, what are your expectations for yield for the remainder of the year?

Joseph M. Dagnese

This is Joe, Matt. So it is a combination of those things that you just identified. So as we look to push our length of haul up, it's taking our rate per mile down. We're seeing a good stickiness in the 4% to 6% rate increase range. We've completed all of our major contract rate discussions with our significant customers, which tend to fall into May through July period. And we're looking now forward into 2015 to restart those conversations for 2015 earlier than we have in the past.

Patrick J. Fossenier

Thank you very much, operator. I think we're done. Thanks, everybody, for participating.

Operator

Thank you. This concludes today's conference. You may now disconnect.

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