Dave Yeager - CEO Don Maltby - President and COO Terri Pizzuto - CFO.

Scott Group - Wolfe Research Ben Hartford - Robert W. Baird & Company Justin Long - Stephens Tom Wadewitz - UBS Todd Fowler - KeyBanc Brian Ossenbeck - JP Morgan Bascome Majors - Susquehanna Financial Group Jason Seidl - Cowen Ravi Shanker - Morgan Stanley Matthew Brooklier - Buckingham Research.

Hello and welcome to the Hub Group Third Quarter 2017 Earnings Conference Call. Dave Yeager, Hub's CEO; Don Maltby, Hub's President and Chief Operating Officer, and Terri Pizzuto, Hub's CFO are joining me on the call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

In order for everyone to have an opportunity to participate, please limit your inquires to one primary and one follow-up question. Any forward-looking statements made during the course of the call or contained in the release represent the company's best 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, and variations of these words. Please review the cautionary statements in the release.

In addition, you should refer to the disclosures in the company's Form 10-K and other SEC filings regarding factors that could cause actual results to 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, Allie. Good afternoon and thank you for participating in Hub Group's third quarter earnings call. With me today are Don Maltby, our President and Chief Operating Officer, and Terri Pizzuto, our Chief Financial Officer. For the third quarter, Hub had revenue growth of 13%.

The Hub segment reflected a 14.5% growth in revenue, with Mode growing at around 3%. All of Hub's business lines contributed to the revenue growth. Disappointingly, this positive third quarter revenue growth was offset as year-over-year operating income declined.

At the time of our second quarter earnings release, we believed that the market was showing signs of tightening and that pricing had bottomed. These signs are now reality, and over the past 6 weeks, we've experienced a normalized peak with tight capacity across our network. Volume is accelerating.

Despite flat intermodal volume in the third quarter, we are up 5% month to date for October. We believe that the capacity tightness in truckload and intermodal, even prior to the impact of the ELD mandate, will result in near term opportunities to increase price, with much stronger contract rates in 2018.

Historically, intermodal pricing lags over the road pricing by up to six months. It's our goal to take advantage of this pricing environment quickly and expediently, particularly with those clients whose business does not have an adequate return.

We're in the process of reviewing pricing for our transactional and contractual customers, and are in various stages of repricing that business. These actions over the past few months have resulted in our margin per unit increasing significantly, although it still remains below 2016 levels.

We intend to focus on increasing our margins from their current historically low levels, and we expect that the bid cycle in 2018 will reflect substantial increases in pricing and margin growth.

Due to the strong freight demand, capacity constraints, a severe labor shortage, and the mandated introduction of ELDs, we believe that this pricing cycle will be strong in 2018 and will likely extend through 2019. With that, I'll turn the call over to Don to go into more depth about the specifics of our business segments..

Thank you, David. As Dave mentioned, with the shift in the market combined with increased cost pressure, we are focused on improving yield. With that said, we intend to focus on increasing margins from their current low levels by increasing price throughout the 2018 bid cycle.

We of course will continue with our disciplined approach to price and service our business with targeted customers, focusing on the right markets to support our network needs. We believe our continued emphasis on the customer has not gone unnoticed, as our customers have presented us with numerous awards recognizing us as a leading service provider.

Although we are being recognized for our service commitments, overall our underlying rail service in the quarter was substandard. Both of our rail partners' on-time performance deteriorated to the point that we are changing transit expectations to our customers.

This not only harms our competitive position versus an over the road option, but also adds unnecessary costs to our operations and reduces fleet utilization. Unfortunately, we do not anticipate improvement in the near term. Now let's talk about the businesses.

In a very volatile market where we experienced severe weather related disruptions at the back end of the quarter, our truck brokerage came in with an impressive 17% top line growth, making this the fifth consecutive quarter of growth.

Our team continued to focus on delivering the highest quality of service to our customer base while at the same time providing emergency relief capacity to the affected regions. With retail peak now upon us and the ELD mandate effective in December, it is our belief that capacity will continue to remain extremely tight across the country.

In this changing market, we believe Hub is positioned well as we continue to focus on our strategic customers by providing value-added services throughout this constrained and challenging marketplace. Logistics continued its strong top line growth with a 14% increase for the quarter and 17% for the year.

Multiple on-boardings throughout the year, with concentration in the third quarter, challenged logistics with higher startup costs and margin compression due to the tight truckload market and customer mix.

We anticipate that we will maintain a higher cost structure through the fourth quarter due to the nature of the on-boardings, along with supporting the challenging capacity marketplace.

As these new on-boarded customers become more mature in our network, we will start to see a reduction in our cost structure while also leading to margin expansion for the business line. We do not anticipate this will occur until the first quarter of 2018.

We believe our logistics offering is well positioned to take advantage of organic growth along with new business opportunities. From a dedicated perspective, the Estenson integration, now branded as Hub Group Dedicated, is working extremely well.

We have a few small wins to date in the first 90 days, a new sales incentive program, a full pipeline, and we are competing for several large new opportunities. We are enthusiastic about the cultural alignment of the two organizations and the management team's focus on safety, customer service, and profitability.

Mode had top line growth of 3% as momentum built towards the back half of the quarter, which included some record days of revenue. Mode continues to leverage their technology platform to drive wins in new product lines, with recent implementations of railcar management and managed transportation solutions.

