Con-way's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: Con-Way Inc. (CNW)

Con-way Inc. (NYSE:CNW)

Q3 2011 Earnings Call

November 4, 2011 8:30 AM ET

Executives

Patrick Fossenier – VP, IR

Douglas Stotlar – President and CEO

Stephen Bruffett – EVP and CFO

Walter Lehmkuhl – EVP

Herbert Schmidt – President, Con-way Truckload and EVP

Robert Bianco – President, Menlo Worldwide Logistics and EVP

Analysts

Chris Wetherbee – Citi

Kenneth Hoexter – Merrill Lynch

Scott Group – Wolfe Trahan

Benjamin Hartford – Baird

David Ross – Stifel

Jeff Kauffman – Sterne, Agee

Jason Seidl – Dahlman Rose

Thomas Albrecht – BBT

Justin Yagerman – Deutsche Bank

Chris Ceraso – Credit Suisse

Bascome Majors – Susquehanna Financial

John Godyn – Morgan Stanley

Thomas Wadewitz – JPMorgan

Ryan Cieslak – KeyBanc

Operator

Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to Con-way Inc.’s Third Quarter 2011 Earnings Review Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I would now like to turn the call over to Patrick Fossenier, Vice President of Investor Relations. Please go ahead.

Patrick Fossenier

Thank you, Brandy. Welcome to the Con-way Third Quarter 2011 Conference Call for shareholders and the investment community. In a minute, I’ll turn it over to Con-way President and CEO, Doug Stotlar. Before we get into the call, I’d like to offer a few reminders. First, certain statements in this conference, including statements regarding anticipated results of operation and financial condition, constitute forward-looking statements and are subject to a number of risks and uncertainties and should not necessarily be relied upon as predictions of future events. Actual results of operations and financial conditions might differ materially from those projected in such forward-looking statements, and no assurance can be given as to future results of operations and financial condition.

Additional information concerning factors that could cause actual results and other matters to differ materially from those in the forward-looking statements and the inherent limitations of such 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, conway.com. I would also like to note that we have a lot of people on the call today. So we’d appreciate if you limit yourself to a couple of questions and then return to the queue.

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

Douglas Stotlar

Thank you, Pat. Good morning, everyone. 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, Herb Schmidt. Steve will provide some commentary on our financial picture, and Greg, Bob, and Herb will participate in the Q&A portion of the call.

I would like to welcome Greg Lehmkuhl to his first earnings call as Con-Way Freight President. The response within the freight organization to his promotion has been exceedingly positive. His personality, experience and skills are the right-fit for freight. I’ve gotten to know Greg quite well over the past several years. His disciplined approach to process and respect for people have been a great asset to me, particularly in the last year. He’s earned the respect of the organization, stepping up to provide the leadership and teambuilding skills that were instrumental in helping Con-Way Freight get its balance back. I look forward to continuing to work with Greg to sustain our progress and build on the positive results we have achieved as a team.

Our results for the third quarter demonstrated improvement across the board as each Con-Way operating segment recorded increases in revenue and operating income compared to last year. The company’s performance in the quarter reflects the consistent execution of our strategy. For the third quarter of 2011, Con-Way reported consolidated revenues of $1.38 billion, up 8.4% over last year’s $1.27 billion.

On an operating income basis, we earned in $61.1 million in the 2011 third quarter compared to $12.5 million we reported last year. Diluted earnings per share were $0.52, this compares to a loss of $0.15 per share in the prior-year period. Last year, our third quarter results were negatively impacted by goodwill impairment and other charges totaling $21.9 million. Excluding these charges, on a non-GAAP basis, earnings in the 2010 third quarter would have been $0.22 per diluted share.

Moving now to a review of our business segments, I’ll start with Con-Way Freight, our LTL company and the largest revenue segment. Con-Way Freight posted third quarter operating income of $40.7 million compared to $13.1 million earned in the third quarter a year ago. Our continued focus on keeping our employees safe, rationalizing network volumes, managing cost and increasing yields delivery improved results. As we noted in our last earnings call, July was a little soft early on, which at the time made us cautious about business volumes for the quarter. That proved to be a temporary condition. Shipment volumes improved sequentially into August and through September.

On the top line, we posted revenue of $843.3 million, a 5.8% increased over last year’s revenue of $797.1 million. As we saw in the first and second quarters, the combination of improved pricing and higher fuel surcharge revenue contributed to increased revenues in the third quarter. Con-Way Freight’s operating ratio this period was 95.2% compared to 98.4% in last year’s third quarter.

Tonnage per day in the quarter declined 5.5% over last year’s period. This decline was by design. You’ll recall at this time last year, we were actively working to moderate volumes in the network to allow us to reduce variable expense and improve the mix of higher yield freight. Comparing monthly tonnage year-over-year, the decline versus last year narrowed as the quarter progressed. July was down 8.2%, August tonnage against last year was down 5.8%, while September came in at 2.5% below last year and October was 1.6% under last year.

Revenue per hundredweight or yield increased 12% in the quarter compared to the prior year. Excluding fuel surcharge, the increase in yield was 6.7%. We had a positive effect from our general rate increase in August, which applied to about 25% of Con-Way Freight business, and we continue to address contractual accounts as they come due, working with our customers to implement reasonable price increases.

Now I’ll move to our logistics segment. For the 2011 second quarter, Menlo Worldwide Logistics, our global logistics and supply chain management operation, recorded operating income of $12.7 million. This compared to an operating loss of $6.3 million in last year’s third quarter, which included a $16.4 million goodwill impairment charge. Excluding the charge, third quarter operating income in the previous year period would have been $10.1 million. Revenue for the quarter was $417.1 million, an increase of 12.7% over the prior year revenue of $370 million.

