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Pacer International, Inc. (NASDAQ:PACR)

Q2 2008 Earnings Call Transcript

August 5, 2008 5:00 pm ET

Executives

Larry Yarberry – EVP and CFO

Mike Uremovich – Chairman and CEO

Analysts

Jon Langenfeld – Robert W. Baird

George Pickral – Stephens

Ed Wolfe – Wolfe Research

Tom Wadewitz – J.P. Morgan

John Larkin – Stifel Nicolaus

Todd Fowler – KeyBanc Capital Markets

David Campbell – Thompson, Davis & Co.

Robert Dunn – Sidoti & Company

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Pacer International second quarter earnings conference call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions) And I'd now like to turn the conference over to CFO, Larry Yarberry. Please go ahead.

Larry Yarberry

Thank you. By now, you should have received the press release that we’ve put out at 4 o'clock Eastern today. And in the press release, it has financial statements comparing our second quarter this year with last year and also year to date this year with last year, and has income statement, the balance sheet, and the cash flow statement.

And as usual before we start our presentation, we need to make our normal disclosure regarding forward-looking statements or predictions of future operations. Such statements are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 and are based on management’s beliefs or interpretation of information currently available.

These statements and assumptions involve certain risks and uncertainties and actual events may differ from these expectations as specified from time to time in filings with the Securities and Exchange Commission. And we assume no duty to update these statements as of any future date. As information, you can also listen to this earnings release on our website, which is www.pacer-international.com. Also tomorrow we’ll be filing our 10-Q.

Now I’d like to turn our meeting over to our Chairman and CEO, Mr. Mike Uremovich.

Mike Uremovich

Thank you, Larry, and thank all of you for joining us this afternoon. We appreciate it. Pacer had a solid quarter in the midst of highly volatile conditions and we are generally pleased with our results. Our performance improved over prior year with revenues increasing $43.5 million or about 9.2% for the three months ending June 27, 2008 compared to the three months ending in June of 2007.

Net income for the second quarter was up 10.4% to $13.8 million compared to 2007. EPS in the second quarter improved from $0.34 to $0.40, an increase of 17.6%. Operating income was up $23.5 million, 9.3% above the same period prior year. Our core intermodal segment revenues increased $32.3 million or nearly 9%, reflecting increases in Stacktrain, Rail Brokerage, and Cartage operations. Stacktrain revenues increased $25.8 million in the 2008 period and reflected increases in all three Stacktrain lines of business. The 8.7% increase in Stacktrain third-party domestic revenues reflected a 10% increase in revenues from our Rail Brokerage unit and growth in our Pacer Direct product as well as increases from other intermodal marketing companies.

Revenue per unit was up nearly 14%, largely driven by fuel surcharges. This was offset by higher fuel payments to our underlying rail carriers and added costs associated with the implementation of our BNI services. These in total resulted in roughly comparable operating margins in the businesses between quarters. While volumes for the first half were basically flat and we did protect share in our major markets during 2008, there was some softening in second quarter volumes for a variety of reasons that I’d like to review with you.

Overall domestic volumes declined 4.6% in the second quarter when compared to second quarter 2007. The major reasons were, first, there was some softening in the market though our figures indicate that our share has declined slightly from the prior year although we held share in the lanes over the last six months. Much of our volume growth exhibited by our major competitors comes from shorter home markets, in which we do not compete.

Our domestic repositioning business was significantly affected by the lack of availability of international boxes. Pacer moves about 70,000 units annually in the service. And with the strong US export market, these boxes were not released by the shipping companies for us to reuse domestically during the quarter. Our truckers’ works stoppage in Northern California and UP’s consequent embargo disrupted that important market for several weeks. The Midwest flood also added to that market disruption.

And finally, we took an aggressive position in pricing in our retail unit, which in retrospect was probably a mistake, and I’ll discuss that in some detail here in a moment. Automotive revenues increased 14%, reflecting a 24% increase to average freight revenue per unit due to the favorable customer and lane mix, coupled with increased fuel surcharges. Volumes declined 8% due primarily to reduced auto sales related to the economic downturn, which resulted in a higher number of automotive plant shutdowns during the 2008 period.

Volume reductions in our parts traffic with the Big Three automakers have been partially offset with growth to part suppliers as they retooled our supply chains to take advantage of intermodal economics. Two of our major contracts were renewed during this quarter reflecting the continued value of this product to the automotive industry. We are concerned about this segment in the third and fourth quarter. I’m sure you are familiar with the challenges in this industry and I won’t detail them. But plant closings, sales declines and actions of the auto companies suggest a very tough second half. So we are staying very alert to this market.

Stacktrain international revenues increased 27% reflecting a 9.1% increase in containers handled due to a combination of higher westbound export business, coupled with a 16% increase in the average freight revenue per container due primarily to the increased fuel surcharges. Given the recent measures of import volumes, we also expect this growth to moderate somewhat in the second half.

At the end of the second quarter, the fleet totaled 28,800 boxes. We expect to end the year just short of 30,000 as we flex up during the peak and off-lease boxes near year-end. We will receive approximately 3,000 new units throughout the year and retire roughly 2,000 older and mostly smaller boxes.

Rail Brokerage revenue for the 2008 period were $3 million or 2.8% above 2007 due to a significant increase in average revenue per load, partially offset by a decline in volumes related to the economic downturn, Midwest loads and some pricing actions. The higher revenue per load, which was up about 15%, was due to a combination of higher fuel surcharges and really significant focus on customer profitability. We’ve been on an aggressive program of improving customer profitability and cost control, and we are very pleased to have seen margins improve.

At the same time, as I have indicated earlier, we made some mistakes in being too aggressive in trying to lead or to hold price. In a number of bid situations, we tried to hold or increase price in spite of competitive conditions and overshot in several cases. A number of our major competitors were more aggressive in price and some of our volume was affected as a result. Given tightening truck capacity and continued high fuel cost, we still believe intermodal services have some upside pricing capability. But we were premature in our more aggressive pricing actions. We attempted to take price up in both our retail and wholesale channels, and volumes suffered somewhat in both.

