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Con-way Inc. (NYSE:CNW)

Q2 2012 Earnings Conference Call

August 1, 2012 08:30 AM ET

Executives

Patrick Fossenier – Vice President of Investor Relation

Douglas Stotlar - President and Chief Executive Officer

Stephen Bruffett - Executive Vice President and Chief Financial Officer

Gregory Lehmkuhl - President (Executive Vice President, Con-way Inc.)

Robert Bianco - President (Executive Vice President, Con-way Inc.)

Herb Schmidt - President (Executive Vice President, Con-way Inc.)

Saul Gonzalez - Chief Operating Officer

Analysts

Matt Alcalf [ph] - Dahlman Rose & Co.

Matt Troy – Susquehanna

Justin Yagerman - Deutsche Bank

Todd Fowler - Key Banc Capital Markets

Bill Greene – Morgan Stanley

Chris Ceraso – Credit Suisse

David Ross – Stifel Nicolaus

Seth Lowry – Citi

Ben Hartford – Baird

Tom Wadewitz – JP Morgan

Ken Hoexter – Bank of America

Scott Group – Wolfe Trahan

Tom Albrecht – BB&T Capital Markets

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 Second Quarter 2012 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’s Second Quarter 2012 conference call for shareholders and the investment community. In a minute, I’ll turn it over to Con-way President and CEO, Doug Stotlar.

Before we get into the call, I would like to offer a few reminders. First, certain statements in this conference, including statements regarding anticipated results of operation and financial condition constitute forward-looking statements and are subject to a number of risks and uncertainties. Actual results of operations and financial condition might differ materially from those projected in such forward-looking statements, and no assurance can be given as the future results. Additional information concerning factors that could cause actual results and other matters to differ materially from those in the forward-looking statements and the inherent limitations of such 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.

I would also like to note that we have a lot of people on the call today, so we would appreciate it if you would limit yourself to a couple questions then return to the queue.

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

Douglas 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 from Con-way Truckload President, Herb Schmidt and Chief Operating Officer, Saul Gonzalez. Steve will provide some commentary on our financial picture, and then in the Q&A portion of the call, Greg and Bob will review highlights at Freight and Menlo and Herb and Saul will comment on Con-way Truckloads results.

Our second quarter performance reflected disciplined operations, good cost controls and margin expansion at all of our business units. The consistent execution of our strategy is delivering the intended results. The key to improvement of our process has been a focus on our fundamentals which remain improving safety, applying lean practices, leveraging technology, and managing price. Progress in each of these areas provided the momentum for an improved second quarter and remain our strategic priorities going forward.

Turning to our consolidated financial results for the second quarter of 2012, Con-way reported revenues of $1.45 billion, a 7.2% increase over last year’s second quarter revenues of $1.35 billion. Our operating income was $80.1 million in the 2012 second quarter, a 33.2% improvement over the $60.2 million earned in the prior year period. Diluted earnings per share were $0.74 compared to $0.52 per share in the second quarter of last year. On a non-GAAP basis, earnings per diluted share in the 2012 second quarter were $0.66 compared to $0.50 in the prior year. The non-GAAP items consisted of gains on facility sales in the current period and tax related adjustments for both years.

Moving now to review of our business segments, I’ll start with Con-way Freight, our LTL operation and largest revenue segment. Con-way Freight posted second quarter operating income of $53.4 million, a 36.5% improvement over the $39.2 million earned in the same period a year-ago. Revenue of $878.5 million, a 4.6% increase over last year’s second quarter revenue of $839.8 million. Con-way Freight’s operating ratio this period was $93.9 million, improving from last year’s second quarter OR of $95.3 million. Excluding the gain from the sale of excess properties, the operating ratio for this year’s second quarter came in at $94.4 million. Tonnage per day increased 0.9% over last year’s second quarter. Second quarter revenue per hundredweight or yield increased 3.2% with and without fuel surcharge compared to the prior year.

The yield adjusted for length of haul and weight per shipment was up 4.1% in the second quarter compared to last year. It was a steady performance highlighted by improving operational efficiency and consistent service execution for Con-way Freight. Our focus on safety continue to return encouraging results as the number of accidents and injuries year-to-date were down 13% and 25%, respectively compared to the first half of 2011. We remain diligent in managing our cost and our lean continuous improvement practices are helping our employees aim more opportunities to eliminate waste and increase efficiencies.

Overall, demand for LTL services in the second quarter was slightly softer and earlier this year. June tonnage was a little light early in the month but finished on a strong note, we saw the same pattern in July with daily tonnage levels strengthening towards the end of the month and finishing slightly ahead of last July.

The balance between supply and demand enable us to implement a general rate increase for non-contractual business and to continue to secure mid single-digit price increases on contract renewals that came due during the quarter. We remain confident in our strategy for Con-way Freight and in our ability to execute that strategy in ways that overtime continue to improve all aspects of the business.

Now I’ll move to our Logistics segment. For the 2012 second quarter, Menlo Worldwide Logistics, our global logistics and supply chain management company, reported operating income of $12.7 million, a 4.9% improvement over the $12.1 million earned in last year’s second quarter. Revenue for the quarter was $448 million, an increase of 13.7% over the prior year revenue of $394 million. Net revenue or revenue less purchased transportation came in at $161.8 million, a 10.1% increase over the $147 million generated in the previous year period. Menlo’s second quarter highlights included increased revenues and profits from both international and domestic US operations. New business coupled with higher volumes from both warehousing and transportation management services contributed increased revenue. Menlo also benefited from double-digit growth at Con-way Multimodal, our freight brokerage operation.