Net income, or revenue minus purchased transportation, came in at $154.7 million, a 9.9% increase from $140.7 million in the previous year period. Menlo benefited during the quarter from stable customer volumes and good cost controls. Its core warehousing and transportation management services posted increases in net revenue and operating income. Geographically, North America’s results were complemented by continued strength in Menlo’s international operations, as Europe and Asia outpaced North America in percentage growth. Menlo is progressing toward a solid year, as demand for high-value contract logistics and supply-chain management services continue to gain traction.

Now I’ll review results at our Truckload segment. For the 2011 third quarter, Con-way Truckload had operating income of $7.9 million, a 43.7% increase over the $5.5 million earned last year. Improved pricing and better operating efficiencies underscored the gains over last year, although these were somewhat offset by higher self insurance expense. Revenue increased 12.8%, to $158.7 million over last year’s third quarter revenue of $140.7 million. Revenue growth can be attributed to higher fuel surcharges and improved revenue per loaded mile. The operating ratio ex-fuel surcharge improved to 93.6% from 95.3% in the year-ago period. Con-way Truckload is running its network efficiently and delivering a consistent, premium service, strong operating discipline resulted in increased asset utilization, higher revenue per mile and lower empty miles.

Demand during the quarter can best be described as steady. Capacity and demand are relatively in balance, although if we get any meaningful uptick in the economy, we’ll see capacity quickly tighten. We are doing a good job managing our needs for drivers, Con-way Truckload has been effective in recruiting and retaining drivers, keeping our fleet fully seated.

The driver shortage, however, is becoming more acute. This will require increased spending for recruiting as we work to keep our driver base at sufficient levels to meet customer needs. Overall, Con-Way Truckload is maintaining its emphasis on premium service, margin improvement and network efficiency.

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

Stephen Bruffett

Thanks, Doug, and good morning, everyone. I will begin with the recap of our third quarter cash flows. The cash from operations was $50 million as compared to an $11 million cash usage in the third quarter of2010, and there were three primary contributors to this year-over-year increase of about $60 million. These included, one, higher net income, which provided more cash from operations, two, lower cash taxes were paid in 2011 due to bonus depreciation and, three, there was lower cash funding of the defined benefit pension plan in 2011 than in 2010.

Net capital expenditures were $55 million during the quarter as compared to $33 million last year. Our CapEx continues to be mostly comprised of tractor purchases for Con-way Freight and Con-way Truckload, as we continue our multi-year initiative to steadily lower our fleet ages.

Year-to-date, net CapEx was $178 million and our full-year guidance for 2011 is now approximately $285 million. This is down slightly from our prior guidance of $300 million and that’s due to timing on a couple of projects that will now be part of the 2012 capital plan. So, a little over $100 million of net CapEx remains yet this year, and that is mostly comprised of nearly 800 tractors that we expect to take delivery of in the fourth quarter. And as a reminder, all these tractors are replacement units and are not additions to the fleet sites. For 2012, our expectations at this point are for net CapEx to be approximately $300 million. We’ll provide an update on our year-end earnings call in early February after our 2012 planning process has been completed.

Financing activities in the third quarter, mostly payments of dividends and capital leases, used $14 million of cash during the quarter as compared to $7 million in the third quarter of 2010. The net result of this cash flow activity was a $19 million decrease in cash and marketable securities during the quarter. So, our cash and cash equivalents were $480 million in September 30th, which compares to $421 million at the beginning of the year.

Moving down to the consolidated income statement, I’ll begin with healthcare costs, which were just over $46 million during the third quarter and that compared to $36 million in the third quarter of 2010. This quarterly amount in 2011 was in line with our historical healthcare costs and was consistent with the $45 million estimate that we provided on our last call. While it is difficult to forecast our expectations for the fourth quarter of 2011, part of that healthcare cost will be $45 million to $50 million, and assuming the fourth quarter healthcare costs are in this range, the full-year 2011 costs would total about $170 million and that is similar to the amount for the full year of 2010.

Depreciation expense was $51 million in the third quarter, the same as in the third quarter of last year, and for the full year, we expect depreciation expense to be about $203 million. As for income taxes, the all-in effective tax rate for the third quarter was 38.8% and excluding discrete items the rate was just under 38%, so we continue guide for a full-year effective rate of 38%.

Before we read the income statement, I want to provide visibility to several items that will likely impact the fourth quarter of 2011. First, most of you already know that beginning October 1st, we restored what we refer to as the basic in-transition 401(NYSE:K) contributions for longer-tenure employees and this represents a total of about $5 million of expense per quarter and the majority of that is at Con-Way Freight. The second item is at our logistics segment, and it involves a settlement that was reached in October regarding dispute over the 2007 acquisition of Chic Logistics. As a result of this settlement, a $10 million gain has been booked as part of Menlo’s fourth quarter results.

The last fourth quarter items involve our Other reporting segment and we currently expect to record a charge related to the reinsurance pool in which we participate, and that charge might be partially offset by gains on the pending sale of the excess properties adjacent to our administrative campus in Portland. If both of these items materialize as we currently expect them to, the net result would be a charge of $2 million to $3 million and, again, this would be in our Other segment.

I’ll wrap up my comments with an update on our defined benefit pension plan. Actions taken in prior years to freeze the plan have significantly reduced the volatility that would otherwise be associated with an active plan. Still, lower-than-expected asset returns and declining discount rates during 2011 have lowered the funded status of the plan. So, if the year were to end now, we would expect our 2012 pension expense to increase approximately $10 million, and that’s up from virtually no expense being recognized in 2011.

The amount of 2012 pension expense will be determined by discount rates and asset returns on December 31st at that point in time. So, we’ll provide an update for you on our next earnings call early February. As for cash lending in 2012, we currently expect to contribute at least the $62 million pre-tax we did in 2011 and we’re considering possibility of making additional contributions to move us further down the path of fully funding and de-risking this frozen plan. So with those comments, I’ll turn it back over to Dough to wrap us up.

Douglas Stotlar

Thanks, Steve. Our third quarter results reinforce the progress being made as we continue to execute against our strategy. Our emphasis remains on safety, engaging employees to drive continuous improvement, increasing margins and delivering a superior service experience for our customers.

