Hub Group, Inc. (HUBG) Q3 2014 Earnings Report, Transcript and Summary

Hello, and welcome to the Hub Group Inc. Third Quarter 2014 Earnings Conference Call. I am joined on the call by Dave Yeager, Hub's CEO; Mark Yeager, our President and Chief Operating Officer; and Terri Pizzuto, our CFO. [Operator Instructions] Any forward-looking statements made during the course of the call represents our best and good faith judgment as to what may happen in the future. Statements that are forward-looking can be identified by the use of words such as believe, expect, anticipate and project. Actual results could differ materially from those projected in these forward-looking statements. As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to your host, Dave Yeager. You may now begin.

Thank you. Good afternoon, and welcome to Hub Group's Third Quarter Earnings Call. It's been a challenging quarter, as we faced headwinds in numerous areas. We have seen deteriorating rail service, equipment shortages, driver shortages and a challenging legal environment in California. Although the obstacles thrown at us in the third quarter were significant, we believe these are short-term issues and we're optimistic about 2015. I'll now turn the call over to Mark, so he can walk you through the details.

Thanks, Dave, and hello, everyone. As always, I will start by taking you through our operating results. Consolidated big box intermodal volume was down 2%, with a 4% volume decrease in the Hub segment and a 16% volume increase in the Mode segment. For the Hub segment, local East volume declined 10%; transcon volume declined 5%; and local West volume grew 2%. We saw volume declines and cost increases out of Southern California due to driver, container and chassis shortages as well as terminal and train capacity constraints. Overall, rail service declined throughout the quarter. On-time service was off double digits on both the year-over-year and a sequential basis. We do not expect a meaningful improvement in rail service until the spring of 2015 as the rails work on adding crews and locomotive power. For the quarter, we saw transit time increase 8/10 of a day and saw a significantly higher percentage of shipments left on the ground. In addition, our ability to reposition boxes in the West was severely restricted by network congestion in key corridors. As a result, utilization of our containers deteriorated from 13.6 to 15 days, and we were unable to execute on our plans for equipment repositioning and new container deployment. During much of the quarter, we had hundreds of boxes waiting at the Port of Los Angeles for UP chassis support and hundreds more marooned in Seattle, waiting to be repositioned to L.A. The deterioration in utilization effectively reduced our fleet size by 10%, producing less capacity than 2013. At the same time, we experienced difficulty accessing rail-owned containers and saw an 11% decline in EMP usage over the course of the quarter as a result of constrained rail box availability. Driver shortages in Southern California, where we recently changed our model from owner-operator to company drivers, exacerbated the problem. While we anticipated retaining 75% to 80% of our drivers in Southern California, we actually retained just 55%, as many drivers decided they would prefer to remain owner-operators, even if it meant switching companies. This shortage forced us to outsource significantly more work to outside drayage providers, purchase drayage in the spot market, utilize nontraditional dedicated power, leased tractors and drivers and fly in HGT drivers from other markets. As you might imagine, this has been an expensive exercise and we are not yet back to normal operations in Southern California, but it has enabled us to continue servicing our customers. Despite all of our operational challenges, we have kept on-time performance to our customers above 90% during this highly disruptive period. We believe the California driver shortage and the extra costs we are incurring as a result are a temporary problem. As the demand naturally slows down in the second half of the fourth quarter, we will be able to bring drivers home and terminate expensive leased tractors. We will then concentrate on rebuilding capacity through hiring company drivers in Southern California and outsourcing to a select group of independent drayage providers. On a more positive note, we are making progress in a number of areas. Pricing improved throughout the quarter and our pricing discipline in local East produced improved margin on a per unit and aggregate dollar basis. We are also no longer having issues with the UP over-chassis supply, gate reservations or repositioning. We are currently in the process of on-boarding 3,500 new containers for a net increase of 1,500 units in 2014. We have already received 2,694 of the new containers, and the deliveries will continue through mid-November with an expected year-end fleet size of approximately 27,500 units. As you can see from our press release, we also ran into significant issues this quarter with our efforts to develop a new integrated user interface for load planning and intermodal dispatch. After 3 years of work and significant investment, we have come to the conclusion that the interface we developed will not provide adequate stability or responsiveness for deployment in the field. We are currently evaluating options with several, much less complicated paths that can, a, produce similar efficiencies and empty mile reductions; b, capitalize on existing proven technology; and c, keep us focused on our core competency, moving freight. We believe this could be accomplished in a relatively short period at a manageable cost and that it is a better solution for us in the long term. It has been a learning experience in terms of our IT capabilities. Clearly, we need to strengthen some skill sets and reevaluate our buy versus build decision making go forward. In the interim, we are instituting a number of operational and pricing process changes that will help us improve utilization, reduce cost and lower empty miles. We set a goal of 2% empty mile reduction in 2015, and everyone here is committed to achieving it despite the OneSystem setbacks. Specifically, we are reengineering our operational workflow and responsibilities, including: improving appointment setting, which will enhance utilization and reduce empty miles; redefining tracking and tracing, which will help customers service focus on the customer; and dispatch, focused on street execution, this effort will also reduce redundancy; improving driver communications through Qualcomm workflow, which will help us improve equipment turns and assist in our driver retention efforts. We remain on track to improve equipment management and utilization through satellite tracking. We have installed our satellite tracking system on 1,285 of our containers, and we'll continue installations on 1,315 more units later this year. In addition, we are implementing an optimization tool to help us improve our pricing. This tool has been implemented in a pilot stage this quarter and will be fully launched in 2015. It will help us expand margin, grow our business and improve network efficiency by making better pricing decisions. Our partner in this endeavor is a proven industry leader. And this approach, which has gone from concept to reality in just 6 months, is an example of our new IT strategy at work. With all these process improvements, we are confident that we are looking at a more normalized Q1 of 2015. Despite the California challenges, Hub Group Trucking continued to grow, with our drivers handling 1% more moves and 8% more loaded miles. Hub Group Trucking moved 71% of Hub drayage during the quarter compared to 66% last year. We also did 68% more moves for Mode Transportation. The California situation contributed to higher attrition this quarter, producing a net loss of 46 drivers for the quarter and bringing the total driver account to 2,868 at the end of September. With peak demand ramping up and less drivers to handle the moves, we are extremely appreciative of the loyalty, dedication and hard work that our drivers demonstrated during the quarter to be able to accomplish these results. As of right now, our driver losses in California are leveling on and we are now beginning to add drivers. October has seen net driver adds, and we believe we will have a positive fourth quarter from a driver-add perspective. As we reported earlier this year, we placed an order for 300 trucks and have now received 216 of those units, with the remainder arriving before the end of the year. Our truck brokerage division saw flat revenue and a 12% volume decline for the quarter as we focused on price increases during bid season to offset underlying cost changes in the marketplace. We also had less high-value added business in the quarter. The Mode Transportation truckload division experienced a 7% volume decline for the quarter. We saw continued double-digit growth in Unyson Logistics with an 18% revenue increase. This quarter, Unyson Logistics was named the Top 10 3PL from Inbound Logistics for their sixth year in a row; a Quest for Quality winner from Logistics Management for the fifth time; our Top Innovative 3PL from Global Trade Magazine; and the Top 100 Best Supply Chain Partner by SupplyChainBrain. We are very proud to see Unyson flourish as a leader in the logistics industry, and believe we are well positioned to pass our $0.5 billion goal this year. Although Mode's logistics revenue increased to a more modest 3% year-over-year, it excelled in other ways, including a consolidated top line growth of 13% and 21% intermodal revenue growth. Also during the quarter, Mode continued to strengthen its pipeline of potential recruits and on-boarded 5 new IBOs and 4 new sales agents to the network. Additionally, during the quarter, Mode completed the launch of a new suite of analytical dashboards for its network of independent business owners. The dashboards provide metrics and alerts to help our IBOs manage their business and improve financial results. In other positive news. Hub Group was honored to once again receive the SmartWay Excellence Award from the U.S. Environmental Protection Agency. We are proud to be at the top of the environmental advocacy movement in the transportation industry and we'll continue supporting the cause, be it by growing our fleet of environmentally friendly day cab tractors or encouraging our customers to consider intermodal conversion options. At this time, I will pass the call on to Terri for the financial details of our quarterly results.

