Q2 2019 Earnings Call
Please standby.
Good morning, and welcome to the second quarter 2019 conference call for old Dominion freight line today's call is being recorded and will be available for replay beginning today and through August 2nd by dialing 7194 or 570 820.
The replay pass code 7082 to one one.
The replay of the webcast may also be accessed for 30 days at the Companys website.
This conference call may contain forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995, including statements among others regarding old Dominion's expected financial and operating performance for this purpose any statements made during this call that are not statements of historical fact may be deemed to be forward looking statements without limiting the foregoing. The words believes anticipates plans expects and similar expressions are intended to identify forward looking statements.
You are hereby cautioned that these statements may be affected by the important factors among others set forth in old Dominion's filings with the Securities and Exchange Commission and in this morning's news release and consequently, actual operations and results may differ materially from the results discussed on the forward looking statements.
The company undertakes no obligation to publicly update any forward looking statements, whether as a result of new information future events or otherwise.
As a final note before we weekend, we welcome your questions today, but ask in fairness to all that you limit yourself to just a couple of questions at a time before returning to the queue. We thank you for your cooperation.
At this time for opening remarks, I would like to turn the conference over to the company's President and Chief Executive Officer Mr., Greg Cannon. Please go ahead Sir.
Good morning, and welcome to our second quarter Conference call.
With me on the call today is David Congdon, our executive Chairman and Adam Satterfield, our CFO .
After some brief remarks, we will be glad to take your questions.
I'm pleased to report the Eau de team delivered solid operating results.
And financial results for the second quarter of 20, not team, including several New Company Records.
We recorded our highest quarterly revenue of 1.1 billion and our highest quarterly earnings per diluted share up $2.16.
We also improved on our industry, leading operating ratio.
80 basis points to 77.9%.
Well, we have seen general softness wouldn't the man and the economy continues to give us mixed signals.
We believe we're continuing to win market share and are maintaining our pricing discipline, while doing so.
Our ability to win market share even in slower periods is based on our superior service offering delivered at a fair price.
Our all time service performance was 99% in the second quarter, while our cargo claims ratio remained at 0.2%.
In addition to providing the superior service metrics, we also improved the productivity of our operations.
Our PMT shipments per hour improved 1.6% in the second quarter, while our dock shipments per hour increased 5.4%.
Our line haul laden load average decreased by 1.6%.
This metric was affected by the decrease in weight per shipment.
The service and productivity metrics reflect our team's outstanding execution of our long term strategic plan.
Ive been particularly pleased with the flexibility of our team and our business plan over the past couple of years.
We responded to the material acceleration in volumes that occurred in late 2017 through 28.
And are now responding to lower than originally anticipated volumes this year.
Managing through both the ups and downs with the business cycle, it's not easy.
So the consistency in our service and financial result has been remarkable.
We have never wavered from our commitment to service the spot the associated costs.
Due to the support it provides for our ability to maintain pricing discipline.
The importance of yield to our financial results couldn't be more apparent than it was in the second quarter.
We have said many times before but the keys to producing long term margin improvement include a combination of density and yield with the support of a positive economy and stable pricing environment.
All the macroeconomic conditions were not ideal.
The strength of our yield performance and improve productivity more than offset the loss of density and operating leverage during the second quarter.
Which has allowed us to improve our operating ratio to a new company record.
As we look forward to the second half of 2019, we will continue to focus on controlling our cost.
We anticipate the softer demand to continue although it is important to note that we are well positioned to respond to any acceleration in volumes that might occur if the domestic economy regains momentum.
Regardless of economic environment, we will continue to execute our long term strategic plan <unk> by providing our customers with superior on time claims free service at a fair price.
We will also continue to make significant investments in capacity technology and training and education of our oddi family of employees.
While these investments may increase expenses in the short run.
We have demonstrated how ongoing investment in our sales is critical to achieving long term market share with solid returns.
Consistent execution on our business fundamentals has helped us create one of the strongest records of growth and profitability in the LTL industry during periods of both economic expansion and contraction.
As a result, we're confident in our in our ability to continue winning market share and its long term prospects for further profitable growth.
And increase shareholder value.
Thanks for joining us this morning, and now Adam will discuss our second quarter financial results in greater detail.
Thank you, Greg and good morning.
Oh, Dominion's revenue increased 2.6% to $1.1 billion for the second quarter.
The combination of the increase in revenue and 80 basis point improvement in our operating ratio allowed us to increase our diluted earnings per share by 8.5% to $2.16.
Our revenue growth for the quarter was driven by the 9.5% improvement in LTL revenue per hundredweight.
