Knight Transportation, Inc. 2Q08 (Qtr End 06/30/08) Earnings Call Transcript

Jul.25.08 | About: Knight Transportation, (KNX)

Knight Transportation, Inc. (NYSE:KNX)

2Q08 Earnings Call

July 24, 2008 4:00 pm ET

Executives

Dave Jackson – CFO

Kevin Knight – Chairman and CEO

Analysts

Edward Wolfe – Bear Stearns

Tom Wadewitz – JP Morgan

Justin Yagerman – Wachovia Securities

Jon Langenfeld – Robert W. Baird

Tom Albrecht – Stephens, Inc.

Chaz Jones – Morgan Keegan & Company

John Barnes – BD&C Capital

Donald Broughton – Avondale Partners

Dan Moore - Analyst

Operator

Welcome to Knight Transportation’s second quarter 2008 earnings release conference call. (Operator instructions) I would now like to turn the conference over to Mr. Dave Jackson, CFO of Knight Transportation.

Dave Jackson

We appreciate your interest in our company. Our call is scheduled for one hour, and we hope to answer as many questions as we can up until 5 PM Eastern Daylight Time. We’d ask the call participants to limit to one question and one follow up question, if needed.

First, I'll start with the disclosure. This conference call may contain forward-looking statements made by the company that involve risks, assumptions, and uncertainties that are difficult to predict. Investors are directed to the information contained in Item 1-A risk factors of Part 1 of the company's Annual Report on Form 10-K filed with the United States SEC for a discussion of the risks that may affect the company's future operating results. Actual results may differ.

I'll review some of the main points from our second quarter earnings press release that was released yesterday afternoon. Total revenue for the quarter increased 14.4% to $206.1 million, revenue before fuel surcharge increased 1.2% to $154.8 million, and net income decreased from $18.2 million in the second quarter of 2007 to $12.7 million in the second quarter of 2008. Our net income per diluted share was $0.15 for the quarter and $0.21 for the same quarter last year.

During the quarter, we paid a $0.04 dividend to shareholders of record on June 6, which was paid on June 27, 2008. Our cash and short-term investment balance at June 30, 2008 was $36.1 million, and we do not hold any auction rate securities.

Our second quarter consolidated operating ratio was 86.6%. Average revenue per tractor increased 2.5% year-over-year. This increase was driven by improvement in our revenue per total mile, with miles per tractor being slightly down year-over-year. We continued our year-over-year improvement of the non-paid empty mile percent with a 160 basis point reduction from 12.8% a year ago to 11.2% for the second quarter this year.

We added 94 tractors to our fleet since the end of the first quarter, year-over-year our average tractor count was down 61 tractors, or 1.6%. Including owner operators, we ended the quarter with 3,768 tractors. In the quarter we opened 3 new service centers: Syracuse, New York and Nashville Tennessee on dry van side, and Dallas, Texas on the refrigerated side. We currently operate 29 dry van service centers, 11 brokerage branches, and 5 refrigerated services centers. We continue to have a debt-free balance sheet and our shareholder equity at quarter-end was $490.9 million.

I'll now turn the call over to our Chairman and CEO, Kevin Knight.

Kevin Knight

Yesterday, as you know, we released our earnings after the market closed. We like to give our analysts, shareholders, and others interested in our business time to digest, so here we are. As you know, these past 4 quarters have been very challenging for us. I’d like to reflect briefly on the dynamics that have created the environment of the past 4 quarters.

First, the pre buy of 2006. Almost all of our competitors’ pre purchased and had up the 07 emission change, thereby creating a glut of capacity. Second, the truckload market has therefore been disconnected from the actual operational cost increases, such as fuels, emissions, as well as other inflationary items over the past few quarters. Third, the cost of fuel has reached cost levels unimagined just a few quarters ago. And fourth, all of the above has taken place during a weakening economic environment. Remember, our business exists for the purpose of profitably serving customers, and in the past we have successfully grown our business profitably. We expect to continue our growth in the coming quarters, and believe that the challenges described previously will start to work in our favor.