On the operating income side, we benefited primarily from higher margins and transportation management services, including improved profitability in both Europe and Asia. Menlo’s this pipeline remained solid and we have notable opportunities being worked internationally, including prospects in Asia and South America. We continue to be encouraged with the performance of Con-way Multimodal, where we added offices and expanded the workforce to maintain the growth trajectory of our freight brokerage business. Our supply chain logistics company continues to differentiate itself in the market, driving efficiencies for customers through application of its proven lean practices and superior operational execution.

Now I’ll review results from our truckload segment. For the 2012 second quarter, Con-way Truckload reported operating income of $14.6 million, a 41.6% improvement over the $10.3 million earned last year. Revenue increased 4.8% to $162.9 million over last year’s second quarter revenue of $155.5 million. Revenue per loaded mile, excluding fuel surcharge, increased 3% from the previous year second quarter. Operating ratio ex-fuel surcharge improved to 88.3 from 91.3 in the year ago period. Loaded miles increased 2.4% compared to the previous year second quarter, while empty miles decreased to 9.2% from 9.4% last year. Con-way Truckload operated efficiently in the quarter, expanding margins and maintaining its momentum. Asset utilization continues to improve as did lane density, empty miles, and revenue per loaded mile.

It’s a fairly flat but stable demand right now for Truckload services and despite a variety of issues that continue to tighten the driver pool, the trucks are full at Con-way Truckload. We have done an excellent job meeting our driver needs through effective recruiting and retention programs. We also have been successful securing rate increases as contracts have come through the annual bid cycle. Con-way Truckload is well positioned for continued improvement as we maintain our focus on premium service and operational excellence as the foundation for future margin expansion.

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

Stephen Bruffett

Thanks, Doug, and good morning everyone. I will begin with cash flows. Our cash from operations for the second quarter was $109 million as compared to $125 million in the second quarter of last year. A good portion of the year-over-year decrease is explained by the $12 million cash refund we have received last year, although no such refund was received in the second quarter of this year. Excluding the impact of the tax refunds, the primary items that added cash flow year-over-year included higher net income and the continuing benefit of bonus depreciation. The main item that consumes more cash this year was related to employee benefits in the form of higher 401K contributions, as some of these retirement benefits were still suspended at this point last year.

Net capital expenditures were $58 million during the quarter as compared to $71 million in the second quarter of last year. As we continued our steady investments in revenue equipment and also received higher than normal proceeds from asset sales as a couple of excess Con-way Freight properties were sold during the quarter. Year-to-date, net CapEx was $136 million and for the full year of 2012 we still expect net CapEx to be approximately $300 million. Financing activities used about $10 million of cash in the quarter, as compared to just over $7 million last year. Financing activities are comprised mostly of common dividends and capital lease payments. At June 31, our cash and marketable securities totalled $460 million, as compared to $451 million at year-end 2011.

The last cash flow topic I’ll cover is that of pension funding and with respect to pension reform measures and the recently passed MAP-21 legislation, we don’t expect to alter our 2012 funding plans based on the near-term relief offered under MAP-21. So we still expect to put the $51 million into defined benefits plans by the end of the year, of which about $12 had been contributed as of June 30.

Moving now to the consolidated income statement. There were no large items to call out from the second quarter, however in order to provide some context, I will point out few items. First, healthcare costs were in line with our expectations at $46 million as compared to $43 million in the second quarter of last year. Second, depreciation and amortization expense was $53 million in the second quarter of 2012, as compared to $51 million in the second quarter of last year. For the 2012 full year, we still expect depreciation and amortization to be about $215 million, that’s down slightly from our previous guidance of around $220 million.

Next, our effective tax rate was 35.4% during the quarter and that’s very similar to the second quarter of 2011. Adjusted for discrete items, this year’s second quarter tax rate was $38.9 million.

Lastly, our fully diluted share count for the second quarter was $56.4 million and we guide you to use $56.5 million for the full year 2012.

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

Douglas Stotlar

Thanks Steve. With a well executed quarter turned in by all three of business units, we are building our company’s success on a strong foundation of improved safety performance and operational excellence, which are driving efficiency gains and opportunities for margin expansion. While the economy is uncertain, our plans aren’t. With the deployment of lean tools and processes throughout the enterprise and the results we have seen so far, we are confident in our ability to consistently improve performance over time.

Before I open up the call for questions, I would like to once again recognize Herb Schmidt. As we announced on our last earnings call, he is retiring next month. So, this will be his last call. I want to recognize Herb for his contributions to our company and thank him for his leadership and service. Herb has done a great job of preparing our own leadership team for this transition and he will be leaving knowing that Con-way Truckload is in good hands.

And with that operator, we’re ready to take some questions.

Question-and-Answer Session

Operator

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

Matt Alcalf [ph] - Dahlman Rose & Co.

Good morning guys, this is Matt Alcalf [ph] for Jason. Can you guys give us some more detail on how your productivity initiatives are playing out? Especially, in cabin onboard [ph] technologies?

Gregory Lehmkuhl

This is Greg Lehmkuhl, talking for freight. So, our lean initiatives are driving productivity improvements really across the board. Doug mentioned in his opening comments on the safety side, we saw 13% reduction in accidents and a 25% reduction in injuries year-over-year. That led to a 24% reduction in both workers comp costs and vehicular costs, a drop in $4.2 million to the bottom line in the quarter. From a customer performance standpoint, the lean efforts are paying off. For the customers, we had one of our best on-time performance quarters ever in our history. Our claims are down 24% year-over-year. Our shorts and losses are down 33%, at about $2 million impact in the quarter. Our productivity in the line-haul and pickup and delivery operations were improved over last year’s second quarter by 1.4%, our dock productivity was up 2%, and all those numbers across the operations our productivity was at all time high. So, I would say really across the board, we are seeing the numbers we anticipated in the quarter from a productivity standpoint.

Matt Alcalf [ph] - Dahlman Rose & Co.

Got you, thank you for that. And on the pricing front, your pricing looks at just a bit lighter than what we have seen from some other carriers. Can you give us some more detail on that?