And with that, operator, it concludes our prepared remarks and we’d like to open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Chris Wetherbee with Citi.

Chris Wetherbee – Citi

Great. Thanks. Good morning, guys.

Stephen Bruffett

Good morning.

Chris Wetherbee – Citi

Maybe if I could just start out on the pricing side, I’m just curious to get a sense of your thoughts about the pricing dynamic as we moved into the fourth quarter. Clearly, there was some strength in the third quarter. We’ve heard a kind of conflicting comments from other carriers in this space just curious what you guys are seeing as we’re moving into October on the pricing side?

Walter Lehmkuhl

I’ll take that. This is Greg Lehmkuhl. So we did see progress in the third quarter. We’re holding the GRI well and we’re seeing our contractual rate increases stay at about the same rate at the mid-single digit level as the contracts come due, so continued progress.

Chris Wetherbee – Citi

So, when you think about kind of core price ex-fuel on the LTL side, should we be seeing, arguably I would say, a deceleration in the rate of growth in the fourth quarter just because comps get a little bit difficult but the absolute number should be continuing to up quarter-to-quarter?

Walter Lehmkuhl

I would agree with that, yes.

Chris Wetherbee – Citi

Okay, that’s helpful. And then just my second question just on the TL side, could you talk a little bit about the insurance expenses, give us a little bit of the order of magnitude of that and how we should think about kind of the cost related to insurance as we move into the fourth quarter?

Herbert Schmidt

Yes, Chris this is Herb. We did have some unexpected severity in auto, work comp and medical in the quarter to the tune of in excess to $2 million. The fundamentals, our key operating metrics were virtually the same second quarter versus third quarter, empty miles, average productivity per truck, fuel mileage are virtually identical and rates were actually up. And what’s ironic is our auto and work comp frequencies were actually down or improved but, again, severity negatively impacted the bottom line more than anticipated. So again it’s kind of luck of the draw, but bad luck of the draw with respect to severity in the quarter.

Chris Wetherbee – Citi

So, assuming operations kind of remain where they would be, you wouldn’t expect to see that 2 million based on the severity of claims in the fourth quarter?

Herbert Schmidt

I would not statistically expect that, because our frequencies are going in right direction.

Chris Wetherbee – Citi

Okay, that’s helpful. Thanks very much for the time guys, I appreciate it.

Herbert Schmidt

Thanks, Chris.

Operator

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

Kenneth Hoexter – Merrill Lynch

Hi, good morning. Can we just talk about Menlo for a minute in terms of your revenues, your net revenues actually increased sequentially nicely but your operating income was relatively flat compared to the gains you saw in the first quarter. Were there a startup cost associated with some of the new contracts or can you talk about that a bit?

Robert Bianco

Ken, this is Bob Bianco. Yeah, we saw increase year-over-year on operating income in the third quarter. Our operating income grew 25.1%I think you’re comparing to the second quarter, is that right?

Kenneth Hoexter – Merrill Lynch

Yes, I’m looking at the press release, sorry.

Robert Bianco

Yeah. So, we feel that we’re in the right spot where we grew our revenues and are – we were able to contain our operating costs and we came out with margins that we were very happy within the third quarter.

Kenneth Hoexter – Merrill Lynch

Okay. So there was no start-up, just looking at it, you had $7 million more of revenues, you were saying there were no start-up costs or anything else?

Robert Bianco

The start-up cost issue, Ken, is more of a mix. You know, we have business in consulting, we have business in transportation management and we have business in warehouse management, and they all come in at different margins. So the variation from quarter-to-quarter can occur, but it wasn’t significant enough where it was a concern on our part.

Kenneth Hoexter – Merrill Lynch

Okay. And then can I – sorry, for my follow-up, can I re-visit on the Freight side on the prior question, it’s on in terms of rates, I know you had the GRI last year, should we see or anticipate the tougher comps as we go forward or do you still see kind of acceleration on that core pricing line?

Stephen Bruffett

I think we answered that. I think the fourth quarter comps do a little tougher, but the core pricing continues to advance at the same level. So, the difficulty in comps Q4 over Q4 will be based on – will be driven by GRI timing.

Kenneth Hoexter – Merrill Lynch

Okay, I appreciate the time. Thank you.

Stephen Bruffett

Sure.

Douglas Stotlar

Thanks, Ken.

Operator

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

Scott Group – Wolfe Trahan

Thanks. Good morning, guys. And congratulations, Greg, on your new role.

Walter Lehmkuhl

Thank you. I appreciate it.

Scott Group – Wolfe Trahan

So, Doug, I think you mentioned at about 25% in the business is impacted by the GRI, can you give us some color, what percent of the business was under the GRI let’s say five years ago and there’s been so many changes in the business, how do you think about the spread in margins today versus the contractual versus GRI business?

Douglas Stotlar

Well, we certainly have more business under contract today than we did five years ago. The amount of customers that were on our standard 599 tariff have declined over time. So and we certainly currently have a larger mix of our customers being represented as national accounts versus what we call commercial and local accounts. So, there has been a shift towards the larger, I’ll say lower-margin type national account footprint.

Scott Group – Wolfe Trahan

Is there any way to put some numbers around that just so we get some context?

Stephen Bruffett

Depending on how far back you dial, we were more of a 60/40 split and today we’re more like 75/25, if that helps. And I think most of that migration over the last five years or so not unique Con-Way Freight but pretty much prevalent across the LTL space in relative proportions.

Walter Lehmkuhl

International accounts are controlling more and more freight and brokers in 3PLs are growing, so between those two things we’re seeing a shift.

Scott Group – Wolfe Trahan

And any color you can give on kind of in terms of what to think about the margin differential?

Walter Lehmkuhl

I mean, so many components that go into that, it’s hard to quantify. I mean it does have some affect in handling margins, we don’t have that, but everything is conditioned on supply-demand and economic setting and so forth, but the biggest factor is the mix.