We expected to have a higher winning percentage in several major bids than we did. Largely this is based on our customer pulse survey, which provides feedback from existing customers. And this survey indicated that our customer service performance was very strong, and we believe that we can take a stronger position on price. This is a constant balancing act, as we try to maximize total margins. We will continue to try and strike the proper balance and be sensitive to competitive conditions as we price. We may have to adjust our desire to increase price if market conditions remain weak.

During the quarter, we also moved to streamline our intermodal leadership team. We intend to significantly grow our retail intermodal services, and at the same time, continue to grow our industry-leading wholesale product. We have appointed Dan Avramovich recently from KCS to lead our retail initiative. Dan has a long and distinguished background in rail intermodal, trucking, and logistics. At the same time, Adriene Bailey, previously Executive Vice President of our Stacktrain division and most recently our Senior Strategy Officer, assumed responsibility for our wholesale organization.

Our market assessment suggests there is considerable upside in the growth of the domestic intermodal market. And Pacer has a tremendous opportunity to grow both sales channels going forward. Entry of some of our competitors into the wholesale channel supports the fact that this channel is viable and profitable and our strong position is one we intend to defend vigorously.

Cartage revenues were up $3.5 million or 13.8% above 2007, due primarily to the increased inter-segment revenue from our Stacktrain and Rail Brokerage units. Use of our Cartage unit by our Stacktrain and Rail Brokerage unit will continue to be a management focus. All three Cartage regions, West, East, and Midwest, recorded increased revenues from the 2007 period. We are very pleased with the progress we’re making in integrating our pickup and delivery services with the basic intermodal movement.

This allows us to offer a very competitive and cost-effective door-to-door service. Cartage operations are going to be increasingly important to our future profitability. The integration of all aspects of the door-to-door service not only improves service, but also removes friction from the various hand-offs and reduces costs. As our retail component grows, this is an important aspect of our future profitability.

Operating income in the intermodal segment increased $7.5 million or 30%. Operating margins declined slightly 0.3% with a cost of purchase transportation increasing 9.1% on a revenue increase of 8.7%. Cost per container per Stacktrain operations were up over 15%, reflecting the increase in fuel paid to our underlying carriers. Further exacerbating the cost increases were expenses reflecting increased volume on BNSF and the attendant start-up costs of that operation combined with the effects of the Northern California truckers’ disruption.

We believe that the added short-term cost of our new BN service will yield significant long-term strategic advantage. The recent floods made this clear. During the second quarter when we were able to reroute our customers traffic on the BN, which was less affected in some markets in the UP by the floods. In addition, access to the BN system positions Pacer to offer a broad range of competitive intermodal services.

In spite of these events, all units within the intermodal segment increased operating income with Stacktrain up $6 million, Cartage up $600,000, and Rail Brokerage up $800,000 from prior year. Discounting the delays experienced due to the Midwest flooding during the quarter, we are experiencing continued improvement in consistency and reliability from all of our underlying rail providers.

We remain cautiously optimistic about the prospects of this year’s peak season. While we see some signs of tightening of truck capacity and West Coast domestic box suppliers starting to be scarce, we expect the impact of fuel increases and the struggles in the housing sector will continue to dampen consumer confidence and hence spending. And this will impact domestic truckload shipments of all types of freight, including intermodal.

Current intermodal market conditions are very volatile, with markets up one week down the next. The settlement of the West Coast labor situation is obviously hardening. We have noticed that volumes overall have shown some improvement very late in the quarter and carrying over into July. This may reflect the normal seasonal increase, but it’s encouraging nonetheless.

Turning briefly to logistics. Logistics revenue increased $11 million or 10.9% over 2007, reflecting increased revenues in our international truck services and truck brokerage units, partially offset by reductions in revenues in our warehousing and distribution and supply chain units. The 20% increase in revenue in our international unit was due to strong export business, coupled with increasing agricultural shipments.

Our truck services unit increased 10.7% and included increases from owner-operator brokerage and company truck operations. Truck brokerage increased 7.7% due to the combination of new internal sales incentive that went into effect in October of ’07 and to fuel surcharges, partially offset by the loss of a major customer in late ’07.

Our warehousing and distribution unit revenues decreased 6.7% because of a customer moving to their own distribution channel, coupled with the closure of a container transload facility. Our supply chain services unit revenues decreased 1.7%, also due to the loss of an individual customer. We are very disappointed in our unacceptable profit performance within logistics. Two of the major business units account for the majority of the poor performance, with the other three business units showing improvement in operating income for the 2008 quarter compared to 2007.

The logistics segment actually recorded a $1.7 million operating loss for the second quarter of ’08 compared to a $1.7 million income in ’07. The primary frustration was centered in our truck services or flatbed operation. This unit saw an increase in revenues quarter-over-quarter, but incurred an operating loss in ’08 because of our inability to fully pass on higher fuel cost, personnel injury, and property damage and cargo claims, combined with high bad debt expenses due to customer bankruptcy.

Recent operations have been profitable, but it’s clear we are not satisfied with our performance in the flatbed business and we are determined to fix it. Our supply chain services unit, while producing an operating income during the ’08 quarter compared unfavorably to the 2007 period due to the loss of a customer in late 2007, combined with the legal settlement in June of 2007, which benefited that quarter but did not recur in 2008.

Overall SG&A was up $2.7 million because of a $3.1 million bonus accrual, which was not present in ’07 and $1.5 million in SAP non-capital implementation cost in the quarter. In addition, during the 2007 period, we received an arbitration settlement that was a credit against SG&A. Total headcount remains below 2007 levels and legal costs were also below 2007. We did have some increased costs because of increased bad debt expenses from truck services and personnel injury and cargo claims.

We continue our program to implement a common IT platform across all units. To date, our capital investment has totaled approximately $20 million, $8.4 million of which was spent so far this year, about evenly split between the first and second quarter. Year-to-date our additional operating expenses totaled $2.5 million, $1.5 million of which was spent in the second quarter, as I mentioned.

The basic design work for many of the new capabilities has been completed and we expect to go live with the first financial implications during the second half. We’ve been very pleased with the support from SAP and other vendors, and we remain on timeline and on budget.