Gregory Lehmkuhl

As Doug mentioned, our adjusted yield, when you adjust the length per haul and weight per shipment was up 4.1%, which is right in line with our trends and expectations. Overall, we are balancing revenue into yield, and we want to keep the right business in the right range, so we think we are doing an effective job of doing that and we are getting the increases throughout the quarter and through July as projected and communicated in mid-single digits.

Matt Alcalf [ph] - Dahlman Rose & Co.

Okay, thank you very much.

Gregory Lehmkuhl

You are welcome, thank you Matt.

Operator

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

Matt Troy – Susquehanna

Thanks. I was wondering with everyone scratching their heads and looking at somewhat foggy crystal ball on the economy, can you just maybe give a little bit more detail in terms of what your customers are saying? We hear a lot of interpretation and concerns obviously around fiscal cliff and the election, that’s going certainly, I am just wondering, in terms of their freight dollars, are people actually raining back yet or are they just talking about potential fear and risk, just wondering what your conversations are or yielding on that front?

Gregory Lehmkuhl

This Greg, I think we mentioned last quarter that we have biweekly sessions with about 30 customers. We continue to see people pretty optimistic about their business even with really really slow economic growth. I think the way that’s playing out into rates and LTL, our industry is clearly more balanced than it was a couple of years ago when the economy got shaky. We are continuing to see our customer treat us fairly, value our service, and give us the increases that we need.

Matt Troy – Susquehanna

Okay. Maybe if you could just reconcile that, obviously the industry has been through a lot in the last 2 or 3 years. In terms of capacity in your network and then more broadly industry capacity, where do we stand, are we close to equilibrium, or as close as you can get, what’s the reasonable bogie in terms of capacity utilization? I know that at a broad average, but just trying to get a sense if the economy is coming along at 1% or 2% growth what that means for industry capacity and then whether or not you are where you need to be? Thank you.

Douglas Stotlar

Matt, there’s a couple of reports -- this is Doug, there is a couple of reports that we look at, that we track that compare industry capacity, it’s primarily in assets, in tractors and trailers, on the LTL, the Truckload industry to kind of level trends. It actually shows that LTL is in the best position it’s been in quite some time from an equilibrium standpoint. Truckloads are a little bit closer to having, perhaps these kinds of levels drop to being a little bit of overcapacity situation. It’s not showing that today, but it’s a little closer to the line. So, from an LTL industry perspective, we are in the best place we have been in quite some time. And certainly in an exponentially different position than we were prior to the 2009 down turn. So, we feel, as Greg mentioned, that our customers recognize this trend and are treating us fairly in our discussions on improving price and getting our margins back because these are pretty capital intense businesses and we need to make reinvestments on our rolling stock and customers are recognizing that fact.

Matt Troy – Susquehanna

Okay. Well, thanks for the time today guys.

Operator

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

Justin Yagerman - Deutsche Bank

Hi, guys. Thanks for taking my call. Greg, you talked about I think 1% improvement in line-haul productivity, 2% improvement in dock productivity, when you think about those, I know you mentioned that that’s record productivity levels, where you guys – where is the bar, where is your goal, and how do we translate those productivity improvements into dollars when we think about margin improvement for the overall company?

Gregory Lehmkuhl

Yes, that’s a big question. I would say overall we have a lot of opportunity in front of us in all areas of the business. I think in June I talked about our 3-year plans and the projects that we have lined up across the business for the next 3 years. We are two quarters into a 3-year plan. A lot of the work we are doing is foundational for future projects. We see a lot of room left in productivity, in sophistication, and how we manage our revenue and customer performance, safety and maintenance, all the key areas of the business. We see a lot of good future improvements. So obviously, some of those are offset by continued cost increases that we face in employee-related benefits, wages in 401K, and some service inflation, but when we look at the 3-year plan we are confident that overtime we will expand margins and we are pretty confident about how our costs and improvements will net out and through a couple of quarters this year and we are slightly ahead of that 3-year plan and we are confident that we can execute against it going forward.

Justin Yagerman - Deutsche Bank

Can you give us some milestones, the benchmarks? When I think about how many service centers were rolled out, on this lean project at this point where do you expect to be at year-end? What it means for a service center to be on this lean process driven methodology?

Gregory Lehmkuhl

We have about 52 of our 300 locations actively up and running on lean. They are very early in their journey. One of the biggest leverage points that the lean process gives us, is not only continuous improvement at the local level, but it gives us a whole new focus on process stability. So, as we rollout, the big initiatives that are generally driven from this office in Ann Arbor, we were able to implement more effectively and sustain the gains over time. So, I think this is kind of a multiplier effect in muting various structured lean continuous improvement process from corporate, drive big things like a haystack, like a handheld technology, like a pro-label, like a lot of our safety improvements and then getting the right foundation at service center level, so you can accept those changes, get it implemented and sustain. From a lean standpoint, I would say we are in the bottom of the first, very very early, we are seeing the benefit in the bottom line. But many of our goals moved in actual and high leverage plains, in line-haul, and pricing are in front of us, versus behind us.

Justin Yagerman - Deutsche Bank

Okay. Doug, if I heard you correctly, you said that tonnage was negative for July, but ended the month positive. I am trying to sense, as I look out at the rest of the quarter, if your customers are right and their businesses are better than the economy is telling us, would you expect that Q3 will see tonnage positive for the full quarter?