Scott Group – Wolfe Trahan

Okay. That’s helpful. And just a second question. So, now they were – it feels like the trends are normalizing, comps are normalizing. So, Doug, as you look out over the next several years, what do you think is the right level of tonnage growth and pricing gains that you think is an achievable number in the next several years?

Douglas Stotlar

Scott, that’s really tough question given the fact that we’re a demand-dependent business and the supply and demand make such a big difference and how those things are going to trend. If you could tell me what the economy was going to do, I might be able to give you a little bit better perspective on it. But what I would like to tell you is we are fundamentally running this company differently than we have in the past. We have the focus on improving every aspect of how we do business, whether it’s back-room functions, P&D operations, how we manage linehaul, use of technology, leveraging our employees using Lean across our entire network, engaging our employees with the frontline for continuous improvement, we have a strategy we are executing against.

And as you can see, we’ve made significant progress improving the fundamentals of the business, we’ve improved all the productivity categories across the board and we continue to find more opportunities. And so we’re going to continue that work, whether it’s a slow demand environment, whether it’s a steady demand environment, or whether it’s an increasing demand environment. And the demand environment to a large extent will affect how much we’re able to move the margins.

Scott Group – Wolfe Trahan

How about on the pricing side?

Douglas Stotlar

Demand environment dictates our ability to get price as well. Now, we can continue to focus on some things that we do have more control over, line density, mix management within the network, and we’ll continue to focus on those kinds of things to get more refined, but we still are constrained by the large supply and demand as it relates to the transportation assets available for the demand in the marketplace.

Walter Lehmkuhl

The only thing I’d probably add on the price side is as the global economy has gotten more unstable over the last couple of quarters, we were concerned that price might waver a little bit and our customers would push back harder on us in the contractual renegotiations. We’re performing better for customers at Freight now than we ever have in the history of our company. Our damage is down 42% year-over-year, our on-time performance is at all-time highs and we’re delivering earlier and picking up earlier in the day than we ever have. So, our customers are seeing the value in our services and they – despite the economic uncertainty we seeing no wavering in our ability to win pricing.

Scott Group – Wolfe Trahan

Okay. Thanks for your time, guys. I appreciate it.

Douglas Stotlar

Thank you, Scott.

Operator

Your next question comes from the line of Ben Hartford with Baird.

Benjamin Hartford – Baird

Good morning, guys. Doug and Greg, I guess just to delve a little bit deeper on the productivity side in Freight, certainly volumes have come out of the network through the course of 2011, but the load factor has remained at or near all-time highs and stayed relatively steady through the three quarters of this year. So, can you talk a little bit about some of the internal productivity metrics through the quarter as volumes were coming out of the network on an employee basis? How did those trend and what kind of upside should we see from here as volume does return or rates stabilize?

Walter Lehmkuhl

Sure. So, our productivity metrics were consistent through the quarter. We were up in all areas including bills per hours, the load factor was up 0.5%, P&D was up 2.3% and dock was up 4.2% and we have, you know, frankly, we have years of initiatives lined up to continue to improve that efficiency. So, despite tougher comps because we have lower tonnage, we’ve made significant year-over-year gains and we have a lot of plans to improve that.

Benjamin Hartford – Baird

How does that employee metrics – productivity metrics compare to, say, the mid 2000s?

Walter Lehmkuhl

Substantially better.

Benjamin Hartford – Baird

Okay.

Walter Lehmkuhl

On all fronts.

Benjamin Hartford – Baird

Good. And then, Bob, maybe on the Menlo logistics side in terms of the revenue, can you talk a little bit about the mix between contractual and transactional revenue today versus two or three years ago? Just trying to get a better – trying to get a sense for what the run rate on a net revenue basis and on an EBIT basis should be going forward?

Robert Bianco

Yeah, Ben, we’re still to this day mostly contractual. We have of our gross revenue on an annual basis, maybe $130 million of it is transactional.

Benjamin Hartford – Baird

So, this $150 million of net revenue, this is a good base to be thinking about the build for 2012 on a run rate basis? Is that a fair way to think about it?

Robert Bianco

Yeah, I would think that way.

Benjamin Hartford – Baird

Okay, great. Thanks for the time, guys.

Robert Bianco

Thanks.

Stephen Bruffett

Thanks.

Operator

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

David Ross – Stifel

Good morning, gentlemen.

Douglas Stotlar

Morning, David.

Stephen Bruffett

Morning.

David Ross – Stifel

Greg, can you talk about the increase in maintenance costs in the LTL division? It looks like it was up 13% year-over-year and 7% sequentially. When does the fleet age start to come down and how much can that be lowered?

Walter Lehmkuhl

Yeah, our fleet age did come up a little bit in the last couple years and we did see maintenance costs spike up a little bit in the third quarter. We going to get about a thousand tractors delivered in the next two quarters and we expect that offset some rising costs we’re seeing in mid-2000 model year tractors. So, I would expect year-over-year maintenance expense in ‘12 versus ‘11 to stay relatively flat, given that we will start to address our fleet age across the fleet: tractors, trailers, forklifts.

Stephen Bruffett

This is Steve. Just to provide further context, we’ve been treading water, if you will, on the fleet age at Con-way Freight, while we’ve made significant progress to put the fleet age at Con-way Truckload and that was a purposeful part of the design of our multi-year initiative to improve overall fleet age. Now that we’re well into the improvement in Con-Way Truckload, beginning in 2012 we’ll begin to shift the capital allocation more heavily in the direction of upgrade and it will become more of a maintenance of the fleet age of Con-Way Truckload and improving fleet age of Con-way Freight in 2012, ‘13 and ‘14.

Douglas Stotlar

And, Dave, maybe just a little more color on Greg’s comment, we are seeing higher costs associated with these engines – the tractors that have the engines 2004 and little newer have model-year changeover with the new engine technology. They’re proving to be a lot more expensive to operate as they get older. And so, we’ll have to figure out what our strategy is for dealing with that long term and so, hence Greg’s comment about we’re going to get rid of some oldest tractors but we’re seeing rising maintenance costs on that middle section of our fleet right now.