We are focusing on transitioning to the rail environment, whether it occurs before or at the time of our current contract expiration. While we will continue to seek some early transition with the Union Pacific, it has to be done in such a way as to protect the value inherent in our current relationship and be done in an orderly fashion.

Pacer is taking aggressive steps to transition to a new commercial relationship with all of our rail vendors. We recognize that after 2011, Pacer will not have the magnitude of its previous rail contract advantage, and our underlying rail cost will reflect then current market conditions. To prepare for this transition, we’ve taken the following steps. We initiated a relationship with the BN that reflects the new commercial realities. Our operations on the BN began smoothly, and we are pleased with the job done by our operating team during the initial phases of this effort. They performed extraordinarily well in the difficult operating climate.

Secondly, we have altered our organizational structure to focus greater retention on driving earnings from off railroad activities, including local trucking, equipment capacity, and other attributes of our door-to-door service. We are also rapidly improving the value-added component of our intermodal product with higher levels of customer service, improved information through the implementation of our new SAP system, and greater customer focus.

All of these actions have significant current cost associated with them, as I alluded to earlier. Nonetheless, our second quarter demonstrates that we have begun to make this transition while still delivering on our financial commitments. This company faces a transition challenge, but we have made good initial progress and have done so in a difficult market. We expect to continue down this path and position this company for a strong healthy future well beyond our current rail contracts.

Our balance sheet remains strong with long-term debt relatively constant at $56 million. We expect cash flow of roughly $80 million this year and will likely further reduce debt as the year progresses. Our first half operating cash flow in ’08 was $27.7 million, which was below the same period last year, but this was entirely the result of the timing of certain items in ’08 versus ’07 and the receipt of an arbitration award in ’07.

We have no immediate plans for acquisitions or capital expenditures beyond the previously announced SAP investment. At the end of the quarter, we had approximately $173 million available under our 2007 credit agreement. Our CapEx was approximately $9.1 million in the first half, about $6.9 million of which was for SAP. During the remainder of 2008, we would expect to further reduce some of our outstanding debt.

While we have authorization for the purchase of up to 60 million in company stock market, we were not active in the market during the second quarter. At today’s Board meeting, the Board of Directors authorized a dividend of $0.15 a share for holders of record on September 19, 2008, payable on October 10, 2008. Today’s market and this year’s performance are extremely difficult to project. The economy seems to be stalled, and while none of our customers are significantly retrenching with the expansion of the auto producers, neither are any particularly bullish on conditions for the second half.

We have previously guided to $1.60 to $1.70 EPS for 2008. Given performance in the first half, we’re comfortable in being slightly more aggressive and would suggest $1.70 to $1.80 is a more likely range. While that’s not much of a change, please recognize that conditions are very tenuous and we are reluctant to commit to stronger performance and maybe justified by market conditions.

All in all, we believe we had a successful quarter. Our core strategic initiative, which I’ve covered in detail on other calls, are producing positive results. Our intermodal segments have been strengthened and organized for focus and growth in both the retail and wholesale accounts. We are making progress on our important strategic efforts in the core intermodal product, and with the exception of our flatbed operation, feel comfortable that our logistics units are making progress.

Our financial condition remains strong. Our numbers are well within the range we predicted in spite of some unusual market conditions and we remain confident of our expectations for the rest of ’08. We still face significant transition challenges over the next several years, but we are pleased with our progress today.

And at this point, I’d be happy to respond to questions that folks have. Joyce, I think if you can put everybody in the queue? Joyce, are you there?

Question-and-Answer Session

Operator

Yes. (Operator instructions) And our first question will come from the line of Jon Langenfeld from Robert W. Baird. Please go ahead.

Jon Langenfeld – Robert W. Baird

Good afternoon guys.

Mike Uremovich

Hi, Jon.

Jon Langenfeld – Robert W. Baird

Mike, can you talk a little bit about the operating expenses within the intermodal division? How much of the cost controls there are things you are doing versus the benefit of having a more consistent network out there with specifically the UP?

Mike Uremovich

A lot of it is – a lot of it recently, Jon, has been network because obviously that smoothes the workflow and in addition speeds the turn on the boxes. So, I would credit that with some very – a large portion of the cost effort.

Jon Langenfeld – Robert W. Baird

And even on the SG&A side, I mean, it seems even from an absolute perspective seems as low as it’s [ph] spent for quite sometime. What’s going on in that line, again, specifically in intermodal?

Mike Uremovich

Well, as you know, across the company in total, we committed to get aggressive in our SG&A spend. And we have done that across all of the units as well. I don’t know as I would isolate just intermodal in that area, though it is clear intermodal has done a nice job in controlling expenses. But that's been pretty much across the board I think.

Jon Langenfeld – Robert W. Baird

That’s more internal whereas the Op expenses, such Op expenses are more external?

Mike Uremovich

Yes.

Jon Langenfeld – Robert W. Baird

Okay. All right. Good perspective there. And then when you think about the pressure on the gross margins with intermodal, you kind of laid out a couple things there. Burlington Northern ramping that up in fuel costs and then just the squeeze on some of the pricing out there, but if you had to put them in order of magnitude, what’s the biggest pressure point as it relates to that gross margin line?

Mike Uremovich

Probably fuel. And I suspect that I would probably put price second.

Jon Langenfeld – Robert W. Baird

And do you have fuel caps out there with your customers?

Mike Uremovich

Fuel caps? How do you mean?

Jon Langenfeld – Robert W. Baird

Well, I mean, do you get to a point on some customers where they quit paying fuel surcharge?

Mike Uremovich

Well, in the retail side of the business in Rail Brokerage, we have some 50-plus fuel matrices that are essentially individually negotiated with customers when you make the deal for that year’s business. So in that sense, yes, we do have some caps regardless of what happens to fuel.

Jon Langenfeld – Robert W. Baird

And so, if you think about it in the quarter there, again, there’s probably a net benefit, but there’s puts and takes on every contract?