First, the pre-buy of 2006. We chose not to participate. Many of the associated costs with the 2007 engine are already being digested by our company, not to mention, we have proven to be sound stewards of our environment. Second, the market does seem to be working its way towards equilibrium, and should steadily reconnect to actual operating costs as time progresses. Third, fuel probably has peaked. Fourth, at some point the economy should start to improve. And last but not least, we have costs in our business that can come out, which we should be able to demonstrate over the next several quarters.

Before turning the call over to questions, just a couple more highlights.

First, I am pleased with how our management team is coming together in this challenging environment. Also, our division managers and sales associates that have made the transition to what is required in this environment will be better prepared for the next cycle. The leadership at Knight Transportation, Knight Refrigerated, and Knight Brokerage are working well together in developing solutions for our customers.

Second, I am energized again about our ability to integrate other small to mid sized companies into our platform. Our Idaho Falls refrigerated division, formerly Edwards Brothers, operated at an 89 this quarter. And Roads West, which was folded into our feeds refrigerated operations, operated at an 87.5.

I’ll now open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is from Edward Wolfe.

Edward Wolfe – Bear Stearns

I think the $64,000 question that everybody’s approaching in different ways is trying to understand -- it really feels like capacity has come in recently, demand’s not there, but at some point this can get explosive. But we’re not seeing it follow through to pricing yet. Is it your sense, having been through a lot of cycles, that maybe this cycle is a little bit different, in that with the changes in engines and other things that the pricing that we saw in 2003 to 2006 that was unprecedented – maybe some of the smaller guys have held in there longer than in the past or are a little healthier coming into this thing than the past? And that maybe this is tightening without demand getting better, it’s tightening now gradually on supply, but not a dramatic push from demand. That maybe the pricing is getting better but it’s going to take a longer time. What’s your sense of 2009 pricing if you had to look out 3 quarters from now where we’re going to start the year, and just directionally, the timing for how this is tightening versus past cycles.

Kevin Knight

Well, probably my answer to that question, Ed, would be simply this: that as you look at the last year in terms of fuel and other cost issues, it’s been more emplaced than any time that we’ve ever witnessed, in my 32 years of tracking. While at the same time, though, because the glut of 2006 pre-buy has basically disconnected the market from actual cost. And so, I believe that whenever equilibrium is struck, there are significant costs that have got to be recouped at some point when the market actually reconnects based on balance.

And it could be, if we get a lift from fuel by fuel continuing to decline, if we’re fortunate enough to see that, then from a customer perspective – maybe their cost won’t increase – but they’ll be able to compensate us additionally on the base rate to take care of some of the costs that we haven’t been able to cover going back for the last several quarters. So I think what would work good is if fuel can come down and that takes pressure off of our customers well at the same time, as the market balances, it should give us an opportunity to get additional rate increase.

I look at it like this, Ed, if you think about just inflation, and if the cost of inflation is 2.5% or 3%, and if you go a couple of years without getting 2.5% or 3%, at some point, if the market truly is the market, those number have to come back. And so, it seems to me like we’re probably 2.5% to 3% behind every year that we go without getting a rate increase net of fuel. You know, I just have to see how the dynamics play out. But I definitely think there’s a tightening. It seems to me like it’s strengthened throughout the quarter, especially in the markets that went into the doldrums first, which was, for us, refrigerated. It’s pretty much exited. That market is in balance and probably a little bit, probably, in favor of the supply right now. But that’s typically how it would work. And then I would expect dry van to follow shortly. So, I think you’re going to see real pricing improvement on the refrigerated side in the second half of the year. I think you’ll see some pricing improvement on the dry side in the second half of the year, with real pricing improvement following, probably throughout 2009, would be my guess.

Edward Wolfe – Bear Stearns

By real pricing power improvement do you mean 7% - 8% or do you mean 2%, 3%, 4%? What is real pricing power?

Kevin Knight

If you look back, Ed, to 2003, I would think that 2009 will probably look like maybe 2003, maybe even 2004 and the next year will look like 2004, maybe even 2005 and the next year will probably look like 2006. So, I don’t think it’s ever an event – it just happens in a pronounced way. But the momentum can definitely change very rapidly, and from our perspective we don’t want to take advantage of the market. We simply want to make sure that we can raise our rates to get us back in equilibrium with some of these inflationary items.