David Ross – Stifel

And so, when do you think maintenance costs could come down if they’re going to be flat in 2012? If there’s continued fleet replacement, do you think maintenance costs on an annual basis could decline in 2013?

Walter Lehmkuhl

Depending on the rate of inflation, I think that might start to be an inflection point for us there, at Con-way Freight.

David Ross – Stifel

And then if you can also talk about service levels at Con-way Freight on a year-over-year basis. Kind of where they were turning last year when you had lot of freight that wasn’t necessarily fitting the network and where they are today?

Walter Lehmkuhl

We are in materially different place from a service standpoint. Our on-time performance has come up, it’s material year-over-year, I just pulled the number, it’s over a point year-over-year and, more importantly, damage is at an all-time low right now. We invested in the SafeStack decking system in our tough fleet and we’ve seen damage come down 42%. So, that’s much more significant to our customers than anything else. We’ve also had a really big push on picking up and delivering earlier and our deliveries before noon are up 40% from a year ago.

David Ross – Stifel

Excellent. Thank you very much.

Douglas Stotlar

Thanks, Dave.

Operator

Your next question comes from the line of Jeff Kauffman with Sterne, Agee.

Jeff Kauffman – Sterne, Agee

Hey, guys. Thank you. Just wanted to follow up on the question that David just asked on maintenance. I’m looking at the fleet age in Truckload, and as you mentioned, it’s down from about 3.6 years to about 2.3 years. So, that’s fantastic. But your maintenance costs looked like they jumped about $2 million. What happened there?

Herbert Schmidt

Hi, Jeff. This is Herb. Quite frankly, it’s the new engine technology. We are struggling a bit with that. But the problems are beginning to work themselves out. We do anticipate by the end of 2012, actually probably earlier than that, we’ll see some improvement in maintenance cost relative to where it is now, because the bugs are beginning to work themselves out. We will be back on our full-year trade cycle for the most part by the end of 2012.

Jeff Kauffman – Sterne, Agee

Okay. So as I think about maintenance costs, as you continue to proceed through the tractor programs both here and Freight, you were running about a $21 million, $22 million run rate, now you’re running $25 million in Freight. You were running about $7 million, $7.5 million run rate in Truckload, now you’re running $9 million. As you work through this in 2012, I should see maintenance costs at both divisions kind of trend back towards the run rate?

Douglas Stotlar

I’d like to tell you we can get back there, I’m just not – we’ll make improvements, Jeff. I just don’t know, given the new technology and the complexity of it, whether we’ll get back to the same kind of run rate we’ve historically have.

Jeff Kauffman – Sterne, Agee

Okay. Could you talk a little bit about kind what the challenges are? I assume you are talking about the post-2010 engines.

Douglas Stotlar

Well, you’ve got both. I mean, you’ve got the mid – on the Freight side, these 2004, 2005 engines, which was our first big generational change, which was EGR-type technology. They’re not having the same – we’re not getting the same kind of longevity out of those engines as we got in the prior versions. And so, Freight keeps our trucks on average about ten years, and so as we get into these seven, eight-year cycles on these trucks we’re starting to see these problems with these units.

And then the newer technology trucks have an awful lot more on the electronics side. We’re trying to dial these things in and we’re seeing continued problems with the electronics and as well as some of the sensors and things associated with these engines. And so the truck is down, you’re waiting for parts and it’s just creating some productivity issues for Herb and his fleet as well. Herb, anything else to add?

Herbert Schmidt

We refurbished 2,300 trailers as well. So, we’re renewing our trainer fleet also and there’s certainly expense associated with that and that will decrease in 2012.

Jeff Kauffman – Sterne, Agee

Okay. One final question on the maintenance here. In the – there was another technology change with the ‘07 engines. Is it too early to tell what’s going on with that breed?

Douglas Stotlar

I’d say it is because we just don’t have – we haven’t had those long enough yet. Again, this stuff seems to be manifesting themselves with this engines that run a lot hotter, as they get more miles on them we start to see these problems manifest themselves. So, I’m not predicting we’ll have a problem, but we might.

Walter Lehmkuhl

Our ‘07s are following the normal curve.

Jeff Kauffman – Sterne, Agee

Okay, and this is just an industry issue, not a Con-Way issue as well.

Douglas Stotlar

Right.

Jeff Kauffman – Sterne, Agee

Okay. Well, guys, congratulations. Thank you.

Douglas Stotlar

Thanks, Jeff.

Operator

Your next question comes from the line of Jason Seidl with Dahlman Rose.

Jason Seidl – Dahlman Rose

Good morning, gentlemen. I’m going to take us out of the maintenance shop for a moment here and talk a little higher level. You have some extra costs coming up, obviously, with the $5 million steep that you referenced on the Freight side and there is potentially driver payment needs to go up on the Truckload side. So, as you see pricing right now and the current state of the market, do you think there is enough to offset these costs going forward in both Freight and Truckload?

Douglas Stotlar

Certainly, our intent is to offset the costs and we believe in the current environment we would be successful in doing that.

Jason Seidl – Dahlman Rose

And, Doug, when you talk to customers right now, what’s their main concern that – just in general performance by the carrier groups? Are they at all concerned about capacity in LTL and in Truckload right now?

Douglas Stotlar

I think customers are very in tune with the fact that capacity is a lot tighter than it has been certainly through the middle part of the 2000s and after the rationalization after the downturn. And I’ll tell you one of the themes, I was recently at the American Trucking Association Annual Meeting, and one of the reoccurring themes at that meeting was the ongoing discussion about driver shortages. There’s real concern in the industry about what’s going to happen with drivers and driver shortages and trying to create new ways to get new entrants into the industry and train a new group of drivers into the work force because it’s already manifesting its ugly head and we are not exactly in a robust environment right now.