Mike Uremovich

Yes. There’s a lot of puts and takes and there’s a lot of timing issues in that. The matrix not only describes the fuel surcharge, but it involves the – it describes also the timing – frequency and the timing of the increase. So, fuel is very volatile on the way up. All right? You can end up not being able to collect from the customer for several weeks depending upon when they reset, perhaps even a month if it takes a full month to reset the fuel charge.

Jon Langenfeld – Robert W. Baird

And conversely, if we see fuel go down here dramatically to, let’s say, $100 a barrel over a short time period, say, the next month or two. Is that a positive or negative for this intermodal segment?

Mike Uremovich

For the intermodal segment, well, it’s going to be a mixed bag. In some cases, it is going to help; in other cases, it will hurt because of the quarterly timing on a number of the rail situations. However, we won’t catch up until later in the year. So we’re going to continue to pay the higher fuel surcharge until the end of the quarter and the fuel surcharge resets at the new lower rate. Some of our customers will begin to pay us on a weekly basis because that’s how often we’ve reset with them. So it’s going to be a mixed bag and it’s going to depend upon how much it drops out fast.

Jon Langenfeld – Robert W. Baird

Okay. Good. I’ll back in the queue. Thank you.

Operator

Thank you. And our next question will come from the line of Alex Brand from Stephens. Please go ahead.

George Pickral – Stephens

Hi, guys. This is actually George Pickral for Alex Brand.

Mike Uremovich

Hi, George.

George Pickral – Stephens

First question, of the $32 million increase in intermodal revenue, how much of that can be attributed to fuel?

Mike Uremovich

It’s the largest single component. I don’t know as it would be half, but it is a big piece of it.

George Pickral – Stephens

Okay. So would it be fair to say 40% to 50%?

Mike Uremovich

Yes. And recall that we pass – that we turn right around and pay that too. So, while it helps the revenue, it also hurts the operating expense line.

George Pickral – Stephens

Right. Along those lines, and I guess following up on Jon’s question, you talk about fuel going down could potentially, I guess, hurt or help. The domestic volumes are going down. You said the auto volumes were bad and you expect them to be bad for the next two quarters. Can you maybe talk about some of the good things that are happening as to why you are raising guidance?

Mike Uremovich

Well, I think – number one, I think performance in the first six months justifies raising guidance, and our outlook is consistent with the increase. The volume issue in the domestic component in the second quarter was a – if you want to characterize it a self-inflicted wound in the sense that we tried to aggressively push price and made a mistake in doing that. And a number of our competition, as I’m sure you’ve heard, were more aggressive downward in their pricing activity than – certainly than we expected. So we have altered that and are persuaded based upon what we hear that the volume that we can get our volume position where it needs to be and deliver the numbers in the guidance that I provided.

Larry Yarberry

And we think that international will continue to perform well. And like Mike mentioned, the automotive business is very questionable.

Mike Uremovich

Yes, that’s a dicey one in the second half. And the thing that’s hurting us most on the automotive is not just the business is down, but it’s down sporadically. I mean, people close plans for two weeks and then open them up two weeks later. And you can’t reposition equipment, you can’t adjust your system to that kind of herky-jerky movement. That’s where it really hurts.

George Pickral – Stephens

Got you. Thanks for that. And I guess sticking with the domestic volumes, can you quantify how much of that was due to the strike in Northern California and how much was due to the flooding in the Midwest?

Mike Uremovich

Well, we don’t think it had significant volume effect on us. And because there was an embargo for a period of time, but then if you look at the numbers, the week following the embargo being lifted, the volume came back. So it appears as if we’ve recovered most of that and it was merely a timing issue as to when we get. From our perspective, it did not have a big effect. The Northern California driver disruption did have some cost effect on us because we had – because of the difficulty with the owner-operators, we had to do some things with lease drivers and things like that that were more expensive than we would have liked, but probably not minimal volume effect.

George Pickral – Stephens

Great, thanks. And last question and I’ll get back in the queue. In the logistics segment, I’m sorry if I missed this, did you say how much Op income you lost due to the flatbed sector? And – I guess that’s the first part. The second part is, could you maybe breakdown how much you lost due to the capacity transportation fuel et cetera versus the increased claims, cost and bad debt expense?

Mike Uremovich

A simple answer is no.

George Pickral – Stephens

How about the complex?

Mike Uremovich

We don’t break out the P&Ls for the individual units within that, but I guess the best way to put it is we certainly would have made money in logistics in the second quarter had it not been for the difficulties at the transport. And I think that’s probably how I would leave it.

George Pickral – Stephens

Very fair. Thanks guys. Thanks for the time.

Mike Uremovich

Thanks, George.

Operator

Thank you. And then we’ll go to Ed Wolfe from Wolfe Research. Please go ahead.

Ed Wolfe – Wolfe Research

Thanks. Hi, Mike. Hi, Larry.

Mike Uremovich

Hi.

Larry Yarberry

Hi, Ed.

Ed Wolfe – Wolfe Research

A little bit about the beanie [ph] contract, first of all, do the services include both wholesale and retail brokerage, and can you give a sense of what the revenue ballpark is? Is it some percentage of the total at this point?

Mike Uremovich

Couple of things. One, it is both wholesale and retail. We have not been public about the magnitude of our commitment to be, I guess the best way to say it is that we are ramping up that up and certainly meeting our volume commitments to – under our contracts with the railroad.

Ed Wolfe – Wolfe Research

Should we think about the wholesale relative to retail similar to what you are doing where it was 2-to-1 wholesale to retail kind of thing?

Mike Uremovich

No. In the BN situation, that is a predominantly retail offering. And that’s an important distinction and good question, Ed, and that it demonstrates our ability to transition our retail business to the commercial reality of having a market – a current market base rail contract.

Ed Wolfe – Wolfe Research

If I look at the retail operating income that’s imbedded in the report, the $32.2 million of intermodal, is there positive retail EBIT? I’m not just talking about Burlington [ph], I’m talking about everything.

Mike Uremovich

Yes.

Ed Wolfe – Wolfe Research

Burlington, is there positive?