Our LTL tons per day decreased 6.3% as compared to the second quarter of 2018 with LTL shipments per day decreasing 2.6%.
These decreases reflect the softer environment for freight and we also believe that some volume loss was due to our long term consistent approach to pricing.
We expect our LTL weight per shipment in the second half of 2019 to be more consistent with the same period of last year, which will also have an effect on a revenue per hundred weight.
On a sequential basis the trends for both LTL tons per day, and LTL shipments per day are both both below normal seasonality in the second quarter.
As compared to the first quarter of 2019 LTL tons per day increased 2.9% as compared to the 10 year average increase of 8.2%.
LTL shipments per day increased 3.7% as compared to the 10 year average increase of 7.5%.
For July our volumes are trending below normal seasonality, although our yield trend is holding steady in terms of the actual reported revenue per hundred weight.
We expect that our volumes to be a little weaker based on how the first month of each quarter is trended since July of last year as well as the way the holiday fell this year.
The actual growth rate in our revenue per hundred weight is lower than the first half of this year. However, due to tougher compares.
With the third quarter of 2018.
A decrease in the growth rate was expected and we want to ensure that this is in no way misinterpreted as it changed our long term pricing philosophy.
We will continue to target increases that offset our cost inflation. While also supporting our continued investments in technology and service center capacity.
We will provide actual revenue related details for July and our second quarter Form 10-Q .
Our second quarter operating ratio improved 80 basis points to 77.9% as a 110 basis point improvement in our direct operating cost as a percent of revenue more than offset the increase in overhead expenses.
Greg detailed the improvements in protein productivity, which resulted in a 70 basis point improvement in our productive labor cost.
Operating supplies and expenses also improved 80 basis points, primarily due to lower fuel costs.
Our aggregate overhead cost as a percent of revenue increased 30 basis points, primarily due to the 40 basis point increase in our depreciation cost.
Given the significant investments we have made in capacity and technology and the de leveraging effect of lower revenues, we expect our overhead costs to be pressured as a percent of revenue for the remainder of the year.
Well the minions cash flow from operations totaled $255.7 million and $461.9 million for the second quarter and first half of 2019, respectively capital expenditures were $159.2 million and $230 million for the same periods.
We continue to expect total capital expenditures of approximately $480 million for this year.
We returned $147.8 million of capital to our shareholders during the second quarter.
$192.2 million for the first half of the year.
For the year to date period. This total consisted of $164.7 million in share repurchases and $27.4 million in cash dividends.
The increase in repurchases during the second quarter, we completed our prior $250 million repurchase facility approximately one year ahead of schedule and began our new $350 million two year program.
Our effective tax rate for the second quarter of 2019 was 26.1% as compared to 26.2% in the second quarter 2018.
We currently anticipate our annual effective tax rate to be 26.1% for the third quarter of 2019.
This concludes our prepared remarks. This morning, operator, we're happy to work with.
Thank you if you would like to ask a question. Please signal by pressing star one on your telephone keypad. If you are using a speakerphone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment.
Again, Please press star one if you would like to ask a question and our first question today comes from Allison Landry with credit Suisse.
Good morning. Thanks.
So I wanted to ask one about pricing from the first quarter call. When you mentioned that at least on the fringes that you're seeing a little bit of a rational or aggressive behavior from some of your competitors just wanted to get an update on that if that's something that you saw persist in the second quarter. If there's been any any sort of change in the <unk> and the pricing landscape it sounds like the yields.
Yields our remaining steady, but curious on that on the competitive side.
Yeah. Allison this is Adam and we still see it is pretty consistent with last quarter and I think that when you look at our yield trends.
Certainly they were are very consistent with the first quarter as well and.
Going out we said it in our prepared remarks on the first quarter call that we view the environment is stable and.
You know things went maybe a little sideways as part of the Q in a but we continue to view things as stable and we're still getting consistent increases in our contractual renewals and so forth and steel.
See in our increases offsetting our cost inflation, which is the primary target that a that we go after.
Each year as a contract is renewing.
Okay. That's helpful and then on the resource side. Since you guys were really ramping up on hiring through most of 2018, and now that demand levels or quite a bit soft or do you think that your sort of overall resource and you need to right size out of bed and how should we think about that in the second half in terms of headcount levels and what impact that may have on productivity. Thank you.
The Allison we have made the necessary cuts to re establish our labor and.
Tonnage levels, but that we're working currently working but we have made those adjustments. Obviously, we did if you look at our productivity gains.
You can't do that without making the labor adjustments. So we feel pretty good about where we are.
Going through the quarter and business conditions will dictate what we do with labor going forward.
Got it thank you.
And we'll take our next question from a Mitt mitts narrow trial with Deutsche Bank.
