Knight-Swift Transportation Holdings Inc. (NYSE:KNX) Q4 2022 Earnings Call Transcript

Knight-Swift Transportation Holdings Inc. (NYSE:KNX) Q4 2022 Earnings Call Transcript January 26, 2023

Knight-Swift Transportation Holdings Inc. misses on earnings expectations. Reported EPS is $1 EPS, expectations were $1.12.

Operator: Good afternoon. My name is JP, and I’ll be your conference operator today. Welcome to the Knight-Swift Transportation Fourth Quarter 2022 Earnings Call. Speakers from today’s call will be Dave Jackson, President and CEO; Adam Miller, CFO. Mr. Miller, the meeting is now yours.

Adam Miller: Thanks, JP, and good afternoon, everyone, and thank you for joining our fourth quarter 2022 earnings call. Today, we plan to discuss topics related to the results of the fourth quarter, provide an update on current market conditions and share our full year 2023 guidance. We have slides to accompany this call, which are posted on our investor website. Our call is scheduled to go until 5:30 PM Eastern Time. Following our commentary, we will answer questions related to these topics. We will answer as many questions as time allows. If we’re not able to get to your question due to time restrictions, you may call (602) 606-6349. To begin, I’ll first refer you to the disclosure on Page 2 of the presentation and note the following.

This conference call and presentation may contain forward-looking statements made by the company that involve risks, assumptions and uncertainties that are difficult to predict. Investors are directed to the information contained in Item 1A Risk Factors or Part 1 of the company’s annual report on Form 10-K filed with the United States SEC for a discussion of the risks that may affect the company’s future operating results. Actual results may differ. And now on to Slide 3; this chart on Slide 3 compares our consolidated fourth quarter revenue and earnings results on a year-over-year basis. Revenue excluding fuel surcharge declined by 9.5%, while our adjusted operating income declined by 39.3%. GAAP earnings per diluted share for the fourth quarter of 2022 were $0.92, and our adjusted EPS came in at $1.

These results included a $15.4 million pretax charge, which negatively impacted EPS by $0.07 for an actuarial insurance adjustment related to third-party carrier risk in our iron insurance business. On a year-over-year basis, lower volumes in the absence of a holiday peak season negatively impacted earnings. Now on to the next slide; Slide 4 illustrates the revenue and adjusted operating income for the fourth quarter and year-to-date periods in each of our segments. In an unusually soft fourth quarter, our largest segments proved their ability to operate efficiently. Our Truckload segment operated in the low 80s, while LTL and Logistics stayed in the mid-80s. Our Intermodal was impacted by weaker demand as well as greater availability of truckload capacity at better service levels.

Freight demand in the fourth quarter was well below typical seasonal patterns. While spot opportunities were very subdued and projects were infrequent as anticipated, general freight demand was softer than expected. We believe this was largely driven by the holiday goods pull-forward earlier in 2022, an existing inventory overhang dating back to last year where some products arrived too late for the season, and general caution around what retailers could expect from consumer demand. Weak demand pressured volumes and pricing, while ongoing inflation was a further headwind on operating income in most segments. The chart on the right highlights the percentage of revenue during the fourth quarter of 2022 from each of our 4 segments as well as the percentage of revenue from our other services, which include our rapidly growing insurance, equipment maintenance, equipment leasing and warehousing services.

We are focused on improving service to our customers and reducing costs as we navigate a tough operating environment. We continue to work on diversifying our business and developing complementary services that bring strategic value to our customers and partner carriers. The next few slides will discuss each segment’s operating performance, starting with Truckload on Slide 5. On a year-over-year basis, our Truckload revenue excluding fuel surcharge declined 7.2%, while our operating income declined by 36.5%, reflecting the comparison of an unusually weak fourth quarter of 2022 against perhaps the strongest fourth quarter we’ve ever experienced. Our Truckload business navigated the softness well and operated with an 82.7% operating ratio. Our efforts to reduce spot exposure and secure more contractual committed freight since the beginning of 2022 helped us maintain an adjusted operating ratio in the low 80s.