Mike Uremovich

I don’t think that we should go into the kind of detail between the two. It’s clear that our operating costs on the Burlington Northern are higher than they are on the Union Pacific. So obviously it is less profitable. But there the unit in aggregate is profitable.

Ed Wolfe – Wolfe Research

And Mike, can I ask you a kind of bigger picture strategic question? You’ve been struggling now since I want to say 2003 or the IPO pretty much with the logistics unit. And now that you’ve separated the retail rail business back into intermodal, what’s the need for the logistics business? Why not at some point shut this down and focus on the other business? What’s the synergy that you see?

Mike Uremovich

Well, in – particularly in the area of truck brokerage, in the area of SCS or traffic management area, all those are important components of the benefit to our customers and the broadened customer relationship. We have had very candidly discussions about particular aspects of the logistics business and how well they pick in the long-term. And right now, I can’t answer that question. I don’t know. We are examining that as we speak and we can’t continue to beat our heads against the wall and divert effort and management time and attention to things that don’t produce. So I guess I probably ought to best leave it at that.

Ed Wolfe – Wolfe Research

I appreciate the honesty. If you look at the $16 million of net revenue in the quarter that was a portion to logistics, what are the two or three largest buckets of that $16 million now?

Mike Uremovich

The international division has been very strong, and as a matter of fact, is doing quite well in terms of its contribution to the other units as well. Warehousing was – I’m looking down at my numbers here. I just want to take a quick look. No, I want to look at the total. Warehousing international – highway brokerage has turned itself into a profitable operation. So those are the ones that are of most importance to us at the moment. Like I said, transport has been an enormous frustration. We have a new team of people down there that are beginning to make some progress, but I got to tell you it’s at least as frustrating for us as it is for them and for you.

Ed Wolfe – Wolfe Research

What’s in transport? Can you give more detail–?

Mike Uremovich

It’s flatbed. It’s flatbed, trucking are operation agency-based. It’s a mini-Landstar. I guess it would be one way to characterize it.

Ed Wolfe – Wolfe Research

I’m guessing there is some interest for that in the marketplace?

Mike Uremovich

I think that’s accurate.

Ed Wolfe – Wolfe Research

You mentioned, Mike, in your remarks about the box shortage, the export box shortage creating a little bit of a drag. How do we think of that going forward? Are we in the ace [ph] inning of that or the second inning of that issue?

Mike Uremovich

Well, I don’t know because it would be a function of what do we think the dollars going to do and is the export market going to soften any in the near-term. I can tell you this, in our forward-looking planning, we’re not looking for that business to be as robust as it was several years ago.

Ed Wolfe – Wolfe Research

(inaudible) all this quarter last quarter you mentioned that you had stopped talking with Union Pacific. Did you meet at all this quarter?

Mike Uremovich

Well, we meet with the Union Pacific frequently on a wide variety of things. So I’d rather not go through the specific dates and times and things like that. But yes, we continue to have dialog with Union Pacific.

Ed Wolfe – Wolfe Research

Regarding the contract and the extension or change of that – the underlying contract?

Mike Uremovich

Well, I’d really rather not go into the specifics of the – or the substance of the discussions.

Ed Wolfe – Wolfe Research

One last one and then I’ll turn it over. I thought I heard you say at one point that volumes improved at the end of June and July.

Mike Uremovich

Yes.

Ed Wolfe – Wolfe Research

That in June looks terrible.

Mike Uremovich

Excuse me? I’m sorry.

Ed Wolfe – Wolfe Research

I’m trying to understand which volumes, whether it was intermodal or truck or what because–?

Mike Uremovich

Intermodal. Intermodal. I’m sorry that I wasn’t more specific.

Ed Wolfe – Wolfe Research

How does that meet up with the West Coast?

Mike Uremovich

Ed, I don’t know. All I can tell you is that we saw a step-up in our intermodal business in July. Some of it caught a little bit by surprise frankly.

Ed Wolfe – Wolfe Research

Is that year-over-year or sequentially?

Mike Uremovich

Sequentially. More than anything else, run rates change. It might have been catch up from the floods. It might have been – who knows what it was.

Ed Wolfe – Wolfe Research

Okay. Thanks a lot for the time. I really appreciate it.

Mike Uremovich

Right, Ed [ph].

Operator

Thank you. And next we’ll go to the line of Tom Wadewitz from J.P. Morgan. Please go ahead.

Tom Wadewitz – J.P. Morgan

Yes, good afternoon. I just have – I guess one first question on some of your comments on the volume side. I think you mentioned earlier, I just didn’t catch it. What were the volume numbers year-over-year in stack and then in retail?

Mike Uremovich

Hold on just a second. I’ll pull them out, Tom. Go ahead, Larry.

Larry Yarberry

On the Stacktrain, as Mike mentioned, our domestic volumes were down and our automotive volumes were down, international were up substantially. Net net, volumes on the Stacktrain were down about 3%.

Tom Wadewitz – J.P. Morgan

About 3%. And what about in retail?

Larry Yarberry

They were down double – about 10% to 11%.

Mike Uremovich

Yes, that was the pricing mistake I was talking about, Tom.

Tom Wadewitz – J.P. Morgan

Okay. So how long do you think it takes to correct that mistake that you made in pricing? Is that the type of thing where you – I guess you kind of get their one year contracts and then you get a shot at it again next year, or are there other contracts that which come due in second half and you kind of tune the dial and you’d expect those retail numbers to improve? How should we look at the volume outlook within retail?

Mike Uremovich

Yes, there is the – obviously there are bids that do come up every month. The classically defined bid season tends to be early in the year. Actually it tends to be in the first quarter than it does in the second. The awards – excuse me, awards to tend to come out in the first quarter. So – but you do see bids every year and you have an awful lot of business that isn’t bid specific, but it is more on a given lane or a given geographic so that we can go in and alter prices and get business – a lot of business outside the bid process.

Tom Wadewitz – J.P. Morgan

Okay. So – I mean, with that in mind –

Mike Uremovich

I guess the real answer, Tom, is that we are not going to have to live for a year with the mistake we’ve made in the second quarter.