Edward Wolfe – Bear Stearns

Somebody on an earlier call today said their sense is that demand tightens pricing much quicker than supply historically, and that they never remember a cycle where they didn’t get a push by demand to get the real pricing. Do you agree with that statement?

Kevin Knight

You know, I just don’t know, Ed. That may be how they feel. We’ve got an environment like we’ve never seen before with fuel where it is. We’ve also gone through a very difficult period with where capacity went. So, I’ve tried to answer the question as best I can.

Edward Wolfe – Bear Stearns

I appreciate it. I’m going to leave you with 2 quick ones and drop off. Just, can you talk about whether there has been a slowdown – some people have talked about a little bit of a seasonal drop-off in July. And then, the last thing is salaries on a per cent mile are up 6.7%, can you talk about what’s going on with wages?

Kevin Knight

You know, first, as far as salaries and wages. In order to protect our market – as you know it’s been very competitive – we’ve certainly spent additional money in order to do that in the last few years. And I would expect that what you’ll see on that salaries and wages line is that you’ll see improvement in the coming quarters. And I wouldn’t expect to see that up like that as soon as third and fourth quarter.

What was the other question, Ed?

Edward Wolfe – Bear Stearns

Just July, whether there’s been a seasonal slowdown.

Kevin Knight

I think it’s felt like the normal July slowdown as compared to prior Julys.

Operator

Our next question will be from Tom Wadewitz from JP Morgan.

Tom Wadewitz – JP Morgan

You had, I think, referred to some costs that might come out when you were making your prepared remarks. And I’m wondering if that’s just a sense of operating leverage in the system, or if there’s something else that you’re referring to looking forward the next couple quarters.

Kevin Knight

Well, I think both, Tom. I think as we’ve reflected on where we are today, certainly, we believer that we can do a better job from a cost perspective. So I think that we’re going to be able to take some costs out period. I think, though, on the same token we’ve got good leverage in the sense that in this slowdown we’ve continued to build out our network, not only from a dry basis, but from a business basis and a brokerage basis. Certainly that doesn’t come without cost, and so, I believe that we’ve got all the right people in the right places and we should be able to, as freight demand builds and as supply continues to go away I think we do have some operational leverage here.

Tom Wadewitz – JP Morgan

Were there specific cost items you were thinking of that give you pretty significant opportunity, or you just meant broader cost discipline?

Kevin Knight

No, I think specifically in salaries and wages. I think we’ve got some opportunity there. I also believe that on the depreciation line, we’ve been taking those 2007 engines and if production continues to improve, we should start to compare a little more favorably there. I think we’ve been doing a lot on the safety side of our business that hasn’t really reaped the rewards we’re expecting thus far. And certainly I think fuel, if it has peaked, I think we’re going to make some progress there. So, you know Tom, I think generally across the board, we think there’s opportunity everywhere.

Tom Wadewitz – JP Morgan

Okay, great. And then I guess for the follow up – How do you think about your approach to growth, if you say 2009, let’s say the market tightens up a bit and you get some moderate growth in the economy – not particularly strong – is that the environment that’s conducive for you to pretty aggressively grow fleet, and see the benefit of that? Or do you think that’s an environment where you’d get some moderate fleet growth and really be a lot more patient for pricing to really kick in?

Kevin Knight

You know, I think if 2009 plays out the way we’re expecting, I would hope we’re in a situation, Tom, where we can add 300 – 400 trucks in 2009. We’re certainly not going to buy trucks if the market doesn’t reward us for buying trucks. And, you know, that’s the environment that we’ve been in, is, you know, basically most of our competitors saying, “if you can’t get your fuel fully reimbursed, and if you can’t take a slight rate increase when inflation is going up 2% to 3% a year, and if your return on invested capital is already paltry at best, why would you invest more money into this business?” You know, I think the truckers have been a little bit beat up, and because the market has allowed it, I think the truckers feel a little bit beat up. There’s no question that we’ve gone through probably the most difficult period in terms of cost inflation, and much of the market has not really felt like there should be increase, and even, in many cases, decreases. So that’s how I see it

Operator

Our next question is from Justin Yagerman with Wachovia Securities.