Thanks, Mark, and hello, everyone. As usual, I would like to highlight 3 points: first, the tough intermodal operating environment with poor rail service and driver availability issues hurt Hub's gross margin; second, Unyson Logistics had a solid quarter with 18% revenue growth; and third, on a high note, Mode delivered another quarter with 2.9% operating margin. Here are the key numbers for the third quarter. There were 2 unusual costs that I want to explain. First, as we reported in our 8-K, we had a $10.3 million charge related to claims alleging the owner-operator drivers in California were misclassified as independent contractors. This includes $9.3 million in settlements for individual drivers and $1 million of related legal, communication and implementation cost. Second, there was an $11.9 million charge related to writing off software development costs for OneSystem since we decided to terminate the project. All the numbers that I'm going to report today are adjusted to exclude the $10.3 million and the $11.9 million charges, which represents a total of $0.37 per share. Hub Group's revenue increased 3% to $913 million. Hub Group's diluted earnings per share was $0.49 compared to $0.50 last year. Now I'll talk about details for the quarter, starting with the financial performance of the Hub segment. The Hub segment generated revenue of $692 million, which is a 2% increase over last year. Let's take a closer look at Hub's business lines. Intermodal revenue decreased to 2%. Intermodal volume was down 4% and fuel was down slightly. Price and mix combined were up. The good news is that price increased sequentially as the quarter progressed. Loads from consumer product customers were down 10%. Loads from paper customers were down 32% and modes from durable customers were down 7%. These declines resulted partially from pricing actions we took to improve freight mix. Rail service issues, which triggered capacity shortages and lack of dray power in key markets also contributed to the decline. We estimate the volume shortfall due to these rail service and dray issues cost us about $0.02 per share this quarter. Truck brokerage revenue was flat. Price, fuel and mix combined were up 12% and were offset by a 12% decline in volume. Length of haul increased 10% to 704 miles. Logistics revenue increased 18%. This increase is due to growth from customers that we on-boarded last year and existing customers. Hub's gross margin decreased by $3.1 million. Intermodal gross margin was down because of rail service issues and higher drayage cost. Rail service severely impacted our third quarter results. Rail service deteriorated further in September to the lowest levels we've seen all year and it continued to decline in October. Slower train speeds and late trains hurt our fleet utilization by 1.4 days and caused us to incur higher repositioning and accessorial costs as well as more empty miles. Service problems were compounded by chassis shortages and insufficient gate reservations on the West Coast. We estimate these rail service issues cost us about $0.07 per share in the third quarter. Higher drayage cost also negatively impacted our third quarter profitability. In late August, we changed our driver model in California from independent contractors to employee drivers. While many of our independent contractors accepted job offers, we thought that a higher percentage of the independent contractors would accept the offers. In order to fill the gap and ensure we met customer expectations, we flew in over 50 drivers to California from other markets and rented tractors for them. We also paid higher cost for third-party drayage carriers. We estimate these actions cost us about $0.02 per share in the third quarter. Truck brokerage gross margin declined because of lower value-added services. Helping offset some of these declines was an increase in logistics growth margins due to growth with customers we on-boarded last year and existing customers. Hub's gross margin as a percentage of sales was 9.3% or 60 basis points lower than the third quarter of 2013. Intermodal growth margin as a percentage of sales was down 90 basis points due primarily to poor rail service and increased drayage cost. Truck brokerage gross margin as a percentage of sales was down 80 basis points because of higher purchase transportation costs and lower value-added shipments. On the plus side, logistics gross margin as a percentage of sales was up 50 basis points due to more cost-effective purchasing. Hub's cost and expenses decreased $700,000 to $41.2 million in the third quarter of 2014 compared to $41.9 million in 2013. This decrease primarily relates to lower bonus expense. A significant portion of our bonus is tied to earnings per share. Because we are not meeting our EPS goal this year, we do not expect to pay any earnings per share-based bonus. As a result, this quarter, we reversed the $3.3 million of EPS-based bonus that was accrued at the end of June. Bonus expense was down $2 million year-over-year, while salaries and benefits were up $1.4 million due to annual increases and higher headcount. Finally, operating margin for the Hub segment was 3.3%, which was 40 basis points lower than last year's 3.7%. Now, I'll discus results for our Mode segment. Mode had a solid quarter with revenue of $245 million, which is up 13% over last year. The revenue breaks down at $123 million in intermodal, which was up 27 -- 21%; $87 million in truck brokerage, which was up 7%; and $35 million in logistics, which was up 3%. Mode's gross margin increased $3.2 million year-over-year due to growth in intermodal and truck brokerage. Gross margin as a percentage of sales was 11.9% this year and last year. Mode's total cost and expenses increased $2.1 million compared to last year, due primarily to an increase in agent commission. Operating margin for Mode was 2.9% or 20 basis points higher than last year's 2.7% operating margin. Turning now to headcount for Hub Group. We had 1,473 employees, excluding drivers, at the end of September. That's down 8 people compared to the end of the year -- end of June. Now I'll discuss what we expect for 2014. Our financial results for September were worse than we projected at the time we filed the 8-K because of higher-than-expected driver attrition in California combined with further deterioration of rail service in September. We project that our 2014 diluted earnings per share will be between $1.69 and $1.74. This excludes the onetime cost associated with the driver settlement and the technology write-off. Our guidance assumes that rail service does not improve nor deteriorate, and that the increased drayage cost we saw in the third quarter will continue into the fourth quarter. We project intermodal volume will be down between 3% and 7% in the fourth quarter. We think we'll have about 36,850,000 weighted average diluted shares outstanding. Our cost and expenses will probably range between $66 million and $68 million in the fourth quarter. Turning now to our balance sheet and how we used our cash. We ended the quarter with $93 million in cash and $72.6 million in debt, including $19 million of capitalized leases. We spent $29 million on capital expenditures this quarter, including $18 million for tractors, $6 million for containers and the remainder for technology and investments. That brings total year-to-date capital expenditures to $76 million. Estimated capital expenditures for the fourth quarter are between $55 million and $60 million, approximately $18 million just for tractors and $32 million just for containers. Just as we've done all year, we intend to finance these purchases with debt. I'm happy that our board has authorized a $75 million share buyback, which expires in December of 2015. That wraps up the financial section, and I'll turn it back to Dave for closing remarks.