Tom Wadewitz – J.P. Morgan

Okay. And so when you look at the current competitive conditions, and I just compare it to how it’s evolved through the year. Did they get worse in the second quarter in terms of what your competitors are doing on pricing and do you think they stay pretty difficult in the second half or do you think it was more exotic and you had a few things and it’s kind of stable or a little better in the second half?

Mike Uremovich

I think it was, generally speaking, episodic, and it was around a half of a dozen or so identifiable major bids.

Tom Wadewitz – J.P. Morgan

Okay. So I mean, with that in mind, you think that down 10% number gets better in the second half or not?

Mike Uremovich

Yes, I do.

Tom Wadewitz – J.P. Morgan

Okay. And when you look at the margin on the retail, was it the case where you got some pricing in certain areas and the operating margin on retail actually improved or was it more that you lost more volume than you expected and there was some negative leverage from that? What was the operating margin year-over-year in retail?

Larry Yarberry

Tom, if you look at the operating income on the Rail Brokerage has actually improved year-over-year.

Mike Uremovich

Yes, margins were up in Rail Brokerage. We did two things in that segment relative to margin. One is that we looked at individual customer situation where we kept the business, but altered the terms of how we're doing it with people and so improve margins. And secondly, when we bid new business, we bid to increase margins. And that’s where we have the volume of that.

Tom Wadewitz – J.P. Morgan

Right. Okay. And then the last question, I know you’ve been asked this a bit on the call in terms of yield, but just to be clear, you had – on the first quarter conference call you talked pretty extensively about – you had a boost from field and don’t get carried away by the strength of the earnings in first quarter. What – how would you compare the impact of fuel on your earnings in the second quarter to what the impact was in the first quarter? Was it a similar boost? Was it a pretty minor boost compared to the first quarter or – maybe a few further thoughts on fuel?

Mike Uremovich

I think I would say that it was comparable. Similar. I mean, there was nothing dramatically different.

Tom Wadewitz – J.P. Morgan

Okay. But it was still – you still had a meaningful earnings benefit in the second quarter year-over-year from the rise in fuel?

Mike Uremovich

Yes.

Tom Wadewitz – J.P. Morgan

Okay.

Mike Uremovich

Going forward, I should add, that’s a different issue of course, because on a going forward basis, remember late last year, fuel began to move a bit. And in addition to the fact, in the third quarter of this year, we are going to be paying second quarter fuel prices in effect. So, if fuel comes down, it will hurt us a little more than we saw in the first or second quarter.

Tom Wadewitz – J.P. Morgan

So it might be kind of a neutral in third quarter, and then fourth quarter it might even be a headwind just given the way the comps seem to line up.

Mike Uremovich

That’s correct.

Tom Wadewitz – J.P. Morgan

Okay. All right, great. Thank you for the time.

Mike Uremovich

All right, Tom.

Operator

Thank you. And we’ll next go to John Larkin from Stifel Nicolaus.

Mike Uremovich

Hi, John

John Larkin – Stifel Nicolaus

Good morning, gentlemen – or good afternoon, I should say. Just to keep beating the fuel issue over the head here just one more time. Just to understand the reason for the pattern that you described in response to Tom’s question. Is it due to the fact that your fuel surcharge basically adjusts weekly? And the fuel surcharge that you are paying the underlying railroads adjusts perhaps every 45 days, something on that order of magnitude?

Mike Uremovich

Yes, every quarter actually, yes.

John Larkin – Stifel Nicolaus

Every quarter? Okay. So that’s the essence of it.

Mike Uremovich

Yes.

John Larkin – Stifel Nicolaus

And then on the loss of domestic volume, I guess a lot has been written about the relative fuel efficiency of intermodal vis-à-vis truck. Yet it sounds like what happened with you all in the second quarter was that you responded to, what I recall, fewer intermodal bids, and sort of miscalculated a bit and some of the competitors came in a bit lower than you thought. Is there any sort of a proactive initiative to go out and try and convince shippers that due to a lower fuel surcharge and the relative fuel efficiency of intermodal that they ought to consider moving some of their truck traffic over to your network?

Mike Uremovich

Well, we do – obviously, John, we – the sales force is doing that everyday. In terms of our second quarter volume issues, that was already intermodal traffic. It was intermodal traffic that was being in effect re-bid. We felt there as an opportunity to take price up or hold it constant. Our competition clearly did not. And so that affected our volume.

John Larkin – Stifel Nicolaus

Was that pricing competition coming primarily from IMCs or is it more of the – what I would call, truckload based intermodal providers?

Mike Uremovich

It was both.

John Larkin – Stifel Nicolaus

Okay. And just lastly, on the disappointing operations in the flatbed arena, you mentioned earlier that it was a smaller version of Landstar. There’s another public company out there called Universal and I’m sure you’re well aware as the same basic aging owner-operator strategy in the flatbed arena. Both of those companies seem to be doing reasonably well in light of how difficult the trucking market is. I think they are capitalizing on the steel market, perhaps the export of construction machinery, agricultural machinery, perhaps some defense department related movements, those sorts of things. Having steered clear what I would call traditional construction type loads, plywood, lumber, roofing, shingles, those sorts of things, which obviously are way off, what is it that’s different about your operation that would make it so difficult for them to perform more in line with the two public comparables?

Mike Uremovich

Well, one of the things that makes it so damn frustrating for us, John, is the exact facts that you just laid out. I mean, you look out and you look at others doing well in the business, and somehow we seem to continue to stumble with this. So that –

John Larkin – Stifel Nicolaus

Is there anything about the Western orientation of the operation that might make it more difficult?

Mike Uremovich

Yes, there does not seem to be anything structurally that should cause that kind of problem.

Larry Yarberry

Year-over-year there are – our gross revenues were up, but we had problems with claims and bankruptcies and other things that impacted their operations. But the revenues were up year-over-year.

John Larkin – Stifel Nicolaus

I guess there’s just a need for more of an attention to detail internally. And then just lastly, a couple of the previous questioners asked about the drop in empty box moves, which presumably some of those boxes you would reload?

Mike Uremovich

You’re talking about the international boxes, John?

John Larkin – Stifel Nicolaus

Yes.