Justin Yagerman – Wachovia Securities

Data contractors, this quarter, are you going to looking for fleet growth in the back half. And then, I guess, as we’re heading into 2009, I know you guys typically don’t do a pre-buy, but how are you thinking about OEMs and competitive engines and all that kind of stuff, because you’re usually pretty ahead of the curve on all that.

Kevin Knight

Well, I would say, Justin, that first off, as far as fleet growth in the back half of the year – we certainly hope to end this year with more equipment than we started the year with, and really, also Justin, we hope we can get back what we ended up taking out in the fourth quarter of last year. So, we’re hoping that, I think our last call I said that we’d like to add back 100 – 200 of the trucks and I think in this quarter we did 94 of those. So I think we’re pretty close to the bottom of the range we’ve give. Personally, we hope that we can bring in another 100 trucks in the second half of the year, maybe even a few more depending on how things develop. But again, we’ve got to see the market work in our favor.

As far as the equipment for 2009 is concerned, we are currently testing a 2010 product and so, we’re in the process of evaluating where we go from here. We’re excited that, I think, we’re going to have good choices with most all of the OEMs in terms of whether we go SCR or whether we go continued EGR. I think there’s just a lot of things that we’re thinking about in terms of equipment in 2010, and fuel, and all of those dynamics. So we’ve got a lot of decisions to make here over the course of the next 18 months. But we’re looking at all possibilities, and I would say, Justin, that we certainly don’t plan any pre-buy in 2009, so we’ll continue to do what we think is the right thing. And that’s as we develop equipment that can have less negative effect on the environment, when it’s available, we’re going to move forward, and we’ll just let it go with that.

Justin Yagerman – Wachovia Securities

Got it. And I guess the follow up question I’ve got – when you think about the quarter and the seasonality through the quarter, it’s been brought up in a few different places that maybe there were some one time things impacting freight this quarter. You had refund checks that went out in June, the Olympics are going on in August which may have rushed some freight into the United States early, or pushed some freight out of the United States early to try to get around the planned shutdowns around that in China. And yet, the flooding in the Midwest, which kicked freight off the rails and pushed maybe some stuff off to the trucks – how do you think about those one-time events in terms of helping you guys in the quarter? Do you think that that kind of spot demand is likely to show up in the second half to really push us into more of a spot market, or are those things kind of extraordinary in your mind? I guess I’m trying to get to figure out how close we are in terms of this equilibrium that we’re talking about now.

Kevin Knight

Well, I would just say, Justin, really January was the bottom for us. And from the month of January, we felt the gap shrink year-over-year, month-over-month in February, in March, April, May, and in June. What I would say is I think that certainly the checks could have helped some, and probably did help some. From our perspective, we felt no good effects, or bad effects, as a result of the flooding in Iowa. We haul very few loads into and out of Iowa, and during that period we continued to haul very few loads into or out of Iowa. So, it may have helped some people, but it certainly didn’t help us. As a matter of fact, it probably hurt us at that, because we do have trucks that do run through Iowa, and it certainly didn’t help those guys. I don’t think what we’ve been seeing since January -- I mean, those one-time events could have helped, but there’s also been one time events that could have hurt. So I think it’s just a study progression towards equilibrium. And that’s how I feel.

Operator

Our next question is from Jon Langenfeld with Robert W. Baird. Go ahead, please.

Jon Langenfeld – Robert W. Baird

Kevin, when you look back, maybe over the last year and a half, what have you learned differently? Clearly, this is the first time that the company hasn’t been in a full growth mode. So, kind of, retrospectively, have you learned anything differently about the organization, or about how you guys do business?

Kevin Knight

I think we’ve learned a lot Jon. First off, we’re a young, growing company and one thing that I learned early on is we had some people that we’re cut out for challenging times ahead and we had some that weren’t. And as you have to parlay more discipline into your organization because of the challenges that are being thrown at you, some people like that and some people don’t. And so, I think we’ve got a better flavor now at how to move our people along and how to pace them in their development. We’ve lost some people that had been with the organization, not really a long period of time, but for the good years and, you know, quite honestly as a leadership team we didn’t have them ready for anything other than good times. I think now, as I look at our leadership team -- first off, none of our VP level and above -- everything is there and all of those folks have been through various cycles with us. I think we’ve learned better how to have our people a little bit more ready for when the cycle changes. John, probably even more importantly, they’ve got a much higher respect now for how tough it is when things aren’t easy. So I think that’s been a significant step for us.