Okay. Thank you, Terri. Again, thank you for your participation on this call. We're obviously not pleased with the third quarter results nor our guidance for the remainder of 2014. However, we do believe that many of the issues that have negatively impacted our earnings are temporary and that they will be remediated quickly. Additionally, we believe that the rails are working diligently towards solving their service issues. As our report is demonstrating with the $75 million share repurchase authorization, we are bullish about our growth prospects and our positioning across service lines. And with that, Terri, Mark and I are happy to take your questions.

[Operator Instructions] And our first question comes from Ben Hartford of Baird. Benjamin J. Hartford - Robert W. Baird & Co. Incorporated, Research Division: I guess just to pick up where, Dave, you left off there at the end, believing that many of these issues are temporarily, which issues at the moment do you think are not temporary? I know there's a number of things that you have highlighted here. But which issues do you think are not temporary? Or things that you cannot solve at some point in time during...

Well, I think the major issue that we do not control is railroad service. The railroads have told us -- our rail partners have told us that they expect that they'll be getting back to normalized operation and normalized service by the spring of 2015. But that, obviously, as -- right now what they're doing is adding locomotives, adding crews, but that's the one area that's really beyond our control. Certainly, the drayage in Southern California is within our control. It's something we think is very fixable as well as just some of the inefficiencies that have resulted from the rail service. We do believe that as we get out of peak that, in fact, that alone should improve some of the rail service. Benjamin J. Hartford - Robert W. Baird & Co. Incorporated, Research Division: Okay. And if we are to believe what the rails are telling us that there should be improvement. But at some point in time during 2015, consistent with what you just said and eventually getting back to and exceeding 2013 levels, that service issue as well should be viewed as "temporary." It's just simply out of your control at the moment, is that fair?

That's the one thing. Yes, agree. Benjamin J. Hartford - Robert W. Baird & Co. Incorporated, Research Division: So in the meantime, how much can you control with regard to pricing? How much does pricing solve some of the issues that you're experiencing here? And now -- and maybe what is the approach, what is the mentality as you head into '15, thinking about price as they lever to solving some of these gross margin issues?