Douglas Stotlar

Well, Justin, I am not quite sure what you expect for the full quarter. I indicated that July was soft during the first couple of weeks of the month, but it’s very similar to June, finished with a strong note and we finished up about one-tenth of a percent from a year-over-year tonnage level improvement over July of last year. So, it’s pretty anaemic and we are not going to pretend to be economist. It feels an awful lot like we did last year where we started off relatively strong during the year and then we hit this soft patch. This year, it’s feeling a little bit different from last year from the fact that at least in our own particular case the egg season started earlier because of the extremely mild spring particularly in the Midwest. So we saw a lot of our agricultural shippers really ramp-up a full month early. So we saw the benefit of those tonnage gains in the March, April time frame and it started to dissipate as we went into May and certainly into June. So, we are going to try to keep our tonnage levels flat year-over-year, that’s certainly our goal, but we don’t know what the forward looks really going to be.

Justin Yagerman - Deutsche Bank

Total July was negative but the last week or two was positive, is that right?

Douglas Stotlar

The whole month was up one-tenth of a percent over July compared to last year.

Justin Yagerman - Deutsche Bank

Okay. And the last one for Steve, curious, as we look out you guys still have lot of cash on the balance sheet, you obviously have CapEx needs and pension contribution, but asides from those, how do you think about uses of the cash on your balance sheet as we look out over the next couple of quarters?

Stephen Bruffett

Certainly over the next couple of quarters those items that you mentioned remain our focus and priority. When we talk about pension and the prospect of longer term interest rates going even further from the historic lows, that continues to add funding obligations over the course of time through the pension obligation. For context, if you rewind all the way back to like 2008 before all of this started, we basically had a frozen plan during that low time. So, nothing really changed about our liability, or nature of our plan, however the liability has gone up over $500 million just due to decline in interest rates. That’s a meaningful factor that we are preserving some cash cushion for. That is part of our current cash position and will likely remain over the next period of time until we can further delever and risk that plan.

Justin Yagerman - Deutsche Bank

Longer term?

Stephen Bruffett

Longer term, we will see. Longer term if we can get the pension obligation behind us and get a little further down the path of our fleet replenishments and some of the investments we would like to make in technology and so on, then it becomes a different discussion about use of capital and where it goes and why and all the conventional potential uses of that cash come into play. But now we are focused on pension and CapEx.

Justin Yagerman - Deutsche Bank

Thanks. I appreciate the targets.

Stephen Bruffett

You bet.

Douglas Stotlar

Thanks, Justin.

Operator

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

Todd Fowler - Key Banc Capital Markets

Great, thanks good morning everybody.

Douglas Stotlar

Good morning.

Todd Fowler - Key Banc Capital Markets

I think I have got the comments now on the tonnage trends for July. Do you have any similar comments on yields? It sounds like in the prepared comments you are still seeing mid single-digit contractual rate increases, but how have yields trended here during the month?

Gregory Lehmkuhl

Similar to last quarter, we continue to see expected gains associated with both the GRI and the contractual rate increases, with good trend in July.

Todd Fowler - Key Banc Capital Markets

I guess with the GRI coming in, should the rate of increase be a little bit stronger during the third quarter? I know the comparisons are a little bit more difficult, but how do you think about rate of change in the third quarter compared to the second quarter?

Gregory Lehmkuhl

It’s early, we will see how the business mix change about that. I think it’s fair to say that GRI will help us and the contractual increases are remaining steady.

Todd Fowler - Key Banc Capital Markets

Okay. And then, when I look at the weight per shipment here during the quarter then over the past couple of quarters, you have actually seen a bit of increase in the weight per shipment year-over-year and sequentially. Is there anything specific going on with your mix that’s driving that? Or how do you think about weight per shipment, the context of yields and overall profitability right now?

Gregory Lehmkuhl

I am not going to claim we know exactly what’s driving this. It could be customers shipping bigger shipment to save transportation dollars, it could be the mix of business, but we have seen a steady increase for a couple of years now and it just seems to be a trend and we are not really sure what’s behind it, frankly.

Todd Fowler - Key Banc Capital Markets

Okay. And then, the last one I have and I will turn it over. If I look at the purchase transportation, the freight business, we have got tonnage that’s basically flat, it sounds like there has been some improvement with the pickup and delivery and the efficiencies, but PT [ph] was up about 9% year-over-year in the quarter, is that just a function of what you are paying on the line-haul side, I would think there would be some benefit on fuel. What’s driving the high single-digit increase in PT cost?

Gregory Lehmkuhl

It’s two things, I think I talked about this last quarter, when you look at our line-haul network, we use sub service to reduce empty mile and make the overall line-haul network more efficient. If you look at the kind of the bottom line from our perspective in line-haul, our total efficiency as measured by our load factor number was at all time high. If you look at the second quarter versus last year, our tonnage was up about a 1%. Our total miles were down. So, we used sub service as one of the levers to increase overall efficiency and reduce empty miles. Our empty miles in the quarter were at an all time low and again if we can get all that out, it worked in reducing miles as well.

Todd Fowler - Key Banc Capital Markets

So, I guess, in what line item do we see -- the efficiencies are kind of worth the offset, I guess for that, we think about, just looking at the cost buckets, where do we see the benefit on the efficiency side servicing in the numbers?

Stephen Bruffett

This is Steve. It’s in the salaries, wages and benefits line where mileage wages reside. Just for some general context, mileage wages at Con-way Freight were down slightly year-over-year despite wage increase. So that helps to put that in context.

Todd Fowler - Key Banc Capital Markets

Okay. Now, that does make sense. Okay, thanks for the time.

Operator

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

Bill Greene – Morgan Stanley

Hi good morning. I wanted to sort of get a little bit more color on the margin trends. You sort of read through some comments here, but as I think about the third quarter, and we think about the timing of the GRI, the lean initiatives, as well as maybe the uncertainty in the economy, is it possible we could get a sequential improvement in OR in the third quarter?

Stephen Bruffett

Bill, it’s possible. It’s typically not the pattern we see. If you think about the third quarter, we have one extra holiday that occurs in the third quarter, we don’t have in the second quarter and one less work day in the third quarter than we have in the second quarter, and we always have July, which is not the best demand month. We have usually three pretty solid demand months in the second quarter, and you have the third quarter as July and then two pretty solid demand months.