Thanks, Thanks, operator, I everybody congrats on the big Congrats I should say on operating performance in the quarter.
So I just wanted to ask about the weight per shipment.
[noise] comps, they obviously get easier and they're starting to get easier.
But shipments have now.
Taking taking a bit of a step down and Adam just curious about as you guys manage the cost structure.
Does the shipment driven decline in tonnage better allow you to adjust the cost structure and if you could just talk about maybe your ability to protect profitability if tonnage declines you're just being more disproportionately driven by shipments as opposed to weight per shipment.
Sure and shipments.
This is something we've been trying to talk more about this year, just given the disparity with the weight per shipment and the changes we saw from.
In the first half of 2018 compared to the second half but.
You know I think you can already see.
What the response has been.
We feel good that we saw some this loan last year and I felt like we got a little bit ahead of the cost curve that where our shipments were still trending positive.
In the first quarter of this year.
They turned to negative but.
Yeah, we talked about our head count coming in alignment with our change in shipments and if you look now and compare our head count where we were at the end of June versus where we were at the end of September were down right at 4% just that one point versus the other and when you look at the change in shipments per day and.
The second quarter of 2019 versus the third quarter of 18 were down in the similar type range is down about 4%. So we've got the head count pretty much in alignment with where shipments are as Greg just said and I think in doing so certainly we saw the improvement in productivity as we progress through this quarter in our direct cost performance as I mentioned.
You know, it's really been great. So we're seeing that improvement in our productive labor costs.
Well get some improvement in summer operating supplies and expenses and some of that is fuel driven.
But that's been been able to more than offset the loss of leverage that we've seen in overhead costs, Yeah and would you just just related to that I would have imagined you have some opportunity on the overtime side and the hour side and we didn't really see that come through just given salaries wages and benefits per employee were actually up a little bit I don't know if that.
Partly related to some inflation in fringe costs and the Phantom shares, but if you could just talk about your ability to maybe control hours prospectively from here just given the decline in the revenue trends.
I think thats what that benefit.
So in our.
Productive labor cost just the labor component.
Has improved 70 basis points as we talked about.
We did see a little bit of inflation, if you will and.
Our fringe benefit costs during the period compared so.
Yeah, we talked about and I mentioned, I think going into this year that I anticipated fringe rate around 34% and that's about where we were.
The second quarter last year, our fringe rate was 32.8% so.
We had a little bit a loss there and some of that was we had a little bit of favorability in the quarter last year and on the overhead side of our labor cost.
It's pretty flat from an overall standpoint percent of revenue.
That's because a lot of our compensation is performance based and so.
With or without the same type of growth and maybe some of the metrics. We saw last year, that's a little bit lower is there kind of coming out in the wash versus.
Fixed salaries and so forth and then that performance based fees right and just one quick follow up if I could just on pricing I mean, you've talked about yield, but Adam I was just hoping you could parse out within that yield what's what's actual same store pricing so to speak and what's the you know 'cause it because it's a little bit tough to figure out because of the weight per shipment and then just slight increase in length of haul not much but slight just trying to understand what the kind of core pricing is within that yield number.
Yeah, Yeah, we stopped given that contractual renewal number.
Primarily because I think that.
For us and maybe some of the other carriers as well and never necessarily seem to reconcile into what the components are but you know what I'll say is we always target revenue per shipment. That's what we're looking at is is the shipments we handle and the revenue for those.
Shipments and then the the cost per shipment and we're still getting our renewals.
Kind of in our long term target range that you know.
80 basis points to a 100 sort of north of cost inflation.
And we always would go through we look at what we anticipate cost inflation is going to be on a per shipment basis. Each year, and then we need that extra as we've talked about with the ongoing continuous investments in our real estate network and in our technology systems that where we try to drive operating efficiencies.
So we've continued to get increases you know, they're not as strong necessarily is what we saw last year.
But we didn't expect that coming into this year.
You know our pricing philosophy is more on an account by account basis in each accounts operating ratio should stand on its own and and a in some of those lower performing accounts, we got higher increases last year that we didnt necessarily thing, which are repeat so I feel good about the way our renewals are trending and certainly that's showing up and as the Big reason why I mean, Greg said in his comments, but the yield performance.
Is what drove this record.
Setting quarter for us both in revenue who are in ABS.
Right. Okay. That's all from me thanks for answering my questions I appreciate it.
And we'll take our next question from Chris Wetherbee with Citi.
Hey, Thanks, good morning.
If you just run through what the tonnage numbers looked like in the month of June I don't know if you had mentioned that before but it looks like they stepped down a little bit from what the quarter to date had been through May just curious what that number was.