During the quarter, Mode received two Carrier of the Year awards from customers, as well as the Quest for Quality award for intermodal service. Now, I will turn it over to Terri to review the numbers..

Thanks, Don, and hello everyone. I'd like to highlight three points. First, intermodal pricing improved as the quarter progressed, resulting in a slight price increase for the quarter compared to last year. We haven't talked about prices being up since the second quarter of 2016.

Second, truck brokerage margins increased 9% in a tough market, due primarily to providing value-added services and growth in spot business. Third, our results include both one-time costs of $0.02 a share and a tax benefit of $0.09 a share.

One-time costs negatively impacting earnings related to inefficiencies in the rail and dray networks caused by the hurricanes and consulting costs for a network optimization study. The tax benefit is for a deduction to claim domestic production activity. Here are the key numbers for the third quarter.

All the numbers that I'm reporting on today include Hub Dedicated, which we purchased on July 1. Dedicated is included in the Hub segment as a separate service line. Hub Group's revenue increased 13% to $1,000,054,000. Hub Group's diluted earnings per share was $0.46 compared to $0.54 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 $821 million, which is a 14.5% increase compared to last year. Taking a closer look at our business lines, intermodal revenue was up 2% due to an increase in fuel revenue and freight rates.

Volume was flat and mix was slightly unfavorable. Local lease volume was up 9%, transcon was up 2%, and local West volume was down 7%. Truck brokerage revenue was up 17%. Truck brokerage handled 3% more loads, and fuel price and mix combined were up 14%. Logistics revenue increased 14% due to growth with new customers on-boarded this year.

Hub Dedicated revenue was $58 million. Hub's gross margin increased by $7.5 million, or 9.6%, due to Hub Dedicated and growth in truck brokerage margin, partially offset by a decline in intermodal and logistics margin. Gross margin as a percentage of sales was 10.5%, or 50 basis points lower than last year.

The addition of Hub Dedicated is the primary reason for the gross margin increase. Intermodal gross margin decreased because of rail cost increases and higher equipment costs, resulting partially from longer rail transit. The cost impact of hurricane-driven network disruptions was approximately $550,000.

We offset a portion of the decline by improving loaded miles and a price increase. These same factors drove a 160 basis point decline in intermodal growth margin as a percentage of sales. Truck brokerage gross margin increased because of higher value-added services and more spot business.

Truck brokerage gross margin as a percentage of sales decreased 100 basis points because of changes in customer mix and higher purchased transportation costs for the contractual business.

Logistics gross margin declined due to startup costs related to business on-boarded this quarter, tighter truck capacity that resulted in higher purchased transportation costs, and changes in customer mix. These same factors contributed to a 250 basis point decline in logistics gross margin as a percentage of sales.

Sequentially compared to the second quarter, the Hub segment gross margin as a percentage of sales increased 20 basis points due to a combination of Hub Dedicated margins and truck brokerage yields increasing 20 basis points. Logistics yields decreased 130 basis points, and intermodal yields were down 120 basis points.

Costs and expenses increased $13.5 million to $70.2 million in the third quarter. The primary reason for the increase is Hub Dedicated, who has 255 employees. In addition, IT costs increased for our transportation management system, and we had $600,000 of consulting costs for a network optimization study.

Partly offsetting these increases is lower bonus expense. Finally, operating margin for the Hub segment was 1.9%, which was 110 basis points lower than last year. Now, I'll discuss results for our Mode segment. Mode's revenue was $259 million, which was up 3% from last year.

This revenue breaks down as $123 million in intermodal, which was down 2%; $87 million in truck brokerage, which was up 10%; and $48 million in logistics, which was up 5%. Mode's gross margin decreased $2.4 million year-over-year due to a decrease in intermodal and truck brokerage margin, partially offset by an increase in logistics gross margin.

Gross margin as a percentage of sales was 11.8% compared to 13.1% last year due to a 220 basis point decline in truck brokerage yields; a 130 basis point decline in intermodal yields; and a 30 basis point decline in logistics yield. Mode's cost and expenses went down $200,000 compared to last year, primarily due to lower bonus costs.

Operating margin for Mode declined 2.3% compared to 3.2% last year. Turning to headcount for Hub Group, we had 2,034 employees, excluding drivers, at the need of the quarter. That's up 307 people compared to the end of June, related primarily to Hub Dedicated. Now I'll discuss what we expect for the fourth quarter of 2017.

We believe that our fourth quarter diluted earnings per share will range from $0.53 to $0.58, which includes a projected tax benefit of $0.05 per share for a deduction to claim domestic production activities. We estimate low double digit revenue growth at Hub and mid-single digit revenue growth at Mode for the fourth quarter.

We expect consolidated gross margin as a percentage of sales for the fourth quarter to range from 11% to 11.5%. We project that intermodal prices will continue to increase. We estimate consolidated big box intermodal volume growth will range from 2% to 4% for the fourth quarter.

We estimate gross margin dollar growth for the Hub segment in the fourth quarter compared to the third quarter will range from 4% to 8%, and that gross margin as a percentage of sales in the fourth quarter will be similar to the third quarter.

We believe that our fourth quarter consolidated costs and expenses will range from $96 million to $97 million, which is slightly higher than the third quarter, driven by an increase in projected Mode agent commissions.