Well, I think there's a couple of issues that we have. I think, first and foremost, obviously, is price. We do remain very disciplined in our approach to bids. We really won't see many, of course, until the middle of the first quarter of next year. Most of the bids are done by now, but we'll retain the discipline. We do see, certainly, truck pricing as increasing substantially, probably in the 6% range. And we think that with the constraints that we're seeing with the rails, that, in fact, will be in a strong position. I would add also that we've also got just some internal areas that we can focus on and intend to. And Mark had talked about them a little bit in his prepared remarks, what we feel is that we can bring a lot of efficiencies and reduce our costs by actions that are taken in-house. And again, those are within our control and something we can do expediently. Benjamin J. Hartford - Robert W. Baird & Co. Incorporated, Research Division: Okay. And so kind of washing up the back half of this year, thinking about the first quarter and 2015, you mentioned that the first quarter should be a more normalized first quarter. But it sounds like, one, that 2015 will be a buildup if rail service doesn't normalize or begin to improve until the second quarter. But do you think that at 20 -- at some point in time during 2015, assuming that there is any discernible improvement in rail service, that you can have a gross margin trajectory that anywhere resembles what you might have thought you would have had at the beginning of this year as you looked into 2015?

Yes. I think we definitely feel that. If you try to take all of the costs associated with the network disruption out, we actually feel that we made progress throughout the quarter with pricing and that there is reason to be somewhat optimistic about the pricing environment, particularly with what's likely to be a tight capacity situation in the over-the-road market. So we think that we'll be able to work our way through a lot of these congestion issues and that, certainly coming into the next peak season, as long as we stay disciplined, there will be an opportunity for us to get price and to get back to enhancing our margins. At the end of the day, if we pulled all this away, I don't think you'd be unhappy with the pricing profile of our business right now. Benjamin J. Hartford - Robert W. Baird & Co. Incorporated, Research Division: Okay. And then the last one, I'll turn it over to somebody else. So just to think about the business strategically, there's a lot of concern. I mean, putting these issues aside, there's a lot of concern about how much gross margin and IMC you ought to earn in this type of environment. Are you confident that, given fixing some of these temporary issues and if we are into a capacity environment, the cycle that is meaningfully tighter than it has been in prior cycles and rates, truckload and intermodal rates continue to rise? That you can, from a normalized base, expand gross margins in the core Hub business? Is that a realistic frame of mind from an investor's point of view?

We absolutely see that we can. We're doing some things with pricing to change some of those processes and add some new tools that help us understand the market better. And yes, we feel like we can get back to more historic margin levels with our core product with intermodal, particularly given the market dynamics that are out there. But I think we're going to go into the year with a better understanding of the market. We're also going to go into the year with a better business base, a business base that isn't as price driven as we entered the year last year. So I think given that and the external industry dynamics and what we're doing internally with our own processes, we can go back and make some progress from a price perspective to get back to levels that we saw prior to 2011.

Right. And kind of as Mark alluded to earlier, if we hadn't experienced all the operational issues with rail service and the driver situation in California, we think our gross margin would be up, because we did increase customer rates to cover the cost increases. We were pretty happy with that. And in total, the rail and drayage use cost us about $6 million in gross margin. So had it not been for those things, we would be up.

And our next question comes from Scott Group of Wolfe Research.

So help us understand this price versus volume mix a little bit better. And because I understand -- I thought that the strategy entering the year was "We're going to be pushing pricing more aggressively and if we lose some volume, okay." But we're seeing the volume declines a lot worse than the pricing increases. So it doesn't seem like it's working. And we've got rail volumes that are growing and the other IMCs are growing volumes. So not sure what -- exactly what's going on. Why the mix of volume is down so much more than the price is up?

Go ahead, Mark.

Well, I'm not sure that's true, Scott. The area that we're down in volume predominantly is local East. And if you look at local East in the quarter, we improved margin on a per unit basis. We also improved the total margin dollars generated by our book of business in the local East. So there has been a tradeoff undoubtedly between price and margin, but I think that the pricing efforts have produced a better margin than we would have and a better outcome than we would've experienced if we had gone out and chased volume.

Let me just add that most of the price increases really came into play at the end of the third quarter, so that says a lot of the bids came through. And as far as the volume shortfall, again, that's going to happen when you're taking price and it's a direct result of that.

Yes. And I think the other factor you do have to take into account here is where we ended up also not hitting anticipated volume levels, largely because of the congestion issue, that being the Southern California market also happens to be our highest margin-generating, highest most profitable business. So when we -- and we ended up shrinking throughout the third quarter for rail service, congestion and dray power reasons. So we did not have as much of that in the mix as we would have otherwise anticipated.

It's really only the last 10 days that we've started to see an uptick out of Southern California year-over-year. So...

Right.

And so what kind of pricing you're seeing in the fourth quarter?

We don't have much new pricing kicking in, in the fourth quarter. It will just carry over from what we've had so far, because not that much business reprices in the fourth quarter. But year-over-year, we expect to see the same kind of price increase that we saw in the third quarter, Scott.

No. I guess I thought that Dave just mentioned that a lot of pricing kicked in at the end of the third quarter. So I just wanted to get a sense of what pricing's tracking up in the fourth quarter.

Yes. We don't disclose price increase numbers. But we did see a positive trend throughout the quarter, particularly in September.

Okay. And then Dave, just want to ask one for you strategically. So you've got several different businesses now between intermodal, brokerage and Mode and Logistics. And it seems like it's been tough to get them all working at the same time. Any considerations at the board levels -- are there parts of the business maybe worth looking into selling off and focusing on core businesses? Is there, maybe, any discussion of, "Hey, does it make sense to be part of a bigger company in total?" Just maybe give us some sense of how you guys are thinking about that at the board?