Sure.
Yeah on the tonnage side.
We had a 7% decrease in tons and the month of June and that was after a 5.8% decrease in both April and May.
Then on the shipment side.
We had a 3.4% decrease in shipments per day in June .
And that followed a 2.1% decrease.
In April and a 1.9% decrease in May.
Okay. Okay. That's helpful. And then the July commentary, although you don't give the number the suggestion was the transition from Twoq to Threeq is a little weaker than typical seasonality would suggest.
It is and.
You know it seems like this trend is been in place now for the last.
Several quarters, but.
I think that our revenue trends have been really consistent as we progressed through the quarter, but.
We kind of start this first month.
Out of the quarter below.
Normal seasonality and it's been that way.
Since going back to July of last year.
And so.
We've been pretty well below.
In January and April this year and so.
But what we've seen is a consistency from the start to the end.
Yeah, So we'd expect to see things continue to build the July head of.
You know has a negative set up and like I mentioned.
We expected to see it a little bit weaker just the way all the days fail with regard to the holiday and continued through the month, but.
I would expect to see it pick up.
You know kind of back above seasonality in August .
Okay. Okay. That's very helpful. And then just mechanically as we think about the.
Revenue per hundred weight that you report and their relationship with the weight per shipment I think you mentioned that weight per shipment is going to begin to sort of move towards comparability or flat relative to the second half of last year, just mechanically that has sort of a negative impact on the revenue per hundredweight growth.
Can we just sort of walk us through or remind us sort of that relationship is it one for one as you see that sort of decline start to normalize the impact on the on the revenue per hundredweight.
Sure you know, there's no completely linear way to track and to adjust for.
Weight per shipment and.
The other mix changes, you've got length of haul and class of rate that.
That impact that reported metric as well but.
Typically and we're still seeing the the increases like I mentioned on the crap on contracts that are renewing and there's no one renewal period for us they are renewing and we're evaluating contracts every day as they come up.
So we would expect and historically, it's shown that you'd expect to see holding mix constant a little bit of an increase going into the third quarter out of the second and so with that said and based on the acceleration that we saw from Twoq to Threeq last year, just assuming a little normal acceleration.
In the actual reported number in the second quarter.
Going into the third and you know that may change that growth rate metric somewhere between the 5% to 6% type range.
Okay.
We have been able to double digits this year.
Yeah exactly.
Okay, great. Thanks, very much for the time I appreciate it.
And we'll take our next question from Ravi Shanker with Morgan Stanley .
Oh, Thanks, good morning, everyone.
So just.
On the on the dotted share I mean, youre youre done it just doesn't run negative for very long I mean, if you go back philosophy or just kind of usually for like four quarters in a row I think you already at that level.
Does it feel like tonnage is going to imminently flip positive in the second half and going into 2020 or do you feel like the macro environment as stew said far too uncertain to make that call.
It still feels a little bit soft and lower comparisons get a little bit easier in the.
Last part of the year, but.
Feels a little soft so we don't expect our tonnage to flip to positive.
But hopefully at the macro pickup in.
We'll have a better end than we expect but right now it just appears to be a little bit solved.
Consistent that's the good thing is it is really consistent day to day, but.
Stop seeing the levels that certainly that we did last year. This time.
And Robbie I'll just add is when you look at it all the macro economic numbers that.
That we pay attention to particularly on the industrial side.
Still showing growth.
But certainly that hasn't reconciled to the freight across the transportation landscape, but say in.
Not just to us.
But there is.
It's been hard to read the tea leaves because you've got a lot of metrics that suggest positive.
Trends and maybe not as strong as certainly as what we were seeing last year, but still all showing positive and.
I think the one bright spot in everything is the fact that the consumer is still healthy.
And and so theres a lot of good.
Economic data on that if you will and so.
In that regard as consumers keep consuming somebody's got to produce and ultimately ship that freight.
Got it that's really helpful and just maybe as a follow up to that.
When you think of what Youre or has historically done kind of in those negative dunnigan marmon sitting in 2016 year or did you already did but it but so far you've you've kept it improving.
Again, you spoke of a number of initiatives that you are putting in place.
Ah, but is your messaging here that you can continue to keep improving the or even a negative tonnage environment.
Again, obviously, if you go into recession, all bets are off but if it continues in the current environment or can keep improving.
Even with the tougher comps that you have.
Yeah Ravi the we've done it now for a couple of quarters.
And I think that I was pleased with the sequential operating ratio performance.
From the first quarter into the second.
We the operating ratio improved 410 basis points in the long term average is 440 so.
Comparing back to periods, where we've had slower revenue growth.