We believe our effective tax rate for the year will range from 32% to 33%, meaning that the fourth quarter effective tax rate will range from 31.5% to 32.5%. This compares to our normalized rate of 38%.

Turning now to the balance sheet and how we used our cash, we ended the quarter with $18.6 million in cash and $298 million in debt, including capitalized leases and $50 million of borrowings on the revolver. We spent $9.6 million on capital expenditures this quarter, mostly related to technology, tractors, and trailers.

That brings total year-to-date capital expenditures to $36.9 million. We ordered 4,000 containers this year, and we're taking delivery of 2,550 containers. We're delaying delivery of the remaining 1,450 containers until 2018. Capital expenditures are expected to range from $40 million to $45 million in the fourth quarter. That wraps up the financials.

Dave, over to you..

Okay, great. Thank you, Terri.

With that, Allie, why don't we open up the lines to questions? Allie, could we open up the lines to questions, please?.

[Operator Instructions] And our first question comes from Scott Group from Wolfe Research. Please go ahead..

So I wanted to ask about the fourth quarter guidance. So if I take out the tax items, I think fourth quarter you're expecting to be $0.13 or $0.14 better than third quarter. We don't typically see such a big improvement from 3Q to 4Q, so maybe help just frame kind of what's getting so much better. I understand the pricing environment is getting better.

Is that really just the only change here, or is there something else?.

Yes, there's a couple different puts and takes. You're right, Scott. A main driver of that is the intermodal pricing, which we continue to expect to go up as it did in the third quarter. We also are expecting utilization of our containers to stay about the same as it was in the third quarter even with the slower rail transits.

And we think we can manage to that. The other item driving the improvement would be in logistics. We are anticipating significant sequential margin growth in logistics from third quarter to fourth quarter.

And then the smallest is probably truck brokerage, where we had a - we have a difficult comp, and we're hoping to see the same magnitude of peak season business that we saw last year to - because it's such a tough comp. And then we have Dedicated, which is new, of course..

Right.

Can you talk about intermodal pricing? So what did you get, if anything, in peak pricing in the third quarter? What are you expecting in the fourth? And then as you look out to next year, what's a reasonable expectation for your intermodal pricing that you get and then what you might have to pay to the rails?.

Yes, Scott. This is Dave. If we look at it sequentially, we have seen strengthening in pricing. And I think in particular this month we're seeing a very strong peak season.

It's - in all candor, in my career this is one of the quickest turnarounds I've seen from when we were in a very negative pricing environment to one in which there's a lot more demand and a lot less capacity. So all very positive.

I think we'll have some additional insights as far as what we'll be able to do for 2018 when we have the fourth quarter call. It's still in the early stages. We have been out aggressively talking to those clients which had margins which are under what we require in order to reinvest. But that's a small percentage thus far.

We have another 20% of clients right now that are in the bid process, which we believe is again going to reflect some pretty hefty price increases for the upcoming year. So we'll be able to give you a lot better flavor of what 2018 will be like as we end just the beginning of the bid season which is in effect right now..

But if truckload guys are saying 5% plus, do you think you can be 5% plus, or is that too much?.

I certainly - historically, as I'd said in my opening remarks, we kind of lag trucking. I would think that the way that the prices have been beaten down over the last 18 months that that would be a reasonable expectation. We'll see if the market cooperates, but certainly I believe that that is a reasonable expectation..

And do you have visibility to your rail cost increases yet?.

We do to a degree. And again, we are targeted. We're very focused on we've got to make sure that in fact our - we exceed our rail costs. Our current gross margins are just unacceptable, and we have to exceed our rail cost increases. In addition to that, I think the other variable that we have is our driver increases that are going to occur.

We may not have the type of turnover that an over the road trucker has at 100% plus, but we're still in the 40% range. And it is going to require higher driver pay in the upcoming year. I don't believe we'll be in the 7% to 10%, but we're probably in the mid-single digits.

So there again, we need to make sure that we exceed not just what we're paying our rail carriers, but the combination with our drivers as well..

Okay. And then last one and then I'll get back in queue.

Terri, can you talk about truck brokerage gross margin percents? Were they the third quarter versus the second quarter, if you can give us that number, sequential?.

It was down - it was actually up sequentially compared to the second quarter. Truck brokerage yields increased 20 basis points..

And our next question comes from Kevin Sterling from Seaport Global Securities. Please go ahead..

Hey, good afternoon everybody. It's actually Will on for Kevin. Just wanted to start out with Estenson. Now that you've got it in the fold, I was hoping you might be able to give us a little help with kind of the cadence of revenues there.

Is there any quarter that kind sticks out as stronger than others? And then on the third quarter in particular, I think it was a little bit lower than the revenue targets you were anticipating.

Is that mostly hurricane related, or was there something else going on there?.

Yes, our dedicated revenue for the quarter was about $58 million. And if you were to compare that to dedicated third quarter of 2016 revenue, we'd be up about 5.5%. So a little light, as you say, compared to what we expected, but we're still delighted with the acquisition and think that we'll get the cross selling synergies that we expect to get.

Honestly, we diverted management a bit with the sale, and so that hindered our sales a little bit. And we have a pretty robust pipeline and some really great opportunities..