I think the other thing is we’re very pleased with where we are from a refrigerated, brokerage, and dry perspective. We’ve actually been operating a little bit spread out, but now we have the leadership of all those businesses together so that, basically, we can work to develop solutions for our customers a little bit more together instead of as much alone as I think we have been in the past. Certainly as the environment improves, I think we’re going to be able to take advantage of that.

I think the other thing, Jon, as we’ve been working the revenue side of our business while things were better, I think we’ve gotten a little bit careless with the cost side of our business. And I believe that there’s another lesson to be learned there, and that is when the market offers you more rate you want to be able to take advantage of that because you can and you deserve to. And I believe that, basically, we let some of our costs expand that I think we could have done a better job on over the last 3 or 4 years. And I think, more importantly, I think our management team feels the same way. So, I think there’s been lessons learned.

I also think that we’re not going to be a pure asset based provider anymore. We’re definitely going to stay committed to the non-asset based side of our business, because we can provide solutions there as good as the next guy. I think in past years, we’ve not wanted to fill that role, but I think from a customer perspective and from a business growth perspective, it’s important for us to be there. So I would say primarily those things, Jon, are really what ring out in my mind – that come to my mind as we speak right now – as far as items that I think are going to make us a better company in the future.

Jon Langenfeld – Robert W. Baird

Yes, it sure sounds like it. You’ve got a culture where growth has been driven as much from a local level as it has from a corporate level, in terms of the local branch operators wanting more trucks. When it comes time to put the pedal down again and really accelerate the growth, do you think corporate is going to have to do more to shake out the cobwebs and say, “Okay guys, it’s time, we’re going to start growing again,” or do you think that there might be a little hesitancy at the local level to do that, given what we’ve been through?

Kevin Knight

You know, first off Jon, I think if anything it would be just opposite. Our guys out in the field, they all want more trucks right now. But what we’re doing is we’re requiring them to demonstrate more discipline in terms of just financial performance of their business and the productivity of their trucks, their ability to integrate and develop drivers, and their ability to provide a high level of service to our customers. In the past, we’ve made it a little bit too easy on our divisions to get equipment. Some of them have shown signs of weakness but we gave them trucks anyway. Our mantra going forward is, “when you show us that you know what you need to know, and when you show us that you really have the ability to produce the right way, then we’re going to give you trucks.”

But more so, John, we’re putting a lot of focus on our divisions. Every division manager that has areas where they still need to develop, and usually this is because of their inexperience, they have a mentor here from our head office that virtually is in that building probably at least a week a month. We’re really trying, Jon -- and it’s hurt our costs some from a travel perspective, etc. but we’re really trying to get these guys ready, for not so much when the cycle turns, but when it gets tough again, and just make sure that they’re ready to go. So, that’s how I would describe it.

Operator

Our next question is from Tom Albrecht from Stephens, Inc. Go ahead, please.

Tom Albrecht – Stephens, Inc.

Let me just start with a real quick factual question. Did you give the shipment count?

Kevin Knight

We didn’t, Tom. We were up, not as much as I would have liked. But we were 171,804 versus 168,487 a year ago.

Tom Albrecht – Stephens Inc.

Okay, and then, Dave when you say that the miles per tractor were down slightly, I’m guessing that was around 2/10?

Dave Jackson

You’re pretty good at guessing, yes.

You know, Kevin, I know your brokerage operation is fairly young and small, but as you look into that, can you comment on a couple of things? Number one, even in its small stage, are you seeing evidence of consolidation in the marketplace? Number two, can you talk about what you may have seen with rates during, for example, the month of June?

Kevin Knight

Let’s talk about the brokerage first, Tom and then if I forget on the second one you can help me again.