You know, it's sort of been in 350 basis kind of range. So.
I felt good about our cost trends there.
Typically the third quarter is very consistent with the second and long term. The operating ratio is typically up 20% to 30 basis points and so feel good with what we've done with respect to our call.
Certainly we've got a few other things that we can focus on.
With respect to saving some money and and protecting some of the costs there but.
Even at its worst kind of going back into.
Some of the periods in 2009 in 2015, it was a 60 basis point increase.
We've still certainly got more.
ER room, rather in terms of where we were last year in the third quarter to show some slight.
Or improvement and.
Yeah, that's definitely the goal for US is to continue to try to protect the bottom line to grow earnings and to improve the operating ratio.
Understood I just last one from me IMO 2020 is around the proverbial corner.
How are you guys thinking about that and maybe any ripple effect through the transportation space.
When that does happen.
So at this point.
We we are going to take the wait and see approach I mean, obviously, we're prepared for it for growth as it comes back.
As I mentioned in my earlier remarks, we.
We have continued to execute on our.
Gaining capacity our plan to gain capacity.
So I think we're in a good spot if in fact, it's better than we expected to be.
You know if it's not we'll make adjustments then proceed accordingly.
Again, I think we've proven that we can make the adjustments that we need to make in a positive or in a negative environment. So.
Hopefully with what we've done, particularly the last several quarters.
You know you see that we are able to do is.
Let's just hope that the things pick up.
Understood. Thank you.
And we'll take our next question from Jack Atkins with Stephens.
Hey, guys. Good morning, Thanks for taking my questions.
Greg I guess first one would be for you just curious.
You said things still feel kind of soft out there, but would be curious to know what you're hearing from your customers about.
Yeah, they're expected business trends in the second half of the year.
Yes yesterday on their conference call. So they expect is industrial production to be slightly negative in the fourth quarter.
You know you sort of aggregate your customer conversations over the past couple of months. How are you thinking about underlying business fundamentals heading into the second half of the year.
Yes relatively positive honestly for the most part of most of our major customers are fairly busy.
So.
Seems to be from that standpoint positive and that that makes you feel good. The other side of that is are things like our customers are extremely happy with our performance and what we're doing it I think that.
Has put us in a very very good position to continue to gain share.
As we go forward, but.
Oh that is definitely a positive our customers do seem to be busy and.
That's a good thing for the industry in particular.
Okay. That's that's helpful. And then following up on that Adam you talked about July being a little bit below normal seasonality.
But the expectation that August would maybe be a little bit better than normal seasonality.
Do you think about the third quarter in aggregate from a tonnage perspective is it your thought there were kind of at the point now where we should as a whole kind of return back to more towards normal seasonality. When we think about threeq versus twoq you or is it just too early to make that call.
Yeah, I don't think we want to.
The give that guidance at this point, but.
We'll continue to watch it and continue to adjust as we need to.
And one of the freight that we get.
Okay that makes sense. Thanks again for the time guys.
That.
And our next question comes from Scott Group with Wolfe Research.
Hey, Thanks, good morning.
So.
Adam your comment about weight per shipment flattening out is that something you're seeing in July is that is that where you think you're going to get to in the second half and then is it flattening out because it's starting to move up sequentially or is it just flattening out because the comps are just a lot easier.
The comp if you recall last year in June our weight per shipment was.
About 1600 20 pounds and then by July It was about 1500 60 pounds and most of that related to we were just getting in a lot of heavier weighted shipments.
Truckload spillover type of freight and we made some operational changes to try to control the exit of that freight versus letting it happened to us naturally and so we saw an immediate effect on our weight per shipment then and we've kind of been in this.
Sort of 1500 50, the kind of 15 80 ish.
Pound range flexing up and down and there is some seasonality aspect of that but yeah, I'd say that it's been pretty consistent this year, which has been another.
Bright spots that we hadn't necessarily seen that going any lower that you might expect from.
A read on the economy per se.
Okay in terms of pricing are you, saying that the competitive pricing environment, you start to see a little bit in first quarter is improving now or is it that it's the same but we're not freaking out about it as much as maybe we reacted last quarter.
And then.
Revenue per shipments been growing five 6% do you think that's sustainable in the back half of the year.
I would say on your your first question.
It's we're still saying it's stable just like we did last year or last quarter, rather and.
It certainly is a thing that that was coming off of two years of.
Favorable very favorable environment.
But so you know is very consistent with what we're seeing and from a revenue per shipment.
Standpoint.
Yeah, I would say ex fuel certainly that that continues to be the target coming into this year, we talked about.
Our cost per shipment expectation of somewhere around 4.5% and so.