During the quarter, revenue per tractor fell 8.6% driven by a 3.9% decrease in revenue per loaded mile and a 4.5% decrease in miles per tractor. The decline in revenue per tractor, combined with inflationary pressures across our business, caused the reduction in Truckload operating income. Most notably, we see ongoing cost pressures in equipment, maintenance and insurance. We continue to take steps to align our cost structure with the reduction in volumes. Having a diverse group of brands and services, including nearly 5,000 dedicated trucks, provides us with flexibility and strategy. For example, as over-the-road truckload volumes have softened year-over-year, our dedicated business has grown top line revenue and improved margins on a year-over-year basis.

Despite the soft market, our customers still value trailer pool capacity at scale, and we see this expressed to both our Truckload and Logistics segments. We continue to invest in our already industry-leading trailer fleet, which grew sequentially to nearly 79,000 trailers. We believe our scale in trailers is a competitive advantage and provides our customers capabilities that are extremely difficult to replicate. Now on to Slide 6. Our LTL segment continues to perform well and make progress on yield and network initiatives. For the quarter, revenue excluding fuel surcharge was $204 million, and we operated at an 85.5% adjusted operating ratio. This represents a 480 basis point improvement from the fourth quarter last year and only a 100 basis point sequential degradation despite demand softening for more than a typical seasonal step down from the third to fourth quarter in LTL.

Pricing remained strong as revenue excluding fuel surcharge per hundredweight increased 13.3% year-over-year. The leadership at both AAA Cooper and MME were able to complete the system integration during the fourth quarter, less than 12 months since the acquisition of MME. This creates seamless connectivity for our customers while maintaining the culture and brands of each company. We believe this positions us to provide additional services to existing customers as well as create new customer relationships. Our Knight and Swift brands have deep relationships with large shippers who in many cases deal with larger LTL providers. Creating a super-regional network in the short term and a national network in the long term will enable us to find opportunities to further support our existing truckload customers with LTL capacity.

Now we’ll move to Slide 7. Our Logistics segment continues to perform well with an adjusted operating ratio of 86.4%. Gross margin also expanded to 22.1% in the quarter compared to 20.7% last year. Overall, revenue was down 42.2% driven by a 28.9% decrease in revenue per load from lower spot market rates and a decrease in load count of 18.6%. Load volumes were negatively impacted by lower import volumes, particularly over the West Coast ports. Our customers continue to value the power-only services we provide, which resulted in our power-only volumes feeling less pressure than our traditional live load, live unload activity. Our vastly growing trailer network allows our customers the ability to optimize their warehouse space and labor costs.

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Third-party carriers prefer power-only business because it saves them hours and each load and unload location, lowers their capital investment and risk, reduces their operating costs and gives them access to freight that historically wouldn’t be able to participate in. We continue to be excited about this business and have several technology initiatives ongoing that will improve the experience for our third-party carriers as well as provide more seamless information internally and to our customers that will lead to more opportunities to utilize our equipment. I’ll now touch on intermodal on Slide 8 before turning the call over to Dave. Revenue decreased to 8.6% driven by a 6.3% decrease in load count and a 2.5% decrease in revenue per load.

Intermodal volumes are being pressured by the general freight environment and the current competitive position of the truckload alternative. Customers are leveraging the extremely low spot rates, quicker transit times and better service in the truckload market. Labor within the rail network appears to be improving as we enter the first quarter, leading to improving transit times and more predictability for our customers. These improvements should help close the service gap between intermodal and Truckload and support future growth for this business. I’ll now turn it over to Dave.

David Jackson: Thank you, Adam, and good afternoon, everyone. Slide 9 illustrates the growth in our businesses that make up the non-reportable segment, which include insurance and maintenance under the Iron Truck Services brand as well as equipment leasing and warehousing activities. For the full year of 2022, we reached $517 million in revenues, representing 69% year-over-year growth. For the quarter, we had a 32% increase in revenue year-over-year. As previously mentioned, the results of the other services were negatively impacted in the fourth quarter by an actuarial adjustment of $15.4 million pretax related to third-party carrier risk in the iron insurance business, which resulted in the $11.6 million operating loss for this segment.