Bill Greene – Morgan Stanley

Okay. So, it’s I guess it’s a tougher setup, but we will see how these things play out, I guess, probably more on tonnage than anything.

Douglas Stotlar

Agreed.

Stephen Bruffett

It’s going to be demand driven.

Bill Greene – Morgan Stanley

Yes, fair enough. And then when you look at kind of the longer-term inflation, I know there is a few moving parts this year, but what’s the safe sort of trend line assumption we can use for kind of where your inflation broadly should be?

Douglas Stotlar

As far as inflation expectations?

Bill Greene – Morgan Stanley

Yes, I guess I am just kind of thinking through like there is a few moving parts this year in terms of when things time by quarter, but if we sort of thought about kind of a 3-ish percent longer-term inflation rate when you think about the inflation in the network, is that sort of fair or – and then, on top of that, of course you get productivity, but I don’t know if that’s a fair starting point, do you think the number is higher or lower in there?

Douglas Stotlar

It’s a good question and it’s difficult to think through, but if you think about 2012, for example, we had a 2.5% wage increase, and that fetches a fair percentage of our total costs. Healthcare is an outlier and it’s well above that percentage, and then we have some other items that are below that 2.5% border line, but it’s probably somewhere between 2.5% and 3% that I would guess, and likely to be somewhere in that range as we look forward in the near-term future, Bill.

Bill Greene – Morgan Stanley

And could productivity initiatives offset all of that or they just not going to be quite there?

Douglas Stotlar

It’s so related to demand and what freight lines look like, we are able to be more efficient to have more volumes and vice versa. So, it is somewhat tangles up in that dialog as well. In a very steady-state environment, I would say we probably wouldn’t completely offset the cost increases, but we make a good getup.

Bill Greene – Morgan Stanley

That’s great. Okay. Thank you for the time.

Stephen Bruffett

Thank you.

Operator

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

Chris Ceraso – Credit Suisse

Thank you. Good morning.

Stephen Bruffett

Good morning.

Chris Ceraso – Credit Suisse

So, now that you are, I guess you said a couple of quarters into the lean process and you are maybe one inning into it, can you think about the progress that you have made and extrapolate that across the service centers that you haven’t hit yet and start to think about over the next year or two or three, what that might translate to into the margin potential for your business? Can you get back to 7% or 8% margins for the company?

Douglas Stotlar

Do you want to take any –

Stephen Bruffett

Chris, I mean, again, we believe we can continue to improve efficiencies in the company, we can improve our network efficiencies and our line-haul operation. We believe we can improve our efficiencies in how we process price increases and our negotiations with our customers and how we match up our lane needs in line-haul with our sales opportunities. We still don’t know what the demand environment is. All of this is heavily hinged on the real ability to really expand margins and get back to historic levels, depending on the growth environment, and we haven’t seen much of a growth environment here this year. That being said, we believe the efforts we are taking will continue to allow us the opportunity for continuous improvement and even in a slow growth environment, to be able to expand our margins. But getting back to the below a 90 OR, we are going to require some help from the growing economy.

Chris Ceraso – Credit Suisse

Okay. I guess I will, for the second question about the pace of demand. It looks like, at June, you said it was basically flat, but you were up about a percent for the quarter, then things must have slowed throughout the quarter. Was that a function of comparisons we got more difficult or was your customer activity slowing down, and if so, any particular parts of the business or end markets that were notably decelerating?

Stephen Bruffett

Let me go through the quarter again with rates. So, April was up 2.2%, this is on a tonnage basis. May was up 0.8%, and then June was minus 0.1%, and now we are seeing July up 0.1%. So, it definitely decelerated as you went through the quarter. Now, a portion of that at least in our case was due to the pull ahead of ags and we have a pretty good, couple of pretty good big customers that are heavy into the ag area. And we are very strong in the Mid-West during the March and April timeframe, and that dissipated as we went through the quarter.

So, we are, at least the way I look at it right now, tonnage levels are remaining relatively flat year-over-year, and that’s what we are going to try to maintain as we go through the rest of the year.

Chris Ceraso – Credit Suisse

Okay, thank you.

Stephen Bruffett

Thanks.

Operator

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

David Ross – Stifel Nicolaus

Yes, good morning gentlemen.

Douglas Stotlar

Good morning.

David Ross – Stifel Nicolaus

Bob, can you talk a little bit about the growth in multimodal? How big is that segment of the business now, and what’s the size that you are looking to grow to maybe in three years?

Robert Bianco

Yes, Dave. So, we are – quarter-over-quarter, we grew multimodal in the 30-plus percent range, and we have been tracking in that range for about three years now. And so, it’s a big growth area. We are putting a lot of investment into that area of the business. We have opened up and set two offices. And so, we expect to see some pretty good growth numbers going forward in there.

David Ross – Stifel Nicolaus

And back on the LTL side, did the fuel, as a general rule, help or hurt you guys in the quarter as fuel prices came down?

Douglas Stotlar

We are talking about the modest improvement.

David Ross – Stifel Nicolaus

Okay. And then, last question is just on the GRI. In the past, you have talked about applying, I think last year, you said to about 25% of the business, down from a high figure number several years ago. Is that falling further or are you starting to kind of reclaim some of that fuel business back, and then any strategies there to kind of improve the amount of business that’s on your own turf?

Douglas Stotlar

Yes, I would say it’s in very stable, so our deterioration is soft, and the GIs helped very, very strong this year.

David Ross – Stifel Nicolaus

And any strategies to kind of improve that, do you think you can kind of bump that number back up over the next year or two?

Douglas Stotlar

I wouldn’t expect to see a big increase in the number on our (inaudible). I think if we can maintain, if that’s good, as the overall trend, as smaller customers get more sophisticated and go to brokers. I think that we have a little headwind there. So, if we can maintain it, that’s good.