Yeah, we want to continue to try to get increases on a revenue per shipment bases that are north of that we are and I think we'll continue to see that including fuel, though we do.
We've seen it in the second quarter and is.
Definitely continued into July where we're seeing fuel rates down versus where they were last year. So thatll be a little bit of a headwind on that.
Metric with the fuel and as well as just topline revenue performance in general.
Okay. Thanks, and just real quick I may have missed it did you say if you think headcount is going to be flat or down maybe up sequentially.
I expect it to stay somewhat flat through the.
The third and fourth quarter.
Okay. Thank you guys appreciate the time.
And our next question will come from Jason Seidl with Cowen and company.
Thanks, operator.
Morning, gentlemen.
In your non industrial business were any of your customers talking about the tariffs impacting them in the first half of this year from a pull forward perspective.
He certainly has been a conversation point.
Particularly customers, we visited several weeks ago out on the West coast.
Several of us and heard a little bit more of it out there, but overall, our retail business continues to perform well for us.
I think we've got a very good product many retailers.
That had been optimizing their supply chains.
Got programs in place that.
Really favor high service carriers and certainly.
That's been a big benefit for us and.
We've seen good growth.
And that element of our business, we call it or must arrive by date.
Business, but it is managing the on time in full type of programs that many retailers are put in place. So that's been good for us and.
Been a bright spot.
So is it safe to say that it is it's come up but probably not really impacted the one Q volumes that much.
Well, it's hard to say, yes, I think there has been an impact there, but we're just continuing to gain market share that maybe as offset any individual customer that may be feeling a little bit of pressure, but we're just we're continuing to gain market share.
And that piece of our business.
Okay Fair enough also theres been some bankruptcies in the LTL side in the last six months have you guys picked up much freight from what you can tell from.
Hi, there those bankruptcies.
We have picked up some but they were both very very small, but we definitely did pick up some we had.
Kind of a flurry of phone calls and opportunities from the get go.
Im sure Weve kept some of that business, but are most probably all the business that we initially took on but.
They're very very small so not I'm not a big impact, but we did get out a big okay.
And is that helps keep pricing somewhat stable in the LTL world.
Honestly I'm I'm not sure either of those were large enough to move the needle.
Okay fair enough listen I appreciate the time as always.
Thank you.
And we'll take our next question from Ari Rosa with Bank of America Merrill Lynch.
Hey, good morning, guys impressive results.
So the first question I wanted to ask you just talked about some of the capacity additions and the extent to which you think that might have a drag on the LR in the second half of 19 or going into 2020.
Certainly with incremental margins in the mid Fortys I think it might north of 50 this quarter.
Maybe you could address what you think of as the sustainability of those levels given given the capacity adds.
Well some of that incremental margin is just a function of the way. The math is working and we've we've talked many times before about the fact that we don't.
Managed the business to incremental margin were.
Independently trying to to put on revenue at a good though are in no way is trying to take cost out of the business and I think.
In the first and second quarters this year.
That that cost element is certainly.
Calls the benefit to that metric but.
Yeah, most of the capacity additions that we make don't have.
A huge impact and speaking of service center capacity, but have a huge impact on that depreciation line.
Certainly the the equipment.
Cost of added depreciation to us and.
We were anticipating growth in shipments.
This year and.
At least in the second quarter were seeing those down so our fleet is probably a little heavy versus where.
We'd like it to be and we cut $10 million out of our capex going into this quarter on the tractor side to help a little bit, but theres other carrying costs. Besides the depreciation on the fleet than we've seen some inflation there as a result and in some of that.
It kind of gets buried overall in the operating supplies and expenses, but but theres certainly been.
Some excess fleet.
Maintenance cost there is just we've got probably more tractors than.
Then we need at this point, but some of that will just transition as we go into 2020, and we'll be looking at what we think the demand environment and what our growth potential for that year will be and will somewhat get offset likely in our 2020 Capex plan.
Great that's great color actually leads well into my next question. So I'm wondering if talk little bit about free cash flow conversion.
Obviously that the net income numbers that you guys are putting up are quite impressive, but the free cash flow as trail that trial that a little bit and that's obviously, partly the nature of asset intensive businesses, but.
You know if there is a slow down do you think there's a little bit of an opportunity to maybe improve that free cash flow conversion and how much of an eye or you guys keeping on that.
Well it depends.
The easy answer to say, but.
One of the things that we look at will be what other opportunities may present themselves and.
What we've seen in slower periods in the past is that gives us an opportunity to potentially accelerate.
Some service center expansions and potentially some.
Opportunities of existing facilities and so we certainly are going to keep our eye open.
For those opportunities.