First off, I would say from a brokerage standpoint the second quarter was very challenging as far as margin, and basically what we saw happening was many competitors that compete in that brokerage area weren’t fully recouping fuel surcharge and so that was kind of the mindset, to kind of sell into the market to gain market share. But in the end now you have this brokerage business, and now you’ve got to find a truck to haul it – it became difficult and we ended up hauling loads every day at a loss. Now still we ended up operating that fairly respectably. I would say our margin would have been, probably, within a point or so of CH Robinson – our gross margin is compared to purchase transportation, and without nearly the diversity and build that they have. But, yes, it was really challenging for our brokerage group in the second quarter, and they did see capacity go by the wayside. Some of their carriers just aren’t there anymore. So, did I answer the brokerage piece?

Tom Albrecht – Stephens Inc.

I think so. You kind of created a new question. Basically, what I’m picturing, maybe incorrectly – the brokerage market is extremely fluid. One rate at 8:00 in the morning might be different by 4:00 in the afternoon, unless you’re trying to portray your brokerage operation as a virtual core carrier, like one of the big firms tries to do. I would be surprised that you would have to haul very many loads at a loss. It seems to me that that would be just a matter of a 24 hour decision on the rates.

Kevin Knight

It isn’t always that way. Actually some of our brokerage business, Tom, isn’t spot and it is actually contracted. And some of it we provide jointly between 2 or 3 of our business. So, in those cases, what we’ve tried to do is we’ve tried to fulfill what we understood our commitment to be the very best that we could. Now, I will tell you that even in that case, we had to go to many of our customers and ask them for more help and, in many cases, we received that help and were successful in moving that freight. But we definitely saw a tightening.

Tom Albrecht – Stephens Inc.

And how quickly will those rates adjust, even in a contractual relationship – 60 to 90 days? I can’t picture them being a year like a regular truckload contract.

Kevin Knight

A lot of brokerage business, Tom, is somewhat seasonal. So some of the stuff that we were struggling to cover in June, we won’t struggle to cover in September. And, so, we’ll keep close tabs on where that is. As you said, it’s a small business and we’ll watch that very closely. Every day, I see a sheet that tells us what our margin was on every load and it’s still just about 130 – 150 loads a day, so at the end of the day I tend to be gravitated to the ones that have brackets around them and I tend not to worry so much about the ones that look like the margin is adequate. We’ll just continue to watch it and continue to develop in that business as we go.

Tom Albrecht – Stephens Inc.

Okay, last question. Do you anticipate the market for used equipment getting to the point where you might have small losses on equipment?

Kevin Knight

So far we haven’t. I really couldn’t say that I would. We’re still selling trailers at a profit, and we’re still trading and selling trucks at a slight profit. So, I think, Tom, we should be ok, hopefully.

Operator

Our next question is from Chaz Jones with Morgan Keegan. Go ahead, please.

Chaz Jones – Morgan Keegan & Company

Maybe if I could circle back around to the brokerage. One thing I was noticing just in the press release and, I guess, correct me if I’m wrong here. Did you actually close two brokerage centers in the second quarter?

Kevin Knight

We did.

Chaz Jones – Morgan Keegan & Company

And was that a result of the market, or just maybe getting some people hired away from you, Kevin.

Kevin Knight

No, I don’t think we’ve lost anybody in the brokerage business. Not that I know of. There’s probably some that haven’t made it, but I’m not sure what the situation is there. Really, that was more driven by the changing in the market. We were trying to consolidate our cost to offset the margins in the market and those were two locations that we will re-open, probably at a time that makes more sense, Chaz.

Chaz Jones – Morgan Keegan & Company

Okay. Have you put future brokerage operations – in terms of them opening - on hold for now then?

Kevin Knight

You know, I wouldn’t say we’ve put it on hold. I would say that we’re just trying to make the decisions that are best for our business. It wouldn’t surprise me, Chaz, if we don’t still open an additional brokerage location yet this year.

Operator

Our next question is from John Barnes with BD&C Capital.

John Barnes – BD&C Capital

Can you give us an idea, on the closures of the brokerage offices, how many people are we talking about and how much cost does that really take out of your cost structure?

Kevin Knight

First off, not really, maybe one or two people. And actually, we ended up transferring maybe one or two into other locations so it isn’t significant.

John Barnes – BD&C Capital

Okay. Do you feel like there’s any real low hanging opportunities left on your call structure? These guys are doing a pretty fair job – you’re still going to be better than most in the industry, even with this record high fuel but I’m curious, is there anything that you’ve really taken a different opinion of – whether it be use of APUs more aggressively, or is there some headcount that you can combat, or do you feel like the right thing to do is keep doing what you’re doing and keep growing with the business, and sooner or later this is going to end?