Okay. Well, obviously, we always do discuss, does it make sense to remain independent or part of a larger company? That's always a topic of our conversation. And we're always open to that discussion if it makes sense for ourselves, our shareholders and our other stakeholders. As far as the business units, and we have had discussion about should we -- is there business lines that we want to spinoff. Unyson has been very, very profitable and a great growth vehicle, and it also helps feed to some degree some of our intermodal and some of our truck brokerage. Plus, really, Unyson is very reliant upon our existing relationships in order to get along with their outsourcing activity. So it would make it a little bit more difficult to, in fact, divest that just simply because there is some overlap. Certainly, it's separate systems. Certainly, it's a different business. But there's certain -- there is also some relationship sales ties that are difficult to take out. From a Mode perspective, they've grown great. Jim Damman and his team have done a wonderful job. And the IBOs have done a great job in continuing to focus on their business and growing it over this period. It, of course, also is very separate, but we had no discussions about the potential for spinning it off.

And our next question comes from Kelly Dougherty of Macquarie.

I mean, just to kind of go back to a similar point we talked about. UP obviously reported really strong domestic intermodal volumes, up 13% this morning and pricing up 4%. I believe you're their largest intermodal partner. So can you help us think about how to reconcile some of those numbers? Just wondering if there's concern about losing relevance with them if you walk away from some meaningful business, I know most of what you're walking away from is not in the West. Or maybe help us think about how the issues in Southern California -- reconcile those numbers. Just a way to think about if there's any kind of change in your relationship with UP that's a little bit bigger than just what's going on right now.

Well, I mean, we certainly are, we think, a critical partner with UP. We are their largest intermodal customer and remain so certainly. We did grow local West, shrank a little bit in transcon, right? But by no means is there -- is the gap closing significantly. We, I think, are still one of their absolute anchor customers across the railroad, not just with the intermodal product. A lot of their growth is coming from premium service. Certainly, they're growing quite well there. They are doing some growth with the IMC community. But for 3 in the last 4 years, we have produced a lot more growth than their other channel partners. So we made a deliberate decision to exit some business that was not profitable. Most of that was not in the UP. We certainly would've grown better with the UP if we would not have seen these service issues, if they would've been a little bit more forthcoming in helping us reposition our boxes into critical markets, if they would've let us in the gates, if they would have not left our boxes on the ground. So to a certain extent, some of that volume growth is attributable to them not necessarily stepping up and helping us the way we wouldn't have liked to have seen. But nonetheless, we continue to have a strong relationship with them and we think they're -- we're a critical partner of theirs and they're a critical partner of ours.

And I appreciate that color. And you've kind of worked out these issues with them, of them being a little bit more supportive in moving things around and getting you access? I mean, was there others that they are putting in priority or their own stuff? Like, can you just kind of help us get some comfort about why it's going to be much better going forward?

Yes. I mean, honestly, we don't know if we were given the correct level of preference here. We did have trouble getting chassis, for example, for boxes that were stuck at the Port of L.A. That was extremely frustrating. We know that their volume was up out of L.A. So we would have liked to have seen better chassis support in L.A. On the positive side, they have rectified that situation. They've also corrected much of the other issues that I was just talking talk about. On-time performance remains an issue, LOGs remain an issue. However, gate reservations are not an issue and repositioning is not an issue right now. So they have resolved a number of these issues and made some progress and worked better with us in the last couple of weeks. But it still remains a challenging environment, and I think you always think that you should get better treatment than what you're typically getting. But at the same time, we are trying to make the best of the situation and make sure that we're covering our customers freight and maintaining our on-time performance levels in the 90s, which we have been able to do.

No, that's fair enough. I just have one other quick question then on the load balancing dispatch system that you guys decided to go a different route. How integral was that system in your expectation to be able to improve margins going forward? Because I think you talked about feeling confident and being able to get back to the levels you thought you'd be at if some of the service issues and dray issues went away. Just wondering what we should think about if you kind of have to go back to the drawing board with it?

Yes. I mean, we put a lot of effort and a lot of time and a lot of resources into OneSystem and it is unfortunate. And it was a critical component to our strategy to reduce empty miles, which is a significant way for us to lower our cost. There's no question about it. We learned a lot during that process and we learned what we need. And one of the good things is we believe that there are now products out available in the market that did not exist 3 years ago that can serve many of those purposes and can help us reduce empty miles. So we've got some process changes that we can implement very near term, and then we can go out into the marketplace and secure that kind of intellectual capital that was really associated with OneSystem in a much more efficient manner. I mean, it's something we think that we can got done in months, rather than years. Certainly, probably not something that would be helping us reduce empty miles next year, but something that would be in the process of on-boarding at that point in time. So unfortunate outcome, right? It was definitely a part of our strategy, but we're working our way around it.

And our next question comes from Todd Fowler of KeyBanc Capital Markets.

I guess I wanted to focus a little bit on the fourth quarter. And based on the updated full year guidance, I'm coming up with a range of $0.36 to $0.41 for the fourth quarter, so a deceleration from where you were in the third quarter. And it sounds like the volumes are going to be down a little bit more than what they were in the third quarter. Is that just the expectation that the service is getting worse and the costs are continuing on the dray side? Or is there something else that's happening related to volumes as we move to the end of the year?