We are already taking steps to enhance our insurance program, which include a recent conversion to a new platform that we expect will lead to improved collections and more timely cancellations. We’ve applied rate increases to various lines of coverage that will bring underwriting results in line with expectations. These service offerings have found tremendous interest from small carriers, especially as we help them improve their cost structure. But later in 2022, we have observed the pressure of the weaker environment impacting these carriers as seen through their difficulties, paying insurance premiums and the practice of extending maintenance service intervals on their equipment. We expect to continue growing the revenues and income from these other services over time and believe this effort supports our ongoing diversification objective.

Next on to Slide 10; this slide illustrates the progress of the intentional changing of the composition of our business into an industrial growth company. The chart on the left shows the percentage of adjusted operating income from each of our segments and our other non-reportable services since the Knight and Swift merger in 2017. We’re pleased to report meaningful contributions in earnings from each area. These diversification efforts are intended to make us a less volatile company and we expect will help us mitigate the downside through truckload freight cycles. Our Truckload earnings now represent approximately 65% of consolidated earnings, which is a meaningful shift from where we were in 2017 following the merger. This reduction in the percentage of our earnings coming from Truckload has been achieved while we significantly improved our Truckload earnings from a 2017 full year combined pro forma Knight and Swift earnings of $319 million to $748 million for 2022.

The chart on the right shows our annual adjusted earnings per share since the merger. Our adjusted EPS has moved from $2.16 per share in the first 4 quarters following the merger to $5.03 per share in 2022. Moving to Slide 11; strong earnings have driven increases in our free cash flow since the Knight-Swift merger, reaching $819 million in 2022. Year-to-date, we’ve used cash to increase our dividend to shareholders by 20%, repurchased $300 million worth of shares and paid down $395 million in long-term debt and leases. Since the 2017 merger, we’ve invested $1.6 billion in acquisitions. Making acquisitions remains a high priority, and our strong cash flow generation and leverage ratio of less than 1.0 provide us with ample capacity for M&A opportunities.

Our balance sheet is strong and we’re well positioned to invest in organic growth, pursue acquisitions, purchase more shares, increase dividends and/or pay down debt. We are constantly evaluating market conditions to maximize our use of cash to create value for our shareholders. On Slide 12, we demonstrate the return on net tangible assets, which remains a key measurement for us. In 2022, we achieved a 19.0% return on net tangible assets. Our goal is to improve this measurement by focusing on 3 key areas: growing our less asset-intensive businesses; two, acquiring and improving businesses; and three, expanding margins in our existing operations. We’ve achieved synergies and improvement in every business we have acquired, be they warehousing asset-based truckload, less than truckload or truckload brokerage.

We believe our focus in these 3 key objectives will leverage our core competencies in areas of opportunity that are unique to us and will allow us to continue to generate significant returns to our shareholders in the long run. On Slide 13, we provide an outlook for market conditions as we begin 2023. We expect the current softness will persist through the first half of 2023 based on indications from shippers that are working through their inventory overhang. This soft environment combined with ongoing inflation in equipment, maintenance and insurance and rising interest rates will increase the pressure on carriers, especially smaller and less well-capitalized carriers. These factors will most likely accelerate capacity attrition in the coming quarters.

I’ll now turn it back to Adam to cover our 2023 guidance.

Adam Miller: Thanks, Dave. On to our last slide here, Slide 14. For the full year 2023, we expect adjusted EPS to be in the range of $4.05 to $4.25. Last year, we expected the first half to be strong and then cool off in the second half, which is largely what happened. In 2023, we expect the opposite: more challenging environments in the first half before we start to see a recovery to a more typical freight demand, leading up to an improving Q4 peak season. Over-the-road truckload contract rates will be pressured with few noncontract opportunities until the latter half of the year. We expect these noncontract opportunities, combined with some return of peak season volume, to result in rates inflecting positive year-over-year in Q4.

