Knight-Swift Transportation - Q1 2017

Transcript

Operator (participant)

Good afternoon. My name is Christina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Knight Transportation first quarter 2017 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Speakers for today's call will be Dave Jackson, President and CEO, and Adam Miller, CFO. Mr. Miller, the meeting is now yours.

Adam Miller (CFO)

Thank you, Christina, and, good afternoon, everyone. Thanks, for everyone joining the call. We have slides to accompany this call posted on our website at investor.knighttrans.com/events. Our call is scheduled to go until 5:30 P.M. Eastern Time. Following our commentary, we'll hope to answer as many questions as time will allow. If we are not able to get to your call due to- or not able to get to your questions due to time restrictions, you may call 602-606-6315. Following the call, we will return your call. During this call, we'll plan to cover topics and any questions specific to the results of the first quarter, as well as our future outlook on the market.

As many of you know, we recently filed a joint press release and held a conference call to announce a merger with Swift, which we're excited about and expecting the transaction to close during the third quarter of this year. During this conference call, we don't plan to go into further detail than already provided regarding the merger. The rules for questions remain the same as in the past, one question per participant. If we don't clearly answer the question, a follow-up question may be asked. Again, we ask you to keep it to one question per participant. I'll now move to the second slide of the disclosure. I'll also read the following here. "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, of Part one 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. Now, I'll start by covering some of the numbers in detail on slide three. For the first quarter to this year, total revenue decreased 0.3% year-over-year to $271 million, while revenue, excluding trucking fuel surcharge, decreased 3.4% to $245 million. Operating income decreased 41.5% year-over-year to $23 million. Net income decreased 35.4% to $15 million. We earned $0.18 per diluted share, compared to $0.28 in the same quarter last year.

Now on to slide four. Knight has always valued and maintained a strong balance sheet. During years of strength, we utilized our cash to invest in organic growth. During challenging environments, we slowed the asset base growth, but continued our growth initiatives in logistics. This leads to meaningful Free Cash Flow that we would ideally use for acquisitions. If we can't find the target, we pay down debt and return to shareholders through dividends and buybacks. Over the last several quarters, we have extended the expected trade cycle of our tractors, therefore, increasing our average tractor age as a response to the rising new equipment prices in a weak used equipment market. We've been proactive in managing our preventative maintenance program with the goal of mitigating the additional maintenance costs associated with a slightly older tractor fleet.

The first quarter, we experienced higher maintenance costs, with some of this attributable to a more severe weather in the first quarter of 2017 versus the same quarter of last year. Managing our maintenance expense will continue to be a high level of focus for our management team. As of the end of the first quarter, we are now debt-free and have generated $54 million of free cash flow. Now on to slide five. Our consolidated revenue, excluding trucking fuel surcharge, was down 3.4% year-over-year as a result of slightly fewer tractors, as well as lower revenue per tractor when compared to the same quarter last year. Revenue from our logistics business was down 3%.

During the first quarter of 2016, we exited our agricultural sourcing business, which made up approximately 11.5% of our logistics revenue in the first quarter of 2016. Excluding the revenue from the agricultural sourcing business, the logistics segment increased 9.4% in the first quarter of 2017 from the same quarter last year. During what has been a challenging freight environment, we remain focused on improving the productivity of our assets in our trucking segment and expanding load volumes and margins in our logistics segment.

During the first quarter, when compared to the same quarter last year, revenue per tractor, excluding fuel surcharge, declined 3.2%, attributable to a 2.3% lower average revenue per loaded mile, a 1% decrease in average miles per tractor, and a 10 basis point improvement in our non-paid empty mile percentage. Revenue in our brokerage business increased 14.3% in the first quarter of 2017 when compared to the same quarter last year, as load volume increased 18.5% and revenue per load declined 3.6%. During the first quarter, capacity in the market was not as tight as anticipated, particularly in California. However, we believe capacity will become more constrained as demand for used equipment remains weak, while additional regulatory burden phase in over the coming quarters.