David Ross – Stifel Nicolaus

Excellent. Thank you very much.

Stephen Bruffett

Thank you, David.

Operator

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

Seth Lowry – Citi

Good morning. This is Seth Lowry in for Chris.

Stephen Bruffett

Hi Seth.

Seth Lowry – Citi

Hi. If I could just press on tonnage again, if I read into your comments, the overall month ended up 10 bps, but the back half seem to be a bit better, which I think is an interesting concern that your GRI this year went into, a few weeks earlier than last year. Doesn’t that feel like the trend is running a bit better than your expectations or doesn’t that imply that the back half of July was up maybe closer to 50 basis points, or am I not reading into that correctly?

Douglas Stotlar

I would say it was in line with our expectations, The back half of July was a little bit better than planned specifically and just for that few days, the month end was real strong. We will have couple of days we are real strong. But overall, as a month, it’s very much in line with our expectations. The GRI had almost, it really had no negative impact on our volumes with local accounts, and like I mentioned, it’s holding very strong.

Seth Lowry – Citi

And I know you noted the pull-forward in ag demand is helping out a bit. Is there or can you give any clarity as to how long that will persist going forward or --?

Douglas Stotlar

I would say the trade out for the most part, the only other kind of demand call-out technique, a couple of automotive companies shut down an extra week in July. That had a small impact on us, and then, if you look across the country, the biggest softness we saw in early July was in the north east on the national account side. Our local accounts, which is clearly are the most profitable accounts remain strong throughout the quarter.

Seth Lowry – Citi

Okay. Thanks. And then my last one, wafer shipment was up, but the shipments were down, is there anything to read into that and how’s that persisted through July?

Douglas Stotlar

We have, and again, I don’t think customers are aggregating shipments, probably – so, we focus more than anything else on tonnage, as those – kind of at anytime.

Seth Lowry – Citi

Okay. Thanks a lot. I will turn it over.

Douglas Stotlar

Thanks.

Operator

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

Ben Hartford – Baird

Hi, good morning guys.

Douglas Stotlar

Good morning.

Ben Hartford – Baird

Greg, could you talk a little bit about the conversations on pricing? You talked about the improvements in service and still kind of helping mid-single digit rate increases. Where are we in the process of having the conversations with customers and customers being receptive to what you are able to demonstrate so far in terms of improvements to service, and maybe being able to charge a premium for that improved service or extrapolating those service improvements forward and having more of a qualitative value-added type approach to the pricing discussions.

Gregory Lehmkuhl

I think our customers are seeing the best performance they ever seen in Con-way, and lining with customers today, many of them that are sort of sensitive, can’t imagine using another carrier. We did start to see some national account business wins in the quarter or in July that we are excited about. I think overall, we do have a price premium today, if not as big as it was. We have gotten some price premium back since adjustment of our pricing in 2009. So, I think customers are recognizing the value giving it very increasing demand, and we haven’t seen, even on accounts, we have pressed a little harder on price, specifically on lanes that are we operating very well, we have said, we have seen low amount of business go away, even with the rate increases, we are outside of our normal range.

Ben Hartford – Baird

Good. I guess if you think about the next two or three years, and I assume a slower growth environment, now where do you see the direction of the LTL market going? Is it going to be a more demand for premium service type shipments, given how lean inventories are given the marketplace support a premium place offering into that, I guess. Greg, can you provide some context to that strategic element?

Gregory Lehmkuhl

I think you are seeing a lot of, a curious focus, a lot more of speed. Inventories are low, the customers everything. As e-business accelerates, people just want to get faster and faster and faster. So, I think we are well positioned for general industry trends and certainly customers are appreciating and aim for our speed.

Ben Hartford – Baird

And then one last question on the truckload, I am thinking about the fleet growth expectation for the balance of the year, the mix has shifted very, very slightly, but to more and more owner-operated. Can you provide some direction to where you expect the company on fleet to be and where you expect the total fleet to be over the course of the next six to 12 months?

Douglas Stotlar

Ben, we have no plans on increasing the company-owned fleet this year. So, we have no capital allocated for that at this time. We expect to continue modest growth in our owner operators over the remaining course of the year.

Ben Hartford – Baird

Okay, great. Thanks a lot.

Operator

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

Tom Wadewitz – JP Morgan

Good morning. Wanted to ask you, Doug or Greg, if you could give us a sense of how you think the LTL competitive dynamic might play out and your performance within that, if we do get to a deceleration in the economy. So, if you are in a kind of a multi-quarter environment with tonnage for the industry is flat, or let’s say, down a percent or two, how do you think things will play out in terms of pricing? And within that, what can you do on your margin performance?

Gregory Lehmkuhl

So, obviously that would be a headwind for us, but so far, it’s always a competitive market space, but we are seeing a very disciplined industry and I think that with supply and demand being so tight, a lot of carriers that need more freight to drive margin improvements, as mortgage price continues to accelerate. And so, even if growth goes from 2%, let’s say, GDP or industrial production to zero, it certainly wouldn’t help the pricing environment, but we haven’t seen any time that with the – to the economy, it’s impacting our ability to get rate increases, and the competitive staff seems to be very disciplined.

Douglas Stotlar

And Tom, as I mentioned earlier in the call, we really feel like the industry is in a completely different place than where it was prior to the last downturn. And so, there is just less capacity in the industry. So, I think it would have to be something pretty significant for pricing to even come close to going negative.

Gregory Lehmkuhl

In our three-year plan, we were conservative and assumed that price would decelerate in 2013 and 2014, and we expect to be able to achieve margin standing despite that deceleration.