Overall Truckload revenue per mile should be down mid- to high single digits in Q1 and trending to be positive by low single digits in Q4. Dedicated rates should increase in the low single digits for the year. Truck count should remain sequentially stable throughout the year with miles per tractor reflecting positive year-over-year by the middle of the year. Our LTL segment is expected to see slight improvement in revenue with relatively stable margins. Sequentially, Logistics revenue per load should drop in the first quarter before increasing sequentially throughout the year. We expect volumes to follow a similar trend. Gross margin will compress as the freight market picks up, pushing logistics OR to climb into the high 80s to low 90s. Intermodal revenue per load in margin will deteriorate in the first half before improving again in the back half.

For the full year, we expect the operating ratio to be in the mid-90s. Revenue and op income in our other services will increase driven primarily by improvement in rates and new customer growth in our insurance business and increased volumes in warehousing. Inflationary pressure will decelerate as labor loosens and equipment availability improves. Gains are expected to be in the range of $10 million to $15 million per quarter, and our CapEx is expected to be in the range of $640 million to $690 million, and our tax rate is expected to be around 25%. Interest expense is also projected to increase from where we were in the fourth quarter as rates continue to climb. So that concludes our prepared remarks. And so JP, we will now open the line for questions.

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Q&A Session

Operator: Your first question comes from the line of Jack Atkins from Stephens.

Jack Atkins: So I guess maybe a two-parter here. But Dave, I’d be curious if you could maybe comment a bit on the fourth quarter to first quarter seasonality given that the fourth quarter of 2022, to your point, was anything but peak. How would you sort of think about that trending sequentially? If you could kind of help us set our expectations there. And then, I guess, just to kind of follow up on your comment about what your customers are telling you about the trends and trajectory of their businesses. Well, I guess, what’s giving you the confidence to think that we’re going to see a trough in sort of freight fundamentals in the first half of the year and that we can kind of build back in the second half? If you could just expand on those two items, I’d appreciate it.

David Jackson: Okay. Thank you, Jack. Yes, I would say that from fourth to first, this is one where the step down is significantly lower than what we’re used to. And I would say that the freight market continues to show signs of life here as we get — as we go through January. And so typically, you would see quite a bit of seasonality in the fourth quarter, which then changes with the holiday in the rearview mirror moving into the first. We do expect first to be seasonably softer than the fourth, they always are. But there’s a good chance that after we complete the first quarter, we’ll look back, and this might have been the most benign change sequentially from the fourth to a first. I would say that some of what gives us some indications of how this will play out maybe from customers would be the fact that in the fourth quarter, so much of their holiday inventory had already arrived.

Some of it has already arrived 10 or 11 months before. It kind of sat around. It just barely missed the holidays. So it seemed that by the time October started, the fourth quarter freight was already — had already arrived and was largely in position. So that explanation made sense to us. And so naturally, our next question is, well, how long are you going to continue to have this inventory overhang. And the general consensus, almost unanimous from customers that have given us this kind of — or given us feedback about their inventories, has been that by the time they get through the spring, things are caught up. And that makes sense. I mean it was — freight was flowing rather normally by the time we got to summer of 2022. So throughout the summer, there wasn’t the traditional delays on imports.

And so the import volumes definitely support the idea that this freight has already been here and came early. So what we expect is that through the first two quarters of this year, we’ll see this softness as a result of freight that’s already moved, and then we start to move back into a more normal cycle. And consumers are hanging in there. And everybody has been trying to figure that out. It’s pretty remarkable that we’ve had the kind of performance as an industry. Certainly for our company, it seems remarkable to have that kind of a performance in the fourth quarter that really didn’t have the seasonal uplift. I think it tells us really — or it’s evidence of the lack of oversupply that came rushing in has normally happened in previous cycles.