With that being said, we remain focused on increasing the productivity of our tractors, improving our yield, managing the size of our fleet based on market conditions, and investing in the long-term growth of our logistics capabilities. Now on to slide six. During the first quarter, we faced several factors that impacted earnings. We were challenged by cost headwinds that included net fuel expense, higher maintenance costs, increased driver-related expenses, less gain on sale of used equipment, and higher professional fees related to the merger with Swift. Other income was also a headwind on a year-over-year basis. As mentioned in the previous slide, our revenue per tractor was down on a year-over-year basis, which also impacted our earnings. Our leadership team remains highly focused on managing through the challenges we faced in the first quarter.

We've already begun to make progress on managing some of the cost deflation and becoming more efficient with our non-driving employees. We expect the environment to become more favorable in the back half of the year, as we believe capacity will continue to exit the market and pricing will inflect positively. Therefore, we continue to make investments in areas of our business that we believe will lead to double-digit returns on invested capital. I'll now turn it over to Dave Jackson for additional comments on the first quarter.

Dave Jackson (CEO)

Thank you, Adam, and good afternoon, everyone. Thanks for joining us. I will start with slide number seven. In the first quarter, our asset-based trucking businesses operated at an 89.5% operating ratio, which includes our dry van businesses, refrigerated businesses, drayage business, and dedicated business. The 750 basis point OR increase year-over-year resulted from several factors. First, a 300 basis point impact from a 3.2% decline in revenue per tractor, excluding fuel surcharge, as a result of a 2.3% decrease in revenue per loaded mile and a 1% decrease in miles per tractor.

Miles per tractor had improved to 1.8% in the first quarter of 2016 last year when compared to 2015, and we gave back 1% of that improvement in this challenging quarter of 2017. The OR was negatively impacted by another 240 basis points from increased maintenance expense and professional fees associated with our recently announced merger with Swift Transportation. Similar to recent quarters, gain on sale of used equipment was weak and net fuel expense high. Gain on sale was $800,000 for the quarter, compared with $3.2 million for the first quarter last year. The year-over-year impact on the OR was negative 170 basis points. Revenue, excluding fuel surcharge, was down 3.4%.

Given the challenging trade environment, we decreased our average tractor fleet by 1.5% when compared to the fourth quarter of 2016. We expect to see improvement to come in the freight demand and rate environment. California and much of the West Coast was weak throughout the first quarter. April demand has been positive, with the West Coast strengthening in recent days. In light of the five year drought that has ended in California, the produce forecast is strong and poised to break out with volumes and demand not experienced in some time. Of course, this comes at the same time as the beverage, especially bottled water, shipping seasons, and that normally peak in the second quarter.

It has appeared that excess West Coast refrigerated supply or capacity in recent months has flooded into the dry market, as there has been too much refrigerated capacity chasing too few refrigerated loads. If we see the strong seasonal demand that is expected, it should have a positive impact on both dry and refrigerated freight. Our non-asset-based logistics segment produced an OR of 95.5%. As Adam mentioned earlier, our brokerage business, which is the largest component of our logistics segment, grew revenue 14.3% with load volume growth of 18.5%. Now on to slide eight. This graph provides insight into each of the first quarters since 2013 for our trucking segment. Each of these first quarters have been unique.

Some, like the first quarter of 2015, benefited from strong contract rates following the freight market tightness experienced in 2014. In previous cycles, we have seen rates promptly catch up to previous year's inflation. There continues to be pent-up, unrecovered inflation over the last two years, as represented on this graph, with less operating income, which is largely a result of unrecovered inflationary costs. We expect rates to inflect positively in the second half of 2017. We expect to see stronger seasonality in the second quarter of 2017, which may slow in the second half of the third quarter, but materially increase in the fourth quarter of 2017.