Douglas Stotlar

And Tom, one of the opportunities that we have going forward is the fact that we are getting more sophisticated about our line-haul needs and tying that to sales opportunity, so we can really get more sophisticated about directional lane pricing. And so, we are in the very early innings of our increased sophistication on that front, and we believe there would be a lot of opportunities over the coming two years to continue to improve our ability in that area.

Tom Wadewitz – JP Morgan

Okay. Great. I appreciate the perspective on that. So, you have had kind of slight freight tonnage growth of, what was it, 1% a quarter. So, let’s say, you just had a deterioration where you maybe down 1% in tons per day. You have got a lot of productivity and issues and so forth. I guess it’s also relative to the 90 basis points improvement in LTL and in the second quarter, what do you think that 90 basis points look like, if you are kind of down 1% instead of up 1% on tonnage?

Douglas Stotlar

It would be hard to speculate right now. I really don’t – I don’t think I could come up with a very good number.

Stephen Bruffett

I just would add in context, this is Steve, that from a cost standpoint, Doug and Greg have spoken about the pricing, algorithms that we are applying, which are helpful. On the cost side of the equation, I think we would become more dialed in on what cost levers to all and how to adjust our variable cost more granularly within a shift, within a location in a region, as I have been seeing as opposed to running the same play every day. So, I think that, that will help on the variable cost side. That would ultimately translate into the year-over-year margin as the scenario, you are playing out, it’s hard to predict exactly, but I do think we have got better and we will continue to get better adjusting our variable costs.

Tom Wadewitz – JP Morgan

Okay. And then one last quick one. Just, when you think about fuel is nice benefit on truckload margin in the second quarter. If fuel is likely to benefit in third, what kind of magnitude of margin improvement would you expect?

Douglas Stotlar

Once again, fuel was modest benefit with truckload in the second quarter. We also had some modest benefit from gains on sale, but we had the productivity benefits of increasing our asset utilization and improving pricing. So, it was a combination of all those things that improved, but fuel is only one portion of that equation.

Tom Wadewitz – JP Morgan

Okay. Great. Thanks for the time. I appreciate it.

Douglas Stotlar

Thanks Tom.

Operator

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

Ken Hoexter – Bank of America

Hi Greg, good morning.

Gregory Lehmkuhl

Good morning.

Ken Hoexter – Bank of America

Just a follow-on, on that real quickly, if you see the volumes falling, how quickly can you adjust the cost base? Doug, I think you were talking about kind of line-haul options and things like that, but how quick can you make some of those moves? And what triggers do you look for them to determine you are going to go ahead and start doing that?

Douglas Stotlar

We adjust the variable cost daily. So, to the tonnage levels that are in the network, and so that happens immediately. One of the things we certainly have found in the past, but there is a point where tonnage levels fall off to a certain point, it becomes fixed cost, because you just have to meet a certain quotient of labor to cover the miles that we run every day to cover all the communities that we serve as well as line-haul miles to connect the network. But we adjust every day on the variable cost side. But it’s just, theirs is not a whole lot of big buckets to go after. We recognized that labor is the single biggest cost, and that’s the area that you adjust the fastest.

Ken Hoexter – Bank of America

Okay. Can you just refresh us, last year if I remember, July was the easiest comp with the largest tonnage decline, how does the declines look on a month-by-month basis for the quarter?

Douglas Stotlar

So, last year, this is ’11 compared to ’10, July was down 8.2%, August was down 5.8%, September was down 2.5%.

Ken Hoexter – Bank of America

Okay. And then, if I can just – I appreciate that. And then, if I can switch over to memo, it looked like you ended kind of a three-quarter, I guess run rate of year-over-year improvement in operating margins, is that economic, is that peak margins? It looked like a sizeable salary ramp-up. Is there anything going on there in terms of performance?

Stephen Bruffett

No. Ken, we are in a stage right now, we think we are forming very well. When you look at our margins in the second quarter, our margins were project-based companies that they really were impacted by three things. One is the mix of business. We have warehousing projects and transportation management projects and other projects, and they all come in at different margins. And the second thing is the startup activity. We have startup activities that brings on additional cost, and we have a fair amount of that in the second quarter.

And then the third thing is we have been investing in our business like brokerage where we see a lot of growth, but first quarter, our margins in net revenue was 7.9%, we were at 7.8% in the second quarter. The second quarter was almost profitable quarter in over two years. So, we feel we are in a great spot right now.

Ken Hoexter – Bank of America

All right. Appreciate that. And then, if I could just wrap up on the tonnages for a second. I guess if looking at those comps as we move through the quarter, given that, Doug, what you are hearing from the customers now, you mentioned that ag kind of pulled forward, but are you hearing – you mentioned the components to stay higher, are you hearing any kind of or seeing any moves to slow down those shipments? It sounded like a real big ramp at the end of the month. Is that, do you expect a big drop-off seasonally then to start off August here?

Douglas Stotlar

I will tell you, Ken, July felt a lot like it did last year the same time. First two weeks were softer than what we have expected, and the last two weeks finished stronger than we expected. Again, we would have a hard time predicting what tonnage trends are going to look like for the remainder for the quarter. We certainly hear some of the same cautionary tone from our customers that we have heard from some of the other companies that release earnings so far this year about the certainty of many of the things in the environment, but we are still seeing relatively stable tonnage trend so far. So, for whatever it’s worth, that’s what we are experiencing.

Ken Hoexter – Bank of America

Appreciate the insight. Thanks for the time.

Operator

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

Scott Group – Wolfe Trahan

Good morning guys.

Douglas Stotlar

Good morning.

Scott Group – Wolfe Trahan

So, just want to clarify a couple of things, first, in terms of the Highway bill and pension, I think you mentioned no benefit this year. Should there be a cash flow benefit next year from the changes in the pension funding from the Highway bill? And then on the ag side, is that mostly a corn equipment that you guys are moving, or should we be thinking about potential negative impact with the draft going on right now?