Kevin Knight

Well, I really feel like, John, there’s some very specific areas where we can reduce cost. And I’m going to be very disappointed if over the next several quarters if we don’t demonstrate that to the people such as yourself who are interested in our business. But I don’t have anything specific -- I know that we can improve in every area if we really have the right culture, and if we really put our minds to it, and if we really get around the table and figure out those things. Certainly APUs are something that we’re highly considering.

One of our challenges, John, we’ve solved the heat side so inexpensively and in a way that burns so little fuel that’s so much more environmental friendly, that we’re hoping that something comes along on the cooling side. And there’s a couple of technologies on the cooling side that are less expensive than APUs and more environmental friendly that we are talking about and that we are looking at. So, certainly in the area of fuel there are things that can be done to improve upon where we are. We’re looking at everything, and I think our leadership is well ready now to basically guide that effort. So, off we go.

John Barnes – BD&C Capital

And then, can you offer us some specific line items where you think there’s really nice opportunity on the cost side. And I guess, one question, with fuel where it is, can you really get back to the 80% level, or what do you think is -- if fuel were to kind of stabilize here at these levels, what do you think that means overall to your OR. Is it 150 basis points of deterioration versus where you kind of peaked at last time, or is it more than that, if you were able to kind of couple the cost reductions that you’re talking about with the higher fuel costs that you’re experiencing today.

Kevin Knight

First off, fuel was about 275 basis points year-over-year and in a normal environment you don’t expect -- we don’t expect for that to be up year-over-year. If we’re getting compensated at fair fuel surcharge, and if we’re keeping an eye on our empty miles, and if we can collect a fuel surcharge that compensated us for our empty miles, non-paid miles, because most of our rates move on shortest route. And then also to give us some help, as far as idling is concerned, until we come up with a better solution, I believe that fuel should track in line with where it was 2 or 3 years ago as a percent of revenue. We did make some progress with some of our fuel, especially in June and so far in July. So, we do have many of our customers that are rethinking fuel and what is the right thing to do there. I would expect that fuel there should be some significant opportunities, not only from a customer cost perspective, but also internally. The things that we can do to improve the fuel cost. I do believe that our salaries and wages can improve I know our insurance and claims can improve. I believe there’s a little bit to be improved on operations and maintenance and I think we’re going to find some things there that we can do a better job on, and even our miscellaneous costs – I think, we’re not talking big dollars, but there are some areas of improvement there. So, I think, John, it’s across the board that we’re going to find ways to more efficiently run our business.

Operator

Our next question is from Donald Broughton with Avondale Partners. Go ahead please.

Donald Broughton – Avondale Partners

When I’m looking at the insurance cost of the quarter, it certainly was higher than last year. What’s driving insurance? Is it higher frequency, is it higher severity, or is it higher cost of your reinsurance policy?

Kevin Knight

Well, first off Don, our insurance costs are probably a little bit less than they were a year ago. Our insurance policy, I should say premium – thanks Dave for correcting me – in our policy, though, we do have a corridor where basically we take on more exposure than the first million dollars for that policy. We ended up having a fairly serious loss that basically took our normal, self insured retention plus the corridor of an additional million dollars. So I believe, Don, that also over the past few quarters we’ve had some claims growth on claims from the past and I think that we’ve pretty much got everything where it needs to be there now.

And also, believe it or not, we’ve been working our tails off from a safety perspective. I mean, we’ve really worked hard with our Safety Directors and we’ve introduced the Smith System into all of our locations – is it in all of them, yeah, we’re getting close to closing in on the end of that introduction - And we’ve gone, I would say Don, from a less experienced Safety Director to a more experienced Safety Director with either more operations or even more driving experience. And so, I think we’re going to make a lot of progress there over time. We’ll probably have quarters where you’ll say, “Oh, you didn’t make any progress.” But it won’t be because we weren’t trying. So, I believe that we’re going to show some improvement there.