We got long term market share goals and we think we've got a long runway of growth ahead of us in that regard and that will require.
Significant investments in service centers, so we can accelerate some of that.
In a slower environment, where in the past other carriers have.
Maid service centers available then I think we'd certainly look at it.
Accelerating on that opportunity.
Okay, Great and just remind me I think we talked about it last call, but remind me, what's the target or the long term target in terms of where you might like to get to in terms of service center footprint.
Yeah that constantly changes right now I think we're at 235 service centers today and.
Kind of got a list of about 40 service centers or so.
But you know as we've gone through time, what we figured out is the company gets bigger.
The network plan and configuration changes and we've kind of figured out with growth that is more efficient for us to have multiple service centers and metro areas.
We've been doing some other operational changes around summer break bulk locations and.
Managing break versus local freight so theres theres multiple elements to it and we don't know what we don't know so.
Yes, I think we get smarter as we go when it comes to the configuration network, but we're trying to build it.
With with optimizing efficiencies both in our line haul in or pickup delivery operations.
My guess is is as we approach the.
The 275, it may be that.
Looking out further on on the growth curve that maybe it needs to be more than that but thats just one of those things that.
Right now we've got a line like the 275.
Okay sounds good thanks for the time.
And we'll take our next question from Todd Fowler with Keybanc capital markets.
Great. Thanks, good morning.
I think that you typically put in the annual wage increase sometime during the third quarter and I was wonder if you could share any expectations that you have from that for this year from a timing and magnitude standpoint.
Oh the same same timing is always we always give our annual wage increase effective the first Friday in September .
And that will be the same this year as well.
And Greg just from a magnitude with the labor environment and with what you're expecting on the pricing side is that something maybe.
Below where it's been in the past couple of years or how do we think about kind of the magnitude of what you'd be putting through this year.
It's going to be somewhat similar Todd but.
I don't really want to talk about numbers exactly there, but it will be somewhat similar to what we've done in the past.
We haven't now.
This internally yet so we're not prepared to.
You're not going to give us the first slug that that's fair, but Adam so with the commentary on the sequential our progression I think you said typically 40 to 50 basis points of deterioration threeq versus twoq.
Is that something that you know you would expect that would be embedded in kind of that thought process on kind of a typical seasonal change within DLR.
Correct.
Okay.
And then you know Adam you made the comment on the expectations for the fringe for the full year to be around 34% and it sounds like that Thats, you know you're right in that range for Q Q.
I think in the fourth quarter of 18, you had.
Yeah, it's a really difficult comp on the fringe side.
You know I know that we've got some of the year to play out but can you help us think about anything that we should factoring in for the second half on the French side that would.
Make the benefits be different then the 34% that you're thinking about or is that something you think you've got pretty good line of sight into at this point.
Well last year in the fourth quarter.
We had several favorable adjustments and typically the operating ratio was about 200 basis points higher in the fourth quarter versus the third.
Last year, it was only 30 basis points higher some of that was.
We go through an annual process of Actuarially evaluating or.
Certain insurance reserves, and we had favorable adjustments in our workers' comp in our.
Auto liability claims.
And we just had several favorable adjustments similar to that that rolled through that fringe line in the fourth quarter last year I think our fringe.
Benefit rate was.
Between 30% to 31%.
And that reflected.
Some of that favorability in the Workers' comp I think we had favorable group group health trends on that quarter and then.
Favorable.
Phantom stock adjustment as well so.
We just had a lot of favorability that rolled through that quarter. It and you never know which way some of those actuarial adjustments are going to go and that's why when you look at kind of that fourth quarter, while I mentioned, the second to third quarter.
Is very very consistent.
Year in and year out Theres more variability from the third to fourth.
Quarter for that reason.
Okay, but first starting point it sounds like we should think about fourth quarter sequentially versus third quarter and be careful for doing fourth quarter year over year comparison, just given the number of benefits in the fourth quarter of last year.
Right wouldn't necessarily expect those to they can go either way, but wouldn't necessarily expect the all of them come in in the same magnitude in.
And all in the same direction like they did last year that was.
A very unusual when you look at that third to fourth quarter of 18.
Type of performance.
Well, Greg gets his wish in the tonnage comes back we won't have to worry too much about those things I guess so.
Let us.
Hi, Thanks for the time guys I appreciate it.
And we'll take our next question from Matt Brooklier with Buckingham Research.
Hey, Thanks, Good morning, just going back to service centers I think you talked previously this year about opening or expanding on.
Six to 10.
Locations, Adam I'm, just curious to hear your thoughts about that number is if we're going to be at the higher end the lower end and if you have the service center count for a first quarter that'd be great.