Yes, Will. This is Don. Our sales folks are very excited. We rolled out a new incentive program for everyone. The market tightening also helps. So as you know, we did not - we've tried to be very conservative in our approaches, but I think we've got a very strong pipeline and the outlook is very good for dedicated..

All right.

And on intermodal, with I guess the utilization remaining flat quarter-over-quarter as we go into Q4 here, are you having to go out into the open market to find equipment using third parties at all?.

No. We do use a fair amount of E&P boxes, but we're not using any more than normal, so our fleet is adequate. Of course, in peak you could always have it increase by 20% or 30%. But I think that we're keeping our commitments to our clients, and so we have not attempted to get additional equipment outside of our normal E&P usage..

Yes, and we got 2,156 of our new boxes as of today, and the rest are supposed to come shortly in November. So that'll be another 400 of our own boxes..

And our next question comes from Ben Hartford from Robert W. Baird & Company. Please go ahead..

Hey, good evening everyone. Don, maybe we can go back to the comment you had made earlier about - I think it was rail service specifically, but you had said you didn't expect it to improve in the near term.

Is that just a function of volume during peak, or is there something else lingering with regard to rail service? And if you don't expect it to improve in the near term, what is a reasonable timeframe for it to improve?.

Yes, we think an impact is volume during peak as obviously impacts service. Obviously, the challenges with CSX on the East Coast is also impacting service across the other railroads. So we don't expect it to retain back to the levels of 2016 anytime soon..

Okay.

Do you expect to - is there any sort of cadence in '18 that you can - that's reasonable to expect at this point in time?.

Yes, Ben. This is Dave. I would suggest that our transit right now has slowed down a bit. It's nothing that's not manageable. Again, we're having conversations with our clients in the case of where we may have to extend transit. It's not more than a day in any case.

It's nothing that's extreme such as what we understand the other rail in the East has experienced. So they really are networks, as you know. And then if one has a cold, the others seem to catch it very quickly because they are so interdependent on each other and interchange so much.

So we don't see anything in the near term that's going to really help us, but we don't see anything that's really going to drag us down further either..

Okay, that's fair. Dave, you had made a comment in the prepared remarks about expecting both margin growth - pricing growth and margin growth next year. We appreciate the magnitude of the pricing environment at present. I think you had called current margins in intermodal to be unacceptable.

So to what extent are you willing to go and drive margin improvement? Are you willing to forsake volume growth? Because obviously the focus more recently has been on growing at or above the market.

So just wondering if there's any change in your attitude as it relates to how fast you expect Hub intermodal to grow in '18, given unacceptable gross margins and a healthy pricing environment both from an over the road truck side but also presumably from a rail point of view as well..

Yes, Ben. I really think that this year, 2018, is going to be a great year to gain price increase and also have a fair amount of truck conversion.

We already have seen that in fact we - or it appears as though we've burned off a lot of inventory, that demand both with the consumer and the industrial economies is very strong, and it's a tight capacity market which will only get tighter with ELDs. So I think you can actually accomplish both this year.

That's not always the normal trend, but certainly I've never - again, I've not seen it change this rapidly or this strongly in my career. And I really do believe that there's tremendous upside opportunities for both volume and gross margin..

Would you venture a guess for what you think the domestic intermodal industry volume growth environment will look like in 2018? Is it going to be closer to what we enjoyed from '05 to '15 when it was well up into the upper single digits?.

I would be surprised if it gets up quite that high. I would think it's more low mid-single digits. It will outgrow GDP, I believe, but I don't know that we'll make it up to the high single digits..

Okay. Terri, I think you'd made a comment about - well, somebody did. Somebody made a comment about addressing both transactional and contractual customers.

What is the split in your core Hub business of what you would deem to be contractual customers or contractual volume versus transactional volume?.

Yes. On the intermodal side, roughly 70% - up to 75% is our business either contracted or does a reprice every year. And in fact, Terri and I spent some time on that.

And where we're able to take price now is on that 25% business where it's not contracted or we're secondary provider in those lanes, right? So that's why we've seen the uptick as quickly as David mentioned. So as these bids come along in 2018, and we said we've got 20% in now, we're taking the price up and challenging it..

Do you expect that split, Don, to remain relatively consistent in 2018, or do you expect it to skew more toward transactional?.

I think it's expected to be the same..

Thank you. Our next question comes from Justin Long from Stephens. Please go ahead..

So I wanted to ask about the fourth quarter guidance and circle back to truck brokerage. Terri, it sounded like your comment earlier in the call suggested that truck brokerage revenue in the Hub segment should be relatively flat year-over-year in the fourth quarter.

So first of all, did I interpret that correctly? And secondly, what are you expecting for the sequential progression of truck brokerage margins on a percentage basis in fourth quarter?.

Yes. For revenue, our projection is the revenue in the fourth quarter compared to the fourth quarter last year would be up slightly. But you're right. It may be between 2% and 4%. And then compared to the third quarter, the revenue growth is accelerated just as it was last year in the fourth quarter..

Right. And Justin, to that point, the revenue in 2016 jumped so significantly for truck brokerage in the fourth quarter, the mountain is pretty high this year. And what we've been able to see is, as we've diversified our product, the value-added services are the ones now that are very attractive because the contracted prices are under pressure.

And the transactional business is where we're being able to take price up..