No. I think that the volume is what we're expecting, just from our business that we've had over the prior 9 months. So it really is nothing other than that. And we're not expecting the rail's service to deteriorate. We don't think that's a fact. We don't think that, that will occur. If anything, I think, we might see some slight improvements as volumes have a tendency to tail off. I would suggest though, we do expect higher costs in Southern California. We -- actually, today, I think we have 64 drivers from out of town that we're paying for their -- in addition to their normal wages, we're paying a stay bonus and a variety of other things. So there's a lot of expenses. But we've made commitments to our clients. And basically, we're investing, if you will, by spending this -- having this additional expense in those client relationships.

Yes, let me give you a little more color on the fourth quarter, Todd. Rail service issues could range between $0.07 and $0.10 this year for worse utilization as compared to last year. Volume shortfall is more empty miles than higher repositioning costs. The cost of driver availability issues in the fourth quarter in California could have between $0.03 and $0.06 a share impact, and that would consist, like Dave said, of the unusually high cost associated with flying the drivers into California from other markets, paying third-party drayage carriers, higher costs and then short-term leases on trucks, which are expensive as well as the additional maintenance. So we think that those costs will go down in 2015 as we hire more drivers, reduce maintenance with more cost-effective trucks and work with third-party drayage companies to more cost-effectively outsource drayage. So in total, the cost of the rail service issues and the driver availability issues in California in the fourth quarter are estimated to be between $0.10 and $0.16.

Got it. Okay, that helps, Terri. And then just a follow-up, Dave, we're coming up on the intermodal bid season. And it seems like there's a lot of things that have been happening to your business in the second half of this year. What is your approach to bids? I mean, do you look at 2015? And is it a year where you can grow in line with what the market's growing into it profitably? Or do you have to focus more on the network and make sure that the business is running the way you want it to before you go out and try and take on additional volume in this environment?

I think that we can get back to what the industry is growing at in relatively short order. We're going to have a 2, 3 month lag here before the bid season really kicks in. That will also give us time to implement some of the enhanced processes that Mark had talked about before. And we are -- we feel very comfortable that we'll be able to get back into a growth mode at a profitable level, which is a critical component. We'll continue to stay very focused on price in addition to controlling our internal costs.

And our next question comes from Alex Vecchio of Morgan Stanley.

It's Alex in for Bill Greene. One of the things that some of the truckload carriers have been talking about recently is the benefit from lower fuel for their -- for truckload over intermodal. I just wanted to get your guys' thoughts on how much of a risk do you think is lower fuel, assuming it persists going forward? How much of a risk is that to the intermodal growth dynamic for you guys?

I would suggest to you that even if fuel goes back down to $1 a gallon, that with the current driver situation, that I don't look for an awful lot of renewed competition from over the road in intermodal lanes. It just -- does not going to make any sense over the near term. And I don't think that they can build the driver capacity quickly enough on lanes that might be over 1,000 miles.

Okay, okay. Got it. And then just sort of switching gears a little bit. Just want to get your thoughts on the net container additions. I think you talked about adding 1,500 net increases for year-end. But your utilization is down and it's -- and I'm just trying to understand why are you increasing your CapEx and your container additions if your utilization is going down?

Yes. Our utilization is not down because the boxes are sitting idle. Our utilization is down because service is taking a lot of days out of our ability to cycle the boxes. So if anything, we actually need more capacity right now in this circumstance to handle the same number of loads. To give you a little example, to complete a circuit as we think about it, positioning boxes, so a box from Chicago to Seattle repo down to L.A., L.A. back to Texas, that's a cycle that's kind of fixed into our strategy and it's a cycle that should take about 22 days. It was taking over 60 days this quarter to get that done in many instances. So that kills your box utilization. So we really actually feel like we need those extra boxes. And we're also confident that this has -- as this gets more normalized, we're going to certainly be able to fill those boxes. We turned down a lot of loads in the third quarter because we did not have boxes. Our volume levels would have been significantly higher under just normalized turndown conditions on the West Coast.

And our next question comes from Brandon Oglenski of Barclays.

It's Keith Mori on for Brandon. I just had a question at intermodal. I mean, clearly, there's a lot of network issues on the railroads, a lot of congestions, a lot of things that are outside of your control per se. Can you maybe talk a little bit about the things that you guys are doing internally to maybe improve utilization over the next 6 months? We know rail service is going to be an issue. You said it's going to happen until at least spring. What can we do between now and then to kind of get better outcomes in that segment?

Yes. I mean, there are some questions. We're doing a few things. Some of them are very near term, some of them are longer term. On the very near term, we're working very closely on coordinating our process flows all the way from customer service, all the way to load planning to carrier to driver management, right? So we're looking at, for example, how we are setting appointments to make sure that we are optimizing the truck capacity that we have and also to make sure that we're picking the right empties from the right places to take and add the pools and things along those lines. So really looking at how we're managing empties, how we're managing dead days and how we're managing markets with the dray capacity that we have. The big thing that we've got that's currently in the works is satellite tracking, obviously. We're well underway there, and that will enable us, we believe, to take about 1 day out of normalized utilization. So I'm not talking about the 15 days minus 1 day, more the 13.5 days minus 1 day. That's something that will take a little bit longer. We probably won't really see the full benefits until 2016. But between now and then, we're working a lot on the operational processes that can help us eliminate dead days, can help us make sure that we're spinning the boxes as quickly as possible. So even if we don't see significant rail service improvement, there's a lot we can do with our own internal processes just to make sure that we're keeping those boxes moving and also to make sure that we're at the right price levels to make sure we maintain network balance and network fluidity.

Okay, that was really helpful. And then I guess another question is around next year's growth. We see intermodal could maybe be an issue until about mid-year. Truck markets are tight, that should be favorable for Mode looking forward. Should we be thinking that you can return to growth rates in the double digits next year? Or kind of what's your thought process on growth for next year?