At the end of the first quarter or.
We're currently sitting at 200.
235 service centers is what our current county is in.
Yes, just based on completion schedules, we think that we'll finish.
Another six service centers this year.
But as we talked about I think on our last quarter call. Some of those service centers, we may just defer the actual opening.
Of those facilities until we start getting into the normal ramp of freight in the spring of next year. So they will be finished and we will be ready.
This may not be that we.
Pull drivers and staff them up and so forth just keep things as they are.
And then move the operation.
In in early 2020.
Okay, so even with lower lower tonnage levels are you still committed it sounds like.
Opening up more.
Service centers is just the timing may be a little bit a little bit different than you had previously thought entering the year.
Of that total six two or three of those will probably.
Just be open and we will be open for business, but what's your committed in in these projects. They fit in the long term plan and that some of what we've talked about our long term plan is just that it's for the long term and and we think we've got plenty of revenue growth opportunity. The decisions, we're making now we're going to be helping us for the next several years and much like the investments. We made in 2016 was right when freight was slower.
Had we not made those expansion projects in the real estate team.
Completing the projects when they did we certainly wouldn't have been in a position to handle the increased revenue that we saw in 2017 and 2018. So we've got to keep those projects going we think they are they are critically important to our long term future and and we want to make sure we complete them and move on to the next location where.
We know that we've got some capacity needs and overall, we like to maintain about 25% excess capacity in the system and even with the.
The seven openings that we had in 2018.
And with the expectation of what we'll complete this year.
Our capacity excess capacity that is in about the 20% ballpark so.
We want to make sure that we keep these go ones.
These projects going and put ourselves in good shape.
From what we know the economy will will pick back up and certainly we.
I believe that our service will continue to drive market share growth for us.
Okay. That's helpful. And then we heard from some of the truckload carriers that the driver market actually is.
Become a little bit less competitive.
Curious to hear your thoughts I know, it's not an apples to apples comparison, but LTL market.
Drivers as the market gotten a little bit looser here and if so do you think that could be beneficial from a cost inflation perspective.
Yeah, we're certainly in good shape for drivers right now we're not we're not hiring other than maybe in a few selected locations, but we're we're really in good shape drivers.
Right now so we don't see that as an issue going forward.
We are continuing to train.
Some additional drivers, but at a slower pace than we did it last year, but.
We don't expect any issues from that standpoint it all.
Okay. That's helpful. Appreciate the time.
Okay.
And as a reminder, that is star one if youd like to ask a question. Our next question comes from David Ross with Stifel.
Yes, good morning.
Hi, Adam just to quick Nit to start on the communications and utilities line item that was down year over year I don't know if there's anything one time in there what the run rate should be going forward.
Nothing material that that's in there.
As any kind of adjustment.
Yes, there's always some.
Minor adjustments, one way or the other that kind of run through there as we may be moving into or out of.
One contract into another but.
That that expense remains relatively consistent quarter to quarter I think.
And so from here do you expected to be about second quarter level for the rest of the year.
It was a little bit lower than where we were in the first but.
So it may step up a little bit more.
You do have some.
Costs that will continue to come on board.
As we're looking at.
Yes.
I went out.
The.
Communication systems.
And gene over into a new platform, we've been working on that project this year and.
That may have caused a little bit as we're kind of in the middle of transition.
A little bit of reduction there in the second quarter, but so it'd probably be stepped up a little bit higher.
Absolutely that was.
Yes that was my next question just for some more color on your Hey, Ob already E.L.D. transition.
Where does that stand are you going to have it done before the deadline is it.
Going better than expected.
It's it's going good David.
As any project major project like this you rollout Theres always a few snafus here and there and we're working through those but but it's going well and we certainly expect to have it completed well before the deadline.
And does that change at all how you run the network did the LDS.
Essentially do anything different from an old dominion perspective than the will be ours did.
No Sir.
I will have the same communications abilities that we had.
No changes at all.
The Big thing for US is working through making sure we get all the the telematics type of information into our our own systems for evaluation.
You know tracked in the hours is the easy part it is all the data we get and what we do with that we want to make sure that.
We're not missing out on.
That's why you can't just plug them in and turn them on and go to work, it's a little more complicated than that but we're working through it we've got a pretty aggressive team on that project and we're working through it David.
Excellent. Thank you.
And we currently have no questions in the queue at this time I would like to turn it back to our presenters for any additional or closing remarks.
Well, we certainly thank you for all your participation today, we appreciate your questions.
And please feel free to give us a call. If you have anything further thanks and I hope you have a great day.
And that does conclude today's conference. Thank you for your participation you may now disconnect.