Yes, and we have a bit more spot business this year than we did last year as well. So whereas last year in truck brokerage maybe 20% of our business was spot, this year it's more like 30%..

And Terri, maybe a follow up on the question about truck brokerage margins in the fourth quarter.

What are you assuming for the sequential progression from third quarter?.

We're assuming improved gross margin as a percent of sales and improved - more margin dollar growth; both..

Okay. Well, taking a step back and I guess looking at the Hub segment as a whole, I think your comment earlier was that gross margins in the fourth quarter should be pretty similar to the third quarter, so kind of flat sequentially.

If intermodal pricing is getting better, truck brokerage is increasing sequentially, which is what that guidance is implying and that's a high margin business, what are the negative offsets to hold Hub segment margins flat on a sequential basis?.

On a sequential basis, it would be I said similar to - I believe similar to the third quarter. And if you press, I guess I would say it could be similar to or slightly up..

To get back to our traditional intermodal customers, we have contracted agreements with our customers. So obviously we have to honor our commitments..

At the same point in time with those intact we have the opportunity to increase prices today. We certainly are doing that. We're reviewing all of our clients. We've reviewed 60% of our business thus has. We have increases that are either before the customer or have been accepted about 5% of our overall business.

Another 20% is currently in bid, and that will be resolved early in the first quarter. So we're taking full advantage of it. But again, to what Don had said, we do live up to our - the commitments that we have made. And so we'll be moving forward on this aggressively, but also keeping in mind that we have made those commitments..

And maybe one last quick one on Estenson. When you look into next year and think about your assumptions to get to that $0.20 plus of EPS accretion, I know you are assuming some cross selling.

Could you just comment on your visibility to that cross selling opportunity now that the business has been integrated to some extent?.

Sure, yeah. We had assumed cross selling revenue synergies for 2018 of about $10 million, and we still feel comfortable with that number. That's not a lot given what we have in the pipeline..

No, I would be very disappointed if that's what we end up at..

Yes. Yes..

And we don't want that..

No, we don't want at all, either way. So it's - yes, I think we've been very conservative in our forecast there..

Right..

Thank you. Our next question comes from Tom Wadewitz from UBS. Please go ahead..

I wanted to see if you could comment on kind of the impact of the rail service. So you talked about you saw some deterioration with your partners, but I think there had been a sense maybe in August that as things were happening on CSX that might create some opportunity for you, obviously, because you run on Norfolk.

Was some of that realized, I mean, it didn't seem like volumes were - I don't know if they are really picking up in the quarter. But was some of that realized do you think looking forward, as CSX probably makes some changes to their terminal network.

And so you might see a little bit more disruption, is that a meaningful opportunity or is that not necessarily the right way to look at it?.

Yeah, hi Tom. This is Dave. We didn't see a lot of disruption on the CSX network in the third quarter. It's only really this past week plus that it appears though the management team there is focusing on the intermodal part of their network, that in fact they're cancelling service in, as I saw in some 468 lanes, I believe it was.

And so we're now beginning to see that disruption. It's a little early yet to see if in fact we're going to be able to secure some additional business. I think the only caution to that might be is that our fleet is currently pretty well deployed.

And so to take on significant amounts of additional business because of service issues on our non-partner Eastern rail carrier could be difficult..

What might that indicate in terms of 2018 volume opportunity, right, because you'll presumably bring on some more containers and have more ability to grow volume.

Would you say that - do you think that's a significant factor, or is that kind of insignificant relative to just broader strengthening in the market and strengthening in truck?.

I think the broader strengthening of the market and the pricing environment are the most important components. Certainly if in fact the CSX network does become very disrupted, we could see some changes. But I don't know that it's at that point currently or that it'll get there..

The local lease business that has the opportunity to go truck or intermodal, we see the opportunity from truck going over to intermodal as capacity still gets tight..

Do you have a sense if the lanes they're cancelling are attracting lanes, or are those kind of too short haul to be interesting?.

Well, actually a lot of them are interchange lines like out of Valleyfield, Quebec, which they put a lot of money into that terminal out to the West Coast and Southwest; Marion, Ohio to the West Coast. So a lot of it seems like it is longer haul, but maybe they have too short of a haul or just don't have enough volume.

I'd understood that they had issue getting enough volume in and out of Valleyfield, which is outside of Montreal. But again, we don't deal with CSX and so that's all hearsay. But I took a quick look at the service that's being cancelled, and it seemed like it was predominantly areas where they just don't have the volume to make the trains profitable.

And that's my guess..

As I consider your comments on outlook for pricing and truck market and all that, they're very optimistic and it seems like that there's a lot of evidence to support that view.

Would we expect stronger pricing and overall gross margin improvement for Hub segment to go pretty much lockstep together, or is there some lag in gross margin - in gross margin percent, some lag in that improvement relative to when you get price from shippers?.

The lag you mean between prices going up and showing with us? Is that your question?.

Yeah, yeah.

Are there any factors that - or would it just pretty much translate through directly, that as soon as you get price coming through, that will flow directly to your gross margin percent?.

What we'll do is, as these bids come in, that's when we'll get the opportunity to price up. So with the 20% in right now, we're getting that opportunity. And as bid season goes in, which is the first quarter of next year, we'll be aggressive in that approach..