I think that intermodal -- domestic intermodal probably will grow overall in the mid-single digit pace, and that's what we're targeting as well.

I guess a follow-up to that would be in the other segments with the truck brokerage. Are these segments enough to maybe help drive some incremental growth in earnings, while intermodal is kind of in-line with the market?

Next year?

Yes.

Yes, we think so. I mean, logistics has had great growth this year. And so we hope to continue that into next year into 2015. Truck brokerage has kind of been a work in progress and we're making a lot of changes. And so next year, hopefully, in the second half of the year, we would expect to grow.

Yes, I think the other segment, Mode, has posted some very solid double-digit growth as of late which, 3 years ago or 2 years ago, we would not necessarily have anticipated.

And our next question comes from Matt Brooklier of Longbow Research.

I wanted to follow up on truck brokerage market very tight. Good demand in general. You guys obviously had some headwinds on the intermodal side. One would think that maybe that would have also provided some opportunity to shift some freight from intermodal into truck, yet your volume was down on a year-over-year basis. And it sounds like you're doing a little bit more work to kind of improve things there. But I just wanted to get a sense for more color on what negatively impacted truck brokerage in the quarter. And then what are some of the things you're doing to improve that division? And then maybe how do we look at fourth quarter?

Yes, it was not a great quarter for Highway. There's no question to reiterate what Terri said, it's clearly a work in progress at this point. We have put a new team in place there in terms of helping to guide the model a little bit. The model itself, to be honest with you, Matt, is not really well-adapted to effectively operating in the spot market. It's not what they do, they're more carrier managers than they are spot brokers. That being said, clearly, they -- we're not able to bring out a lot of new opportunities at this point yet. We're working very hard to develop our carrier base more carefully and we're working very hard to be more selective in bringing business on. We've had a period the last 1.5 years, I think, where we brought some business on that, honestly, we weren't able to execute on. So we've been maybe too cautious, and maybe we missed an opportunity this quarter. We are confident that this is a team that can succeed -- they've succeeded with Highway in the past, and we think that they bring a good strategy to the table. And we will be able to perform well and perform a valuable service, particularly as people are more and more concerned about getting reliable capacity more consistent or sometimes more complicated business. So it's just probably not something that's capable of turning on a dime and capitalizing on tightness in a specific market scenario. Can we develop that capability? Maybe. That's probably not something we'll be able to fix near term.

Okay. But I guess -- I mean, is the thought process here that this tighter market and truck brokerage not performing as well and maybe being a little bit more contractual that, potentially, you reassess kind of what the business looks like, what the mix looks like and, potentially, you're doing more spot business on a go-forward basis? Or do you keep what you have in place and just focus on the execution portion of it?

I think we like it. We certainly -- there was a time when we had more capabilities to work the load board, the load board market, those kinds of things. We kind of got away from that, in all honesty, the last couple of years, as load boards really died. And we directed ourselves much more towards carrier management. So when things tightened up, we weren't necessarily in a great place to be able to capitalize on that. It's certainly a market we would like to build better capabilities around. And it's a market that, honestly, a lot of our big customers would like to see us participate more aggressively in. So it's definitely something that we're investigating.

Okay. And then the incremental outsourced drayage that's currently a headwind, and I think the 64 drivers that you've had to fly in from other markets, what's your sense as to how quickly you can kind of start to improve upon that? Can you start to accelerate finding replacements for the drivers right now? Or who are displaced and starting to starting to ramp down what you're doing in terms of outsourcing drayage? I'm just trying to figure out how long does it take? Is it 1 quarter, is it 2 quarters? Very tight driver market, I think, it would be difficult to replace all of them in a short period of time, but I just wanted to hear your thoughts on that.

Yes, sure, Matt. Absolutely. Well, I think you have to think about it as kind of steps, right? And probably, our first step is to get the guys who are here from out there, who are in L.A. from out of town home, right? And we're pretty confident that we'll be able to do that certainly by Thanksgiving, right? We want to get those guys back, right? Then we want to get rid of the expensive leased tractors, lease drivers, those kinds of things, because that's a much higher cost than outsourcing to traditional. Then we phase more and more out of the spot third-party dray business that we're currently having to buy and really direct a lot of it towards some key strategic dray partners that we're in the process of developing. So what we want to do is phase out those other higher cost option, really concentrate on adding company drivers, but also having a much closer relationship with a select few dray partners to handle consistent bundles of business for us. So we think that will enable us to have an adequate driver supply in place going into 2015. You've also got -- that market really does slow down quite a bit, which will help us. So we don't think we're that far away. We don't think it's multiple quarters. We think we can go into 2015 with our cost much more normalized in that market.

And I would add also that despite the fact with the company drivers, we do believe that we can add them, we pay a very good wage. And in addition to that, if you think about just from lifestyle perspective, our drivers are home every night. And so I think that, that's part of the issue with the over-the-road issue that they just -- it's not an attractive lifestyle. And certainly, driving a truck is a hard job. But certainly, if you're home every night, it makes it a lot easier.

Yes. And we do think it's leveled out and we're now in the building process. We've even seen some of the guys who went, who decided to leave, come back.

Yes, so we're hoping to see more of that as well.

And our next question comes from Kevin Sterling of BB&T Capital. Kevin W. Sterling - BB&T Capital Markets, Research Division: [Question Inaudible]

[indiscernible] California was the place where the law seemed to be evolving the most rapidly. It is something that we are in the process of watching. I think you guys have seen there have been some -- the decisions in some other circuits that give us some concern. But there's no plans immediately to make any classification changes or to make any model changes at this point in time.