Stephen Bruffett

So, I will go first. This is Steve and address the pension funding question. I didn’t mean to imply that no relief was available to us this calendar year. With Map 21, our mandatory amount of funding did diminish, however we feel that given our funded status is prudent to continue to in a steady fashion, the pension plan try to solve it all at once, but over a period of years, improve our funded status and de-risk the plan. So, we have chosen to go ahead and stay with our original plan of putting $51 million of cash in the plan.

As we look forward into 2013, there is some relief available. The relief fund of this program goes away pretty quickly, assuming rates stay low, but like I said, we don’t have an exact number for 2013 yet, but it would likely be a pretty steady type of behavior on our part to continue to fund the pension plan.

Douglas Stotlar

And then, Scott, on the ag side, we have got pretty wide range of agricultural customers we support, and I think of it in three primary categories. You have the equipment manufacturers and parts distribution related to the equipment. You got the irrigation supplies that we handle, and then you also got feed and the fertilizer which you get from the ground early on. And so, that was reflected with just a pull forward, pretty strong pull forward because of the fact that particularly here in the Mid-West, farmers went to field 30 days earlier than they could ordinarily get in the field.

Certainly, there could be some demand destruction as a result of the drought, because simply some of the crops probably won’t even get harvested because there has been so much damage at this point, which will impact parts, etcetera. So, we don’t know what to expect there, but it was primarily a pull-forward rather than – the demand was strong, it was just 30 days earlier than it was. So, we didn’t see that same type of demand on agriculture that we were nearly seeing lately in June.

Scott Group – Wolfe Trahan

Okay. That’s helpful. And then, just wanted to go back to the LTL margin comments, first. It’s hard to be so specific, just wanted to make sure I am understanding what you are saying Doug. Are you saying that if tonnage day is flattish in the back of the year that it’s tough to know how much margin improvement there is going to be, or there is a chance that we can actually see margins take a step back on a year-over-year basis in the near term?

Douglas Stotlar

Again, the pricing environment is important for us to be able to continue to expand margins. We continue to believe that we are going to have improvement in our productivity and gain the efficiencies as we go through the quarter and through the remainder of the year. But we also know that Q3 historically when compared to Q2, is a more difficult quarter from the fact that you don’t have the same demand levels that you have in Q2, and you also have increased an additional holiday, which adds, in our case, about $4 million of costs and there is one less work day. So, we believe that margin expansion is possible, but it’s going to be difficult.

Gregory Lehmkuhl

Yes, and I think it’s important to distinguish our earlier comments were largely sequential, second quarter moving to third saying that it’s difficult to achieve the same margin in the third quarter as in the second. Your question went a little different angle, but it was year-over-year, third quarter to third quarter. So, that’s a little different response there to clarify.

Scott Group – Wolfe Trahan

Sorry. Maybe I just missed, I guess that sequentially it’s tough to keep that 94 for OR, but on a year-over-year basis, would you still expect improvement in the back half or is that still a tough, now just given the muted tonnage levels?

Douglas Stotlar

I think the challenge right now is the muted tonnage levels and how does that play out in the pricing environment.

Scott Group – Wolfe Trahan

Okay. Fair enough. And then, last thing, on the truckload side, best of luck on the retirement herb, leaving on a high note, with a sub-90 OR, and just want to understand, because Doug, I think you mentioned you had a little bit of help from fuels, a little bit of help from gains on sales. Do you think that this sub-90 OR is sustainable going forward the next few quarters?

Douglas Stotlar

I think given this herb, and I appreciate it, Scott, your kind words. I mean, certainly we are on a good trajectory. There has been no magic bullet and it’s just been blocking and tackling, modest rate increases, improved field recovery, focus on density, reducing driver dual time and empty miles. So, certainly if the environment stays as it is today, I would expect us to continue to improve.

Scott Group – Wolfe Trahan

That’s very helpful. Last thing with that herb, are you seeing any material change in the pricing environment on truckload?

Douglas Stotlar

No, it’s steady. Steady modest rate improvement. We are up about 3% year-over-year, about a nickel. And you know, we continue to see that environment as conducive to getting reasonable modest rate increases going forward.

Scott Group – Wolfe Trahan

Okay. Great. All right, thanks a lot for the time. Appreciate it.

Douglas Stotlar

Thanks Scott. Just one more clarification point. We do think we can improve margins year-over-year in 3Q. It’s just to what magnitude is the building question here.

Scott Group – Wolfe Trahan

Okay. That’s very helpful. Thanks Doug.

Operator

Your final question comes from the line of Tom Albrecht with BB&T Capital Markets.

Tom Albrecht – BB&T Capital Markets

Hi guys. Two-fold questions, number one, what’s more important to productivity, growing ship accounts or tonnage, because now, there are different dynamics there? And then the second question is on the yield issue, ex-fuel, your yield has only improved $0.03 from the March quarter, and I know with kind of beat this to death yields, but I was a little surprised that the increase wasn’t more like $0.10 to $0.15 per hundredweight. So, if you could just kind of share thoughts on both of the issues.

Gregory Lehmkuhl

Sure. From a productivity standpoint, while you do get some productivity gains in the city, the pickup and delivery with shipment counts, the bigger impact is with tonnage, because tonnage translates the pallets and pallets translates to dock productivity and line haul productivity, which is the biggest lever in the business.

We look at yields year-over-year more than anything because of the seasonal trends in our business, in our cultural mix, and when we look year-over-year, our adjusted yield when adjusting for length of haul for shipment is right in line with our expectations at 4.1

Tom Albrecht – BB&T Capital Markets

Thank you.

Gregory Lehmkuhl

You are welcome. Thanks.

Douglas Stotlar

Brandy, go ahead and give the replay information, please.

Operator

This concludes today’s Con-way Inc. second quarter 2012 earnings review conference call. You may now disconnect.

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