Jason Seidl – Dahlman Rose

Okay, thanks for the color as always, guys.

Douglas Stotlar

Thanks.

Operator

Your next question comes from the line of Thom Albrecht with BBT.

Thomas Albrecht – BBT

Hey, guys. Can you hear me?

Douglas Stotlar

Hi, Thom.

Thomas Albrecht – BBT

All right. So, let’s set aside price for a moment in terms of what can drive your operating ratio improvement. You really have come a long way, the network is stable, your service is improving. But, if I sort of look at three big buckets here, I’d like you to talk about where your biggest opportunities are. One would be sort of overall mix and network efficiency, secondly would be improved claims experiences and third would be the management in your variable cost, which it looks sort of fixed. Which of those presents the greatest opportunity in the next four or five quarters?

Walter Lehmkuhl

Mix. Mix combined with network efficiency. So we are doing a lot of work on our linehaul network right now and deciding where we want Freight and better ways to optimize the network on a nightly, weekly basis and Freight mix plays directly into that. So those two ideas are linked directly. So, I’d say between the three, I’d combine those two. We have a huge focus in that area and there is material opportunity.

Thomas Albrecht – BBT

Okay. And then as good as the quarter was, your sequential improvement was less than some competitors, does that suggest that the rate of improvement from here on now will be more gradual. I mean, you’ve a big year-over-year improvement these last few quarters, but is it still big or is it much more gradual from this point?

Douglas Stotlar

Well, I think the real heavily lifting has been done, it’s going to be more gradual going forward. Many of these things we’re working on are all incremental improvements. And so, we’ll continue to chip away at the efficiencies, we will continue to work hard on the mix and the network efficiency aspects. But everything else are incremental, we’re trying to sweep every corner.

Thomas Albrecht – BBT

So, basically attain a fairly close desire to get back to about a 95 OR. Will you be prepared to talk about an OR goal, either today or in early February, for what you might be able to obtain in 2012? Would it be better than 94% for example?

Douglas Stotlar

We’re probably not going to put an OR goal out there. We felt we needed to do that based on where we were last year to get the momentum going. We have a lot of momentum within the comp part a lot of what our progress going forward will be economy-based, so we’re not going to throw a goal out there. But I will tell you we are not going to sit here on our rest on our laurels here based on the gains we’ve made. We’re nowhere near happy where we are from the operating ratio standpoint and we are going to relentlessly work to get back to historic-type margins.

Walter Lehmkuhl

One area that we haven’t talked enough about, I think, on this call is safety. We have a huge focus across the enterprise on safety. Year-over-year at Freight, our injuries coming off a very good year are down 28% year-over-year, our accidents are down 14%, and that’s all about keeping people safe and sending them home to their families, but it’s also a pretty nice financial tailwind (inaudible) over multiple years.

Douglas Stotlar

And I think it just gets back to the point I tried to make earlier, Thom, that we are trying to address every aspect of how we run our business and make every aspect of our company more efficient and more effective.

Thomas Albrecht – BBT

Absolutely. Okay, thank you.

Douglas Stotlar

Thanks.

Operator

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

Justin Yagerman – Deutsche Bank

Hey, Doug. Hey, guys. How are you?

Douglas Stotlar

Hi, Justin.

Justin Yagerman – Deutsche Bank

You didn’t give a margin goal but you said that you’re going to try to get back to historic-type margins. What do you consider historic margins for Con-way? Is that just sub-90% or we talking – back in 88% or so? Historically, this company has been in one of the premium players in the space and we’ve seen other companies in the same environment able to get to closer to those type of margins. What does it take to get there?

Douglas Stotlar

Well, we need a demand environment that continues to improve. So, certainly a recession won’t help that goal. And then, we need to continue to focus internally on what we need to do to execute to get back to those margins, which means all the things we have already talked about; improvement of our mix, network efficiencies, our focus on Lean across the entire enterprise, our focus on Lean at Freight and getting our frontline personnel to help us improve our processes and practices, continued initiatives on safety, continue to improve our sophistication with our costing line and tying our costs to our pricing formulas.

And so, again, it’s a – continue to improve our sophistication. We are a older, middle-aged company at this point and we have some legacy costs that some of our competitors simply don’t have, so we recognize the fact that we have to be more efficient than our competitors if we are going to get back down two of those margins and that’s our goal.

Justin Yagerman – Deutsche Bank

I mean, if I hear you correctly through the prepared remarks and the Q&A, I mean, it sounds like all of that is happening and we’re not in a recession. When do you expect the tonnage to see an inflection point to go positive, so you stop having to right size labor and productivity to down year-over-year tonnage? I mean, tonnage is actually growing sequentially right now if I heard you correctly. So, I mean, the operating leverage should start to kick-in in a bigger way with pricing where it is I would think?

Douglas Stotlar

Well, obviously, we’ve overcome all of the costs that we had to bring back this past year with PTO and wage restoration and other factors and we added to that. There’s still a bit more to come back, as we know, in the fourth quarter we have our basic and transition coming back. And so we are going to continue to keep the same game plan on, to keep the progress going and if the environment continues to remain positive, we’ll continue to make progress.

Justin Yagerman – Deutsche Bank

So, when do we cross over to up year-over-year tonnage if we remain on the same kind of trajectory that we are at right now?

Stephen Bruffett

This is Steve. I think part of that is driven by what last year looked like. This year has been very stable and following normal seasonal trends. And so the closing of the gap to last year is more about what last year looked like. We’ll be at or near even tonnage in the fourth quarter, maybe slightly up, slightly down, but close to the fourth quarter of last year.

But that doesn’t mean there is a lot going this year. We’ve tried very purposefully to dial it in a steady fashion and just follow normal seasonality, which we’ve done. So, it sounds like there’s growth per se going on, we’re trying to keep things in steady fashion. Now, going forward, we’ll revisit what targeted range looks like, but it’s been very important for us to inject that stability into the system as we’ve moved through 2011.