So to answer your question about it going to the bottom line, Tom, it would absent any increases from the rails, which won't happen until - we have an increase that goes in on January 1 for NS. And then we have another increase that goes in June for NS, and our UP increase goes in in June.

And then we anticipate that we will have to increase driver wages, and that would probably happen near the first of the year..

It almost happens throughout the year probably….

It depends on….

Certainly..

Some..

Yes..

It sounds like it's a strong enough environment that you should be able to get kind of that price above your inflation. So anyways, all right. I appreciate it. Thank you for the time..

And our next question comes from Todd Fowler from KeyBanc. Please go ahead..

Dave, just on the outlook again into the fourth quarter and the volume expectations, I guess I'm curious to get a sense of the visibility that you have from a peak season standpoint and what you'd be expecting from the duration of the peak that's something that should run into December.

And I think the comment was that October is up 5% month to date, but you're talking about 2% to 4%.

So I'm guessing that's maybe the monthly comparisons, but is there anything that's attributing to you going from 5% to something possibly lower for the whole quarter?.

Very good question, no, at this run rate we are….

You're making me nervous a little bit..

I'll try more general conservatism. Yes, I would say that the - October started off very strong. And this is one of the strongest peaks we've had in a few years. It's at least probably four or five. And so I think that as much as anything else, we're looking at it from a conservative basis.

We do have a strong end of November and mid December last year, which is a bit of a hurdle. We're not sure how the extent to which this peak will last. So I think if it's anything at this point, those are the primary drivers as to why we're being a little more cautionary with the 2% to 4% versus the current run rate..

And Todd if you recall last quarter - last fourth quarter, peak started very late, right?.

Yes..

People were wondering when it was going to start, and it kicked in, it was very intense. This started earlier and it's been intense..

And in Q4 last year, we were up 5.2% in the fourth quarter..

I can get these offline if you don't have them handy.

But do you have the monthly volume comps for the third quarter, and then do you have them for the fourth quarter last year?.

Monthly? No, I don't have those handy for last year.

For this year in the third quarter, are you asking for?.

So if you have how the third quarter progressed..

July was up 1.4%, August was flat, September was down a bit. And that's with - that's just the month. If you did it on a per day basis, September would have been up 3%..

Okay, got it. So there's, yes, counter shift. And then just thinking about the pricing commentary, and we've talked about this a lot already on the call. But on one hand we know that the truck markets tightening and that that's going to provide some cover for intermodal pricing.

But it sounds like that the rail service issues are maybe getting a little bit worse.

Dave, how do you think about what kind of carries the day in a deteriorating rail service environment versus a tight truck environment from a pricing standpoint from your intermodal book?.

I would say that, first of all, I do believe that the truck market is going to continue to tighten. And the rail service, while we've seen some deterioration again, it's nothing that we can't manage. It's nothing that is becoming severe at this point in time. We're still truck competitive overall.

So I believe that we have a lot of upside opportunity from a pricing perspective, because we have to keep in mind that this past year, and really the last 18 months, has been a terrible pricing cycle within transportation. And it's not just us that who's pricing was brought down. It was all the intermodal and all the truckload carriers.

And I think that what we're going to be doing with these increases is getting back to a more normalized margin with which we can continue to reinvest in our business..

And then just on Estenson here in the quarter, do you have a number that we can either - from an EBIT or an EBITDA contribution standpoint here for the quarter? And then have you finalized at this point all of the accounting adjustments and those sorts of things as we think about the depreciation and amortization run rates going forward? Is that all reflected at this point in the third quarter numbers?.

We're pretty well finalized with the purchase price allocation, there's still a few open holes, but it's substantially completed. And that'll be in our Q when we file it, and it's of course included in the balance sheet that we just issued today.

In terms of the depreciation and amortization related to Dedicated, for the second half of the year we think it will be about $10 million. And beyond that for '18 and '19 we are still finalizing our numbers. We don't have that..

The D&A for the second half of this year is $10 million?.

Correct..

And then, Terri, do you have an EBITDA number for the third quarter?.

We're not disclosing that..

Okay, that's fine. I just thought I would ask. And then just the last one I had and I think this is probably self-explanatory. But the original guidance that you had out, or the most recent guidance, the 1.45 to the 1.55, that I'm assuming did not have the tax benefits of $0.09 this quarter and the $0.05 for the fourth quarter, in that..

That's correct, Todd..

And our next question comes from Brian Ossenbeck from JP Morgan. Please go ahead..

So just a couple of smaller ones here. Maybe, Dave, you can talk about it. You mentioned a couple times now how the market has turned as fast as you've really seen in quite some time. Is that - and you did mention that things were getting tighter last quarter.

So was this really hurricane and weather related that was the tipping point? And it sounds like things are still strong into October.

Do you expect that to kind of taper off here, or you really think that we've hit an inflection and we shouldn't be expecting a little bit of a correction, a normalization from the weather disruption on demand and supply?.

I do believe that we've hit an inflection where we burned off a lot of the excess inventory that we had, and demand is - appears to be picking up. I do think you're right that the hurricanes were a tipping point. That seemed to just push it over the edge. It was already teetering, and they certainly pushed it over the cliff.

If you look back at Katrina, it probably impacted capacity for probably nine months, and that was hitting New Orleans. And you figure this year if you hit the fourth largest city in the country with Houston, it hit much of Florida, it certainly has had an impact and will have an impact.