Mike Uremovich

Yes.

John Larkin – Stifel Nicolaus

And that opportunity I’m guess you’re assuming is going to be gone permanently or reduced permanently. Is there any way to perhaps capture some of that traffic with other equipment other than the empty boxes that are no longer available from the shipping companies?

Mike Uremovich

Well, yes, clearly we try to do that. It’s a question of whether or not where the shipping companies. You see if the shipping company’s box turns out empty in Chicago and they have an export load from Des Moines, they are going to move it empty to Des Moines for the export load instead of giving it to us in Chicago to move. Obviously we are chasing that same business in our domestic boxes, but there are certain freight that tends to move better in the smaller boxes than the big one and you end up getting – having a pricing problem, because the shipping company has put in different kinds of freight in it basically. That’s – but you are correct that it doesn’t alter the amount of freight moving. And – but we can’t – it’s hard to transload some of that volume into the larger domestic boxes.

John Larkin – Stifel Nicolaus

Would it make sense at any time perhaps to consider adding some used 40-foot boxes into your fleet to perhaps capture some of that business or would that be non-economic?

Mike Uremovich

Probably we looked at it, but it probably wouldn’t be economical because it’s a one-way move by definition.

John Larkin – Stifel Nicolaus

Got it. Very good. Thanks for your help.

Mike Uremovich

Okay, John.

Larry Yarberry

Thanks, John.

Operator

Thank you. And we’ll now go to Todd Fowler from KeyBanc Capital Markets. Please go ahead.

Todd Fowler – KeyBanc Capital Markets

Hi, Mike. Hi, Larry.

Mike Uremovich

Hi, Todd.

Todd Fowler – KeyBanc Capital Markets

Mike, in the new guidance, what are you looking for from contributions from logistics now?

Larry Yarberry

Well, certainly we are looking for a profit instead of a loss.

Mike Uremovich

I don’t know how the year is going to turn out there yet.

Larry Yarberry

In the second half, we are looking though for a profit.

Todd Fowler – KeyBanc Capital Markets

And I guess the magnitude of the profit, are you still looking for – if I remember correct, I want to see at the beginning of the year the original EBIT contribution was somewhere around $10 million. So, are you still looking for $3 million or $4 million in the back half or is it basically closer to breakeven at this point?

Mike Uremovich

No, it’s going to be more in the $3 million to $4 million range than – or 5, not just breakeven.

Todd Fowler – KeyBanc Capital Markets

Okay. And then I guess to get you there, what are some of the immediate fixes that – as you look at that business that in the next two quarters you think you can put in place to kind of get that contribution up to that level, seeing where it kind of fell out here in the second quarter? And assuming that based upon your commentary, it doesn’t seem like you’re anticipating much of a change than the overall economic environment?

Mike Uremovich

Well, fundamentally the biggest single change will be the fact that if the flatbed operation as appears to be the case stops losing money, it’s been – we get a step-up from that pretty clearly. International is going to continue to be strong. It looks like the PDS will continue to be strong. And if we can push fuel through on the flatbed side and manage some of the equipment down there better we believe that we’ll be on track.

Todd Fowler – KeyBanc Capital Markets

And is the fuel issue on the flatbed side, is that contractual or is it just the matter of having the conversation and–?

Mike Uremovich

Well, it’s a matter of when you have an agency-based structure, you don’t have as much control ultimately over pricing and over fuel surcharges, as you do when you have a direct situation. And so it’s hard to push – pull fuel through if the agent has given some of it away on his end. And so that’s basically where the problem is in that kind of a structure. And we have not been as good at that as we should be.

Todd Fowler – KeyBanc Capital Markets

Okay. That’s helpful. And then on the Stacktrain at this point, what percentage is automotive of total Stacktrain revenue?

Mike Uremovich

I don’t know [ph] it by volume – I’m going to do a quick calculation.

Larry Yarberry

It should be around 20%.

Mike Uremovich

It should be around 20%. 20% – 25% on volume.

Todd Fowler – KeyBanc Capital Markets

25% on volume or on revenue?

Mike Uremovich

Volume.

Todd Fowler – KeyBanc Capital Markets

Okay. And then your expectations moving to the back half of the year is for automotives continue to basically turn negative on a volume assumption?

Larry Yarberry

Year-over-year.

Mike Uremovich

Year-over-year, yes.

Todd Fowler – KeyBanc Capital Markets

Year-over-year, right. Yes, that’s right.

Mike Uremovich

Yes, I would expect that.

Todd Fowler – KeyBanc Capital Markets

Okay. And then just lastly, Mike, maybe just a little bit more color. It sounds like you guys are going to be taking up the fleet flexing up here in the back half of the year. Those are some of the commentary. It sounds like automotive is going to be weak. It sounds like international and basically the trends that we're seeing is going to remain that way. What is the thought process? Is that to ramp up more for the beanie? Is that to just basically have additional capacity to meet some of the anticipated new account wins or what's kind of the thought and what you are doing with the container fleet at this point?

Mike Uremovich

Typically what you do is – we’ve already received about two-thirds of the boxes we order. And typically what you do is you flex up going into peak even if it’s a relatively modest peak. And then we will tune the fleet size at the back end of peak based upon where we expect demand to be at that time. So if, for example, automotive or something falls a great deal more than we might – than we expect at the moment, we might turn back more boxes and the year-end fleet might end up being slightly smaller than indicated. You’ve got a lot of flexibility here in terms of how many of these boxes you keep on lease.

Todd Fowler – KeyBanc Capital Markets

So the risk would basically be that you would just incur that incremental operating lease expense during the third and fourth quarter that would kind of be your sum costs in this situation and then once you got to the fourth quarter, you’d reduce the fleet at that point.

Mike Uremovich

Yes, you’d reduce it as your demand tailored off. I mean, you would keep using it for as long as you need it and then size the fleet as the peak declines.

Larry Yarberry

The way we stagger our operating leases we have flexibility to off-lease enough equipment to right-size the fleet at really low cost.

Todd Fowler – KeyBanc Capital Markets

And the lease terms are basically eight years, is that correct?