It really is a state-by-state issue and with California being the most extreme. But -- so we're just looking at each state and determining what our course of action should be, right? Kevin W. Sterling - BB&T Capital Markets, Research Division: Right. And I'm sure California, I imagine, is probably your biggest state in terms of drivers. Is that fair?

No. Actually, it's not. Texas would be larger and Illinois would be larger as well, would it not?

Yes, I think Illinois has a bigger tractor count. Kevin W. Sterling - BB&T Capital Markets, Research Division: Okay, all right. And then a lot of discussion about the rail service issues. What would -- what are you -- what's been the biggest impact on your operations? Is it utilization? Is it having to do more over the road? If you had to kind of rank them, what's the biggest, I guess, negative impact?

Rail service issues, we estimate, cost us about $0.07 this quarter. And certainly, a part of -- the biggest part of that would probably be utilization then repositioning costs, accessorial costs, more empty miles. And those are the main buckets.

Yes. And that doesn't take into account all the lost business.

Correct. That's another $0.02 of volume shortfall.

Right. Kevin W. Sterling - BB&T Capital Markets, Research Division: Okay, all right. And last question here. You talked about scrapping your in-house system that you're trying to build. If there's one thing you could put your finger on that went wrong, what would that be? Is it maybe just collection of data? Or is there something else there that really kind of gave you decision -- where you made the decision to scrap it?

Yes. I mean, the real problem I think lies at the very root, and it was an early decision that was made. I think we decided on a very complex approach and a very complex architecture. And I'm not a systems guy, so I'll probably get this completely wrong. But the reality of what happened, as we took it out into the field, we could see that the linkages between the modules wasn't functioning correctly, right? But what we also observed was that the way we had built this system was very complex and required a lot of interaction between different databases and some very complicated tools were at the base of that architecture. And we reached the conclusion that even if we fix these linkages, it's very possible that this architecture will never have the kind of stability and responsiveness that we need to manage our business. So unfortunately, I think those mistakes that ended up forcing us to abandon this project were made very, very early on in the process.

And our next question comes from Justin Long of Stevens.

And Terri, I just wanted to follow up on the EPS headwind, all-in from the service issues and drayage in the fourth quarter you talked about that being $0.10 to $0.16. I just wanted to make sure I was clear on the all-in impact in the third quarter. You said $0.02 from volume, $0.07 from rail service and an additional $0.02 from drayage. Is that correct that it was an all-in $0.11 impact in 3Q?

That's exactly right.

Okay, great. And I know you're not going to give 2015 guidance until next quarter, and there are a lot of moving pieces that we've talked about. But could you just speak to your level of confidence at this point? And you can start to see earnings growth start to inflect higher next year versus the flat-to-down trends we're seeing right now?

Yes, we really haven't even finished our budget for next year yet. So we don't want to give guidance on that until February, when we release our earnings for fourth quarter, because there's a lot of moving parts and it depends on rail service. And so rail service, as Mark and Dave mentioned earlier, not projected to get better until the spring. So we have that headwind in the first half of the year. We don't know what kind of winter we're going to have. So realistically, we won't -- and we won't see any growth from bids and new pricing until the second half of next year. So we think that we'll have volume growth in the second half of next year, but probably not in the first half of the year.

Okay. And one last one, if you don't mind. I know this year has been a heavy CapEx year. But as we return to a more normal level of CapEx over time, how are you thinking about the potential free cash flow of the business? Is there an easy way to kind of talk about that?

Sure. Well, we have a share buyback authorization in place for $75 million. And certainly, we intend to execute on that opportunistically. And then our first use of cash though would be acquisitions. So we're still -- have -- we've seen some interesting things in the market. We're looking for something that would be complementary to our service lines, a good cultural fit, immediately accretive and not a fixer-upper.

And our final question comes from Scott Group of Wolfe Research.

So I was hoping maybe -- we talked through a lot of issues on this call between rail service and drayage and drivers and I think a few other things. Maybe Dave or Mark, can you just go through each one, one more time and just give us a sense which one is -- go through each one. Is this -- is it getting worse right now? Do you feel like it's stable right now? Or do you think -- or any of them improving right now? It's just not clear to me what's still getting worse and what if anything is stable and maybe there's something that's starting to get a little bit better at this point.

Well, sure. I mean, I think the thing that's gotten -- the things that have gotten better are some of the issues we were talked about with being able to reposition boxes, being able to get in the gate, being able to get chassis support. Those things have gotten better, there's no question about that. Right now, rail service has not gotten better as of yet. We've had some fits and starts and some -- a little bit of improvement here with a step back there. So it's hard to say. Within the fourth quarter rail service does not -- is not trending well. And it certainly didn't trend well throughout the third quarter. So we think that fix is still something that's out there in the 2015 world. From a dray perspective, the costs are going to be ongoing at least through Thanksgiving, when we can start to bring some guys home and end some things along those lines. So I think while we're not losing more drivers in that sense it's leveled off, we have certainly continued to incur some unusual expenses, just to make sure that we can meet our customer requirements. Utilization is -- I would suspect is going to get a little bit better over the course of the quarter. But then you hit December and, of course, that's never a good month from the utilization perspective. But it'll probably be more normalized compared to last year at this time. So end of the day, I think that's kind of where we come out. The one that I would say appears to be improving, which we are optimistic about, is pricing.

And we have no further questions at this time. I will now turn the call back over to David Yeager. Please go ahead.

All right. Thank you again for joining us on the call today. Certainly, as always, if you have any additional questions, Terry, Mark and I are available at any time. So again, thank you for your participation today.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.