And then you also have the ELDs, which it appears as though those are absolutely - the mandate is going to go in, and that is going to further tighten capacity or at least productivity when you speak of productivity of drivers who are not on ELDs who are driving beyond the legal limits.

So we strongly believe that this is not an aberration, but it something that we'll see through all of next year and very likely into bid season in 2019..

And on the ELD topic, are you seeing anything in your capacity carrier base, any changes as you see some of perhaps the smaller fleets on the brokerage side start to adopt or pick up some of the devices, perhaps become more compliant than they maybe were before, especially the smaller fleets?.

I'll let Terri get that, as I know she just got that number..

We've surveyed our top 2,000 carriers, which is about 75% of our volume in mid-September and they were about 80% compliant..

So we are taking this very seriously and monitoring our carriers. And just - obviously we have to be complying within the law, and those carriers which are not ELD compliant we'll have to cease using..

Okay, great. Thanks for the -..

I guess the interesting thing about that, Brian, though is that obviously our clients are undergoing the same type of process I would envision. And so again, we're only at this point at 80%..

Yes..

And we're getting pretty late in the ballgame. So it's something that's definitely going to have an impact on the trucking market and trucking capacity..

So we might give a little bit back from the hurricanes, but you're already seeing some compliance and probably a little bit more to go here in the kind of the rush to get legal, I guess is what you can call it..

Right..

Just a couple of small ones on CapEx. It looks like you're going to spend as much in the fourth quarter as you had spent year-to-date 3Q.

Imagine that's just the timing in payments for the containers, or is there anything else within that $40 million to $45 million?.

Right, the containers. There's Dedicated, that's about $16 million, and then some tractors as well and some technology. It's a combination..

And the CapEx number has shifted a bit, and obviously you've purchased - made a deal this year. Any early indication on what we should expect for 2018? Sounds like you're going to pick up some of the containers you originally thought you could get this year into next year.

But are we - do you think you're going to trend back towards north of $100 million next year, or what does the early read on that look like?.

Our best guess is between 130 million and 140 million with about a third of that for technology, a third of that for Dedicated, and a third for intermodal, which would include tractors and containers..

Last quick one is just the network optimization study. Maybe give us a little background, what that was, what it was intended to accomplish, and when you might see some of the benefits. Thank you..

We undertook the network optimization study specifically with - as severe as the pricing compression had been over the last 18 months, we wanted to have an outside party come in, validate some of our assumptions, look at how we're pricing things, how we're costing. And I think it'll have some immediate impact.

I think directionally we've been on the proper path, but they certainly - it will more than pay for itself with some benefits and the insights that were offered..

And our next question comes from Bascome Majors from Susquehanna Financial Group. Please go ahead..

I wanted to follow up a little bit on that last question.

Was the study more about network design, balance, that sort of thing, or is it really knowing more about how any particular or what any particular move costs you and how to maybe price that more in line with those costs as opposed to some historic practice? I'm just trying to think of what if anything this means for your go-to-market strategy as we get into what should be a bid season next year where you have leverage in a way that you haven't had in some time.

Thanks..

Bascome, it's as if you were sitting in some of our meetings. It was all those things. It was looking at our network, looking at our flows, looking at how we cost some of the imbalances that we have and some of our existing practices and how we even look at our dray costs when they're internal. So it was all of those things. It was an extensive study.

And again, I think it was very worthwhile. And there was nothing that would suddenly turn on the sunshine and turn on the light, but there was a lot of incremental gains we'll be able to make. And we think that - many of those we've already started implementation and will be fully ready for the upcoming bid season..

And just from a high level - I know we've done a lot of questions on your expectations for pricing, cost inflation, et cetera.

But from a high level, if you look at your business over let's call it a decade or more, operating margin compared to gross revenues, before this year you were kind of running pretty steady at 3%, 3.5% in a post-recession basis, and even as high as 5% in the years kind of peaking last cycle and heading into the recession. I'm just kind of curious.

If things go well, as it sounds like you certainly expect they will next year, what sort of operating margin could be kind of in play for Hub Group into next year and 2019?.

Yeah, Bascome, it's a good question. We are still in process of doing our budgeting for next year, so I'll have more information on that when we release our fourth quarter earnings in February. But our goal is certainly to get it as high as it can. And we realize, because of the pricing environment, that it has - it's not where it needs to be.

And so that's why we're so focused on getting price in not just intermodal, but getting price in all our lines of business where we need it..

Yes, we've got to get the price up. If you've seen the last 18, 24 months, it's been a very difficult environment. And we're investing in our technology. We're investing in equipment. We're investing in drivers and tractors. So we're going to continue down that path, but the profitability path has to be up as price is the largest lever..

And you led into my last question really great there. Earlier I think the words you used was we have pricing visibility from our rail partners to a degree.

Can you just help us understand maybe what degree you don't have visibility on and what the levers are that could drive that higher? Because I imagine that they will certainly seek to push on those..

We really do not discuss our contracts with our rail partners. But needless to say, if market prices are going up they would like to see additional increases as well.

So our goal is obviously to be able to cover their cost increases, our drayage price increases, our general cost increases and add to the gross margin, which is just unacceptable at this point..

Our next question comes from Jason Seidl from Cowen. Please go ahead..