Donald Broughton – Avondale Partners

Well, nobody doubts your safety and your vigilance on safety, Kevin. I just looked at the per mile number and it’s gone up on a per mile basis by $0.018 per mile and that’s a pretty big jump for you, or at least historically. And I’m just trying to figure out how to model it

Kevin Knight

Yes, it’s about a penny or a penny and a half per share.

Donald Broughton – Avondale Partners

Exactly. We’ve talked before about how growth for growth sake is insane, and profitable growth is the only kind of growth you’re interested in. And also, that you can see the financial results coming in your operating fundamentals long before it shows up in your earnings per share. Certainly that was evident when you were cutting fleet. Would I be wrong to say, “If Kevin Knight is growing his fleet again it means he thinks that the operating fundamentals are turning in the right direction that he can take this thing back towards the kind of peak returns you had in previous cycles?”

Kevin Knight

You know, Don, I would say that we certainly wouldn’t have let the growth come on if we wouldn’t have sensed that the market was improving. And I believe, Don, that between integrating small acquisitions and the 34 asset based service centers that we have now – I believe those guys can still swallow trucks if the market gives it to us. So I don’t know when to say we’re gonna be there. I’m not ready to say we’re ready to go back to 400 or 500 trucks a year, but I definitely see it coming in the future.

Donald Broughton – Avondale Partners

You’re certainly migrating that direction, and, did I hear this right earlier in the call? Did you say that you think 2009 will be pricing that’s equivalent to 2003 and 2010 could be pricing equivalent to 2004 and 2005?

Kevin Knight

Yes, I think that, Don, as it develops – we got good pricing improvement in 2003 and very good pricing improvement in 2004 and 2005 and good pricing improvement in 2006 and so that’s where I see it’s going.

Donald Broughton – Avondale Partners

That’s 4 to 5 in 2003 and 6 to 10 in 2004 and 2005. Things could get interesting very quickly if that’s where you’re at.

Kevin Knight

You know, they could, and I hope we can do a good enough job on the cost side to where we don’t even have to go there. But we’ll just have to see where it takes us.

Operator

Our next question is from Dan Moore.

Dan Moore - Analyst

I’ll be relatively brief here. I just wanted to ask you about fuel prices a little. I got in here a little bit late on the call, but as we look at fuel prices – and also I’m going to ask you a little about rates – but as we look at fuel prices here, obviously we’ve had a fairly substantial drop in crude that hasn’t translated into diesel yet. I know there’s been a lot of proactive work on all the carriers’ parts to improve fuel surcharge mechanisms and those kinds of things, but it would seem to me we might have a pretty nice bump in earnings if the trend continues or even if crude stabilizes here and diesel comes in a little bit with the crack spread.

And then I wanted to also ask you about what your plans are for rate increases. I know a lot of your competitors plan to go flat with rate increases here in the next month or two.

Kevin Knight

Well, Dan, I would say from a fuel perspective, certainly we are making progress in terms of recovery and certainly if fuel will come back into equilibrium and even start to head south on us, we could finally catch up for some of the fuel that we haven’t recovered. So certainly that would be a good thing from an earnings perspective. I think from a rate work perspective, we’ve done some rate work. We started doing rate work in May and June, primarily from a fuel perspective. And I would expect that we’ll be doing rate work for the balance of the year, and don’t know what that will translate into as far as our gain, as far as revenue per mile, it will really depend on how far the market strengthens and how –

Dan Moore – Analyst

Hazard to guess a range, Kevin?

Kevin Knight

Well I would say that I would hope, Dan, that there’s maybe a couple of percent out there – maybe 2% or 3% to come as we move into the second half of the year. You might not see all of that hit the numbers until first and second quarter next year, and then hopefully, maybe there would be even more by next year. We’re certainly two or three years behind in terms of offsetting some of these costs. And I think more importantly, Dan, when you look at the operating ratios of who I’ve always considered to be the best, and that’s the guys who are public. I’ve never seen so many mid 90s and above where people were so excited in my life. Anyway, I’m thinking an ROIC at 4% or 5% just don’t quite cut it. We certainly don’t have any customers that ever make investments expecting to get a 4% or 5% return on their invested capital, and I certainly believe that the market understands that if we want guys around to haul the freight we’ve got to work with it.

Kevin Knight

Well, thanks everybody for being part of our call.

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