Justin Yagerman – Deutsche Bank

Why is tonnage down in October? And if you could, could you remind us of year-over-year tonnage comps for October, November, December?

Douglas Stotlar

Tonnage in the October was down 1.6% compared to the prior year. So we closed that gap all during the third quarter and then beginning of the third quarter.

Stephen Bruffett

Yeah, and that closing of the gap, to add to your comments, is really driven by what last year it looked like more so than this year. This year, it’s just dialed in following normal seasonality.

Justin Yagerman – Deutsche Bank

Okay, and once you get caught up on this 401(k) in Q4, that flows through next year, so, that will be something that we got to contend with. Is there anything else that we should be thinking about that’s looming out there? Like wage increases or other healthcare jumps in terms of costs that would mask operating leverage that should be coming through?

Douglas Stotlar

Well, Justin, you hit on a couple of things. I mean, our employees haven’t had a wage increase since 2008. So, as we continue to monitor the calls to the marketplace, we’ll view what’s happening in the competitive set, it’s likely that we will have to do something in 2012 concerning wage increases for our employees. Healthcare costs continue to escalate and while we were successful so far in our prediction this year of kind of keeping it flatline, we don’t know that we’ll have that same success next year.

So healthcare inflation is something that certainly could step up. Steve already mentioned the fact that, right now, if we were to set the how it looks for next year on a pension expense, it’s kind of go up by perhaps around $10 million. So, there is certainly some cost headwinds. Our intention is once again to offset all the cost increases as well as show some margin growth next year.

Justin Yagerman – Deutsche Bank

Okay, great. Thanks for the time, guys, I appreciate it.

Douglas Stotlar

Thanks, Justin.

Operator

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

Chris Ceraso – Credit Suisse

Thank you. Good morning.

Douglas Stotlar

Hi, Chris.

Stephen Bruffett

Good morning.

Chris Ceraso – Credit Suisse

Wanted to spend a minute on the purchase transportation. I noticed that, that expense was up as a percent of sales pretty meaningfully, both sequentially and year-over-year. What was going on in there and why was that up was there a change in the mix of your business or what’s happening? We would expect to see you get some leverage on that line considering that you had pricing gains in real terms sequentially and year-over-year?

Walter Lehmkuhl

There’s two components to that, but by far the greater one on that is the fuel year-over-year and also price increases that we took or rate increases that we took in April.

Stephen Bruffett

To clarify that a bit, this is Steve. Inherent in our purchase transportation line is the fuel surcharges that we pay to those predominantly couple of providers that provide that service. So adds some volatility to that line for that purpose.

Chris Ceraso – Credit Suisse

Right, but presumably you had fuel in the top line, too, and this went up as a percent of sales. Is there anything more to it than that?

Stephen Bruffett

Just trying to think, so, you’re looking at the consolidated income statement, right?

Chris Ceraso – Credit Suisse

Correct.

Stephen Bruffett

In Load as well as Freight?

Chris Ceraso – Credit Suisse

That’s right. So, no, that’s it, it’s just the fuel?

Douglas Stotlar

Primarily fuel and then we have our brokerage unit continues to grow, which also uses purchase transportation, so it’s not necessarily just a freight phenomenon here.

Chris Ceraso – Credit Suisse

So no change to your line haul network or -?

Stephen Bruffett

No.

Chris Ceraso – Credit Suisse

Okay.

Stephen Bruffett

There is no strategy to change our sub-service network.

Chris Ceraso – Credit Suisse

Okay. Thank you.

Douglas Stotlar

Thanks.

Operator

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

Bascome Majors – Susquehanna Financial

Good morning, guys. Bascome Majors in for Matt. I was wondering if we could step back a bit and talk a little about the LTL competitive dynamic. There’s stability in the history that you haven’t seen for a while seemingly with a competitor recapitalized for several months and everyone seeing to hope the price on during the quarter. Does it feel anything like a pre-crisis environment out there? And if not, what are the big changes and how do you address those?

Douglas Stotlar

Well, on the pre-crisis environment, we had too much capacity in the industry. I mean, the LTL industry has been in basically a recession of declining tonnages since 2006. And everyone was still building their networks while the tonnages were starting to cascade away as a commitments in CapEx, et cetera. So, the industry didn’t really stop building and start to recognize that we had a problem until 2007.

So there was this just way too much capacity sloshing around out there before the downturn of 2008 and into 2009. That capacity has, for the most part, rationalized itself. And so, as we sit here today, we’re as an industry, even in today’s environment, that’s pretty close to equilibrium. And so the environment feels completely different than it did pre-crash.

Bascome Majors – Susquehanna Financial

All right. Thanks for the time, guys.

Operator

Your next question comes from the line of John Godyn with Morgan Stanley.

John Godyn – Morgan Stanley

Thanks for taking my question.

Douglas Stotlar

Good morning.

John Godyn – Morgan Stanley

As we think about the price trends we’re seeing in LTL and TL and the different forces at play driving price in both those businesses, can you just talk about whether you’re more excited about the potential for price growth in LTL or TL in 2012 assuming similar macro?

Douglas Stotlar

Well, I’ve got to say I’m pretty happy with where both companies are positioned, both industries I should say, are position based on the supply and demand and the current environment demand. So I think both industries are poised for the opportunity to see an expanding margin environment and a continuous improvement in the pricing environment as a result of where we are from a supply and demand standpoint.

The Truckload bid cycle, at least in our case, is different than it is for LTL. LTL is spread out pretty evenly throughout the course of the year. Truckload is more heavily loaded to the beginning of the year. So, we’ll see where we are from a traction standpoint as we get into the first quarter and start to wrap up the first quarter bid cycle. Herb, anything to add to that?