Larry Yarberry

They are predominantly eight years, yes.

Todd Fowler – KeyBanc Capital Markets

Okay. Okay, that’s helpful. Thanks for the time guys.

Operator

Thank you. And now we’ll go to David Campbell from Thompson, Davis & Company. Please go ahead.

David Campbell – Thompson, Davis & Co.

Yes. It sounds like most of my questions have been answered, but just to go back on the logistics, flatbed problem, some of the companies have indicated the pricing power is better. So despite the fact that is an agent relationship that should help in the third quarter, if you can stay out of – apparently have some problems with bad debts and claims expense and stuff like that, but it sounds like there should be a solution here.

Mike Uremovich

We think so, David.

Todd Fowler – KeyBanc Capital Markets

Rather than selling the units, it seems like there should be a solution.

Larry Yarberry

The revenue is certainly not the problem on transport. It was more operational and one-time type things with bad debts and claims and injuries and things, which I think are behind – that’s all behind us now. So we would look going forward that they should return to profitability.

Todd Fowler – KeyBanc Capital Markets

But it sounds like in your forecast for the rest of the year, you are assuming that intermodal gross margins will continue to decrease sequentially. Is that what we should look for?

Mike Uremovich

I don’t think we indicated that.

Todd Fowler – KeyBanc Capital Markets

No, but it seems to be built in to the numbers.

Larry Yarberry

You’re talking of net revenues or –?

Todd Fowler – KeyBanc Capital Markets

In net revenues, yes.

Larry Yarberry

Net revenues.

Todd Fowler – KeyBanc Capital Markets

As a percentage of gross, yes.

Larry Yarberry

Well, net revenues of course as we expand to be in business, we do pay more for shipments than we do on the legacy contract. And also as fuel adjusts, we’ll be paying the vendors more on fuel.

Todd Fowler – KeyBanc Capital Markets

All right. Okay. That’s good. Thank you.

Operator

And we’ll next go to Robert Dunn Sidoti & Company. Please go ahead.

Robert Dunn – Sidoti & Company

Hi, guys. I just had a quick one on – are you still looking for $80 million in free cash flow for this year?

Larry Yarberry

Cash flow from operations.

Robert Dunn – Sidoti & Company

Cash flow from operations. And do you know what CapEx is going to be? I assume that’s 12 to 15 range?

Larry Yarberry

CapEx for six months has been about $9 million. And yes, I would think that CapEx is going to be somewhere in 18, 20.

Robert Dunn – Sidoti & Company

18, 20. Okay, great. Thanks.

Operator

Thank you. And our last question will be a follow-up from Jon Langenfeld from Robert W. Baird. Please go ahead.

Jon Langenfeld – Robert W. Baird

Yes. Mike, when you do the postmortem on the pricing or you try to bring pricing up, how much of that was misreading the market in terms of what it would bear versus your competitors stepping up being more price aggressive? I mean, I’m sure the answer is both, but – I mean, any sort of qualitative feedback you'd give on that would be helpful.

Mike Uremovich

Well, on the one hand, Jon, I like to think that we had read the market perfectly and it was just the competitors came off the wall and did something we didn’t expect. But I’m sure as you’ve pointed out, it probably was a combination of both. I’d have to – you have to take it bid by bid. There were some aggressive bids that frankly we thought just were not justified by market conditions. But it’s sometimes we – and I’m not taking any shots at anybody because we get the same way – sometimes you get sort of emotional about business that you had and lost and you retaliate to get it back. So I think we had some of that in the second quarter as well.

Jon Langenfeld – Robert W. Baird

Because it sounds like you’re seeing that there is just – really you can isolate it to a handful of contract bids that came up more so than this was a broad-based increase in price aggression?

Mike Uremovich

Well, those clearly are the relevant and obvious examples. On a day-to-day basis, I’m not honestly close enough to it know whether or not that happens on individuals. I know when it happens on the big bids because I am involved in those.

Jon Langenfeld – Robert W. Baird

Got it, got it. And then you made the comment in your prepared remarks about short haul and not being as involved in that space. I mean, at what point – or what prevents Pacer from getting involved there because clearly there is a lot of truck conversions that are out there where you can do more? So, I’m wondering what your strategy is on that front?

Mike Uremovich

Well, we’re examining that because obviously there are some opportunities there. We don’t have and have not focused on at this point the kind of underlying rail contract that would be necessary for us to participate in that business. Whether we should or not is something we’re actively considering.

Jon Langenfeld – Robert W. Baird

And is that – would you say that’s true? I mean, the contract that’s conducive to that, are those more of the type that the truckload providers are going after or do some of your IMC competitors have it as well?

Mike Uremovich

Well, we’ve seen a lot of action out of the truckload providers particularly.

Jon Langenfeld – Robert W. Baird

On that shorter length of haul?

Mike Uremovich

On that shorter length of haul. And there are a number of them as you undoubtedly know, that still move trailers in that kind of service.

Jon Langenfeld – Robert W. Baird

Yes. Okay. And then the last question, Larry, do you have the exact share count, diluted share count for the quarter?

Larry Yarberry

34,750 versus a year ago 36,640 [ph].

Jon Langenfeld – Robert W. Baird

All right. Great. Thanks a lot guys.

Larry Yarberry

Thanks.

Operator

And gentlemen, I’ll turn it back to you for any closing remarks.

Mike Uremovich

Okay. Well, thank you again all for joining us. We’re faced with some unusual conditions out there and we continue to be pleased with the kind of progress we’re making in the fundamental transition. We remain frustrated with certain aspects of the logistics operations, but we will fix those. And we will deliver the expectations that we suggest. So, thank you again all for joining us.

Operator

Thank you. And ladies and gentlemen, this teleconference will be made available for replay after 7:30 PM this evening until September 5 that midnight. You may access the AT&T executive playback service at any time by dialing 1-800-475-6701 and entering the access code 953111. International participants may dial 1-320-365-3844. And again, access code 953111. And ladies and gentlemen, that does conclude our teleconference for today. We thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.

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Source: Pacer International, Inc. Q2 2008 Earnings Call Transcript
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