Well, thank you, operator. Hey, guys, it was asked and answered. Thank you very much..

Our next question comes from Ravi Shanker from Morgan Stanley. Please go ahead..

A few big picture questions here at the end.

When you said that you have 70% to 75% of your volumes contracted, and when you think of what's going to happen next year or what's expected with pricing and maybe even costs, do you think you can get those contracts repriced to the level you want in 2018, or do you think that's potentially going to be a multiyear exercise?.

We think we can get our prices up in 2018..

Enough to kind of cover your - the cost inflation and kind of what we will see in the marketplace on the trucking side as well?.

Correct, to cover the cost of our increases, cover inflation, and to expand margin..

Shifting gears, when we think of the growth in e-commerce and the omni-channel shift and the fact that boxes need to get from Point A to Point B maybe quicker than ever before, what kind of role do you think intermodal can play kind of when you have kind of Amazon putting things on 767 from a DC to another? Do you think that intermodal is competitive and can continue to play a role in fulfilling that supply chain?.

Absolutely. If you look at the expansion and use Amazon as an example, they're fulfillment centers, right? They're picking up from vendors and suppliers. So we see a very big runway for intermodal and Hub participating in that.

In addition to that, we also offer e-commerce customers other services, whether it be value-added or visibility, cross dock services. And intermodal plays a part in that cross dock operation..

And then just finally, we've been seeing a number of announcements from truck OEMs potentially launching heavy duty Class 7, Class 8 electric trucks in the next couple of years, maybe even sooner. I'm wondering if you have evaluated or thought of using some of those trucks in intermodal drayage..

Yeah, we are in the process of trying to keep very, very close to some of the new technology, including such things as what Peloton is doing, as well as others.

If you think about it, an electronic - an electric truck would be most useful for a company such as ourselves where our average length of haul is about 100 miles and so that it can get home every night to recharge. So there are some real applications.

I think it has yet to be really determined if in fact they can make it so that the battery weight does not make it uncompetitive as far as the amount of freight you could haul in a truck. But it certainly has some applications, and we're keeping very close to it. And I've enjoyed a lot of your articles that you've written about some of these changes..

Our next question comes from Matthew Brooklier from Buckingham Research. Please go ahead..

I'll be quick here. It's been a long call. You talked about some cost incurred during third quarter given the hurricanes.

Did the hurricanes impact your volume in 3Q?.

Our intermodal volume, yes..

Intermodal, yes..

It hurt our intermodal volume. It probably helped our truck brokerage volume..

Yes, that's right..

Yes, realistically..

And then on the intermodal side of things, was that completely lost volume, or did some of that volume get shifted into maybe October?.

It probably got shifted into October, if you think about it. Some of it is….

Some of it went truck though..

Some of it went truck..

Yeah, I think definitely some of it went truck. As an example, the Florida intermodal ramps were pretty well shut down. And even if you could get into Florida, diesel fuel was very tight for quite some time. The same is true with Houston where the ramps were very negatively impacted.

So there may have been some that waited, but certainly the more critical shipments, the generators, the water, they went truck..

I'm just trying to see if some of that shift from September volume - or volume that should have moved in September got delayed and maybe moved into October, if it was like a big contributing factor to your….

Not to us..

I really don't think that that's the case, no..

No. We didn't assume in our $550,000 that we lost a lot of volume. It was more cost related..

And then you mentioned earlier regarding the potential for a driver pay increase. Is that for your drayage drivers? It is for your dedicated drivers? Maybe just give a little bit more color there..

Yes, Matt. It would actually be for both. And I think it's going to be very geographically driven as far as where. But I think that everyone that's in the trucking business at this point in time has got to grapple with driver turnover as well as driver pay and how you retain them most effectively..

I mean it's not, it sounds like it's more strategic versus like an across the board wage increase..

Yes, absolutely. We just had a wage study done to compare how we are. So we always try to go to the upper level of compensation just so we can attract the best drivers, limit accidents, limit all the potential issues you have. And so we just had the study done.

We're in the process of examining it, and we'll have a pretty good idea of what may need to be done in the near term..

And the potential for those incremental costs to hit the P&L, that would be what a first quarter event potentially?.

Some of it would hit in the first quarter, as Dave mentioned earlier. But it's really throughout the year..

Yes, it'll be phased in..

Okay, spread out. That's all I got. Thank you very much..

And our next question comes from Ben Hartford from Robert W. Baird & Company. Please go ahead..

Terri, real quick, could I get a few parameters for 2018? How are you thinking about the tax rate for 2018?.

Probably between 38%, 38.5%, but I can give you more specifics come February..

And then another placeholder, CapEx for 2018?.

Between 120 million and 130 million is our best guess..

And any sense on what you're comfortable with, with regard to a leverage ratio to be, let's say, over the next 12 months?.

We would still be comfortable going up to 3 times if it was the right acquisition. Right now we're at about 1.6..

And without an acquisition, would you expect that leverage ratio to rise or fall?.

Fall..

Fall, okay. Great. Thank you..

And as we have no further questions, I would like to turn it back over to Dave Yeager for closing remarks..

Thank you, Allie. And thank you everyone for participating in Hub's third quarter earnings call. As always, Terri, Don, and I would be available if there's any additional questions or clarifications. Thank you again for joining us..

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