Herbert Schmidt

We did see continued traction in pricing in the third quarter versus the second quarter, John. And based on what we’re hearing from the customers, we believe that there’s going to be some pricing traction during the bid cycle in the first quarter. And I think I wouldn’t term it as robust but I wouldn’t term it as robust but I would say it’s steady. And I think we’ll see some improvement in the first quarter. As of right now, pricing is relatively flat. We’re not digressing, but we’re not progressing in fourth quarter, but there’s virtually no bid activity in the fourth quarter.

John Godyn – Morgan Stanley

Okay. Thanks. And then in the release, you mentioned demand has been steady in Truckload and some regions are becoming capacity constrained. Can you just elaborate on that and, specifically, what regions are becoming capacity constrained?

Herbert Schmidt

Well I think it’s easier to tell you which ones are not. The Southeast is an area where we have some excess capacity and we’ve seen some excess capacity pretty consistently. Aside from that, for the most part, capacity has been relatively tight across the country.

John Godyn – Morgan Stanley

Great. Perfect. Thanks, guys.

Douglas Stotlar

Thanks.

Stephen Bruffett

And real quick before we take the next call, on a follow-up on the purchase transportation question that was asked previously. And this will all be visible to everyone once the 10-Q gets filed early next week and we can see the segment results in more detail, but purchase transportation at Con-Way Freight was only up $4 million year-over-year in the third quarter and as a percent of revenue, was actually down a little bit.

So all of our – virtually all of our consolidated increase in purchase transportation year-over-year was at minimum and supporting their gross revenue growth and net revenue growth and it’s predominantly passed-through type activity. So hopefully that clarifies that portion. We can now proceed now to next question.

Operator

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

Thomas Wadewitz – JPMorgan

Hey, good morning. I think you’ve been asked a couple of questions on price, but I guess I’ll give it a shot as well. Why not, right? When you look at 2012 and if you have – if I go back to the third quarter, the third quarter demand in the transport, generally, it seems like it was kind of steady. Not a whole lot of a year-over-year growth across, let’s say domestic transport, but LTL pricing was pretty resilient, and I think came through pretty well. If you continue for a couple of more quarters and the market transport demand is flattish or maybe up a little bit, do you think that discipline continues in 2012? And I’m considering LTL in particular in a flat grade environment in 2012, can you get 4%, 5% price or is that being a little bit too optimistic?

Douglas Stotlar

Well, it’s certainly our expectation and it’s what we’re going to do as company is continue to try to keep the progress going, but we can’t control the market forces. But we’re going to continue to focus on the steady march that we’ve been on, on not only trying to seek price increase, but also continuous improvement in our product.

Walter Lehmkuhl

The only thing I’d add to that is now more than ever in our history we’re negotiating contract prior to their due date and customers are – some customers are eager to do that. We’re renegotiating first quarter contracts now because customers want to lock in their single-digit price increases and it’s a good sign, I think.

Thomas Wadewitz – JPMorgan

Okay. Doug, I know you can’t control the market, but I guess what you’re – that we saw in third quarter, what you’re seeing today, looks like continued discipline from the LTLs despite overall tonnage being kind of muted. Is that a fair way to look at it?

Douglas Stotlar

There would be our observation, yes.

Thomas Wadewitz – JPMorgan

Okay. How much pricing in the LTL do you think you need to have just our figure inflation in 2012? Do you need 3% price to offset your inflation and if you get more than that, that drives the margin or how would you look at price versus inflation in 2012 in LTL?

Douglas Stotlar

I think it’s right round that 3% mark.

Thomas Wadewitz – JPMorgan

Right, okay. Great, thanks for the time.

Douglas Stotlar

Thanks, Tom.

Operator

We have time for one last question. And our question comes from Ryan Cieslak with KeyBanc.

Ryan Cieslak – KeyBanc

Good morning, guys. Thanks for taking my call.

Douglas Stotlar

Good Morning.

Ryan Cieslak – KeyBanc

Just really quick on the OR within Freight. It seems like there is a lot of moving parts here going into the fourth quarter with the cost coming back in. But you guys are doing something on productivity and safety, and, Doug, your expectation is I guess at this point and into October, how should we think about I guess the progression of that Freight OR from the third quarter to the fourth quarter? I know historically it’s declined anywhere from 150 basis points to around 200 basis points sequentially. But maybe just directionally give me your thoughts on how do you think the margins within the Freight should trend here into the fourth quarter?

Douglas Stotlar

Well, there is no doubt margin will decline in the fourth quarter. You’ve got multiple holidays that occur in the fourth quarter, we start to see tonnage levels drop off significantly once you get past the Thanksgiving weekend and then you also start to have some weather-related impact. So, I think you could go back and look at some of our historical declines and expect something like that to occur in the fourth quarter of this year. And keep in mind, we also are layering the $5 million coming back for the basic and transition for the 401(k).

Ryan Cieslak – KeyBanc

Okay. And then just lastly, just maybe an outlook on what you’re seeing, I know you gave some updates on October in terms of the tonnage trends in LTL and it seems like things are remaining firm in Truckload also. But just maybe the Freight activity expectations into November, anything different either from a seasonal standpoint, better or worse, I guess as we head into November here?

Douglas Stotlar

Our expectations when we set our plan levels up were based around normal seasonal patterns and we continue to follow a normal seasonal pattern. So we’re pleased with how demand is holding up so far.

Ryan Cieslak – KeyBanc

Okay. Thanks, guys.

Douglas Stotlar

Thanks.

Stephen Bruffett

Thanks.

Douglas Stotlar

Operator, could you give the replay information please?

Operator

Thank you for participating in Con-Way, Inc.’s Third Quarter 2011 Earnings Review Conference Call. This call will be available for replay beginning at 11.30 A.M. Eastern Standard time today through 11:59 P.M. Eastern Standard time on Friday, November 18th, 2011. The Conference ID number for the replay is 175-05-559. Again, the conference ID number for the replay is 175-05-559. The number to dial for the replay is 1-800-585-8367 or 1-855-859-2056, or internationally, 1-404-537-3406.

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