This outlook is based on the continued weakness in the used equipment market, limited capital investment in equipment additions, and the implementation of electronic logging devices, or ELDs, that will reduce supply. Any pickup in the broader economy, of course, would only accelerate things. Next to slide nine. This graph is similar to the previous, but shows the logistics segment. Despite the challenging rate environment, overall logistics revenues were down slightly compared to the first quarter of 2016. However, when excluding the revenue from the agricultural sourcing business we exited during the first quarter of 2016, the logistics segment increased revenues 9.5% when comparing first quarters year-over-year. In a strengthening environment, we believe we will see meaningful growth as we are successful at finding capacity for our customers with positive gross margins for our business.

As an example, you can see that trend on the graph from the first quarter of 2013 to the first quarter of 2015. Now on to slide 10. Our focus is creating value for stakeholders. Our efforts to strengthen our value proposition to our customers, including our evolving service offering, continue without significant variation in the up and down markets. However, when it comes to creating value for our shareholders, we adapt and change depending on the opportunities and challenges associated with whichever end of the market spectrum we're faced with or anticipating. In stronger markets, we may add trucks or open new service centers. Exploring acquisition opportunities has long been an active effort. We see an opportunity for massive value creation with our recently announced merger with Swift Transportation. Growing logistics is always a priority.

The variable nature of that business makes it even more attractive in challenging environments. When we see less robust freight demand, we are less likely to add trucks organically. This results in significant free cash flows, demonstrated with $154 million in free cash flow in 2016, and an additional $54 million in free cash flow already for the first quarter of 2017. Now to slide 11. We are actively working with Swift on the transition plan. As mentioned at the time of the announcement, we will operate each business independently, and we expect significant synergies as a result of helping one another improve while leveraging economies of scale that are not disruptive to the operations, our driving associates, and our customers.

We talked about this transaction in the press release and conference call on April 10 of 2017, and will not have more to add in this call from those comments already made. We would refer you to that call, the press release, and the slides for answers to your questions. Experience, visibility to data, and new technologies continue to aid our efforts to be the safest fleet on the road. In addition to the technology that we've included in the specs of our new trucks for some time now that improve safety, we are deploying additional technologies that have been proven to be effective in the coaching and training of driving associates, their exoneration in some circumstances of false allegations, and are helpful in the settlement of claims.

Reducing cost continues to be the most obvious item within our control that will have the most impact on earnings in the current term. We are very disappointed with our cost performance in the first quarter and have made several adjustments that have led to improved cost per mile in March, and we expect that to continue in future months. Improving the driving job remains a priority. We're investing in new technology to help in this effort, and we will continue our vigilance in understanding the freight market trends to best position our company. I'll now turn it over to Adam to present our earnings guidance.

Adam Miller (CFO)

Thanks, Dave. Slide 12 is our final slide, where we'll discuss guidance. Based on the current truckload market and recent trends, we are reaffirming our previously updated second quarter guidance of $0.24-$0.27 per diluted share. Again, that excludes any deal costs associated with the merger with Swift Transportation. At this point, we're not providing guidance for the third quarter, as we are anticipating closing the merger with Swift during the third quarter. The timing of the close, impacts from transaction costs and purchase accounting may significantly impact third quarter results, which makes providing guidance very difficult at this time. So I'll walk through some of the assumptions made by management for the second quarter guidance. So the first assumption is no organic growth from our current tractor count, which will result in a slightly smaller fleet on a year-over-year basis.

We expect revenue per total miles to increase modestly from first quarter to second quarter, but still remain slightly negative on a year-over-year basis. Last year, in the second quarter, we improved miles per tractor 1.7%. We anticipate miles per tractor will be flat to down slightly as compared to last year. Our assumption is that net fuel expense will continue to be a slight headwind in the second quarter. Again, it's hard to predict fuel, though. In our brokerage business, which is the largest component of our logistics segment, we expect to see close to double-digit growth in both load count and revenue. However, we may experience some margin compression as tighter capacity in certain markets may result in purchase trans expense outpacing revenue per load improvements. We expect driver wages will continue to be inflationary on a year-over-year basis.

We also expect gain on sale will continue to be a significant headwind as the used equipment market remains challenging. For reference, gain on sale in the second quarter of 2016 was $2.7 million, and first quarter gain for this year was approximately $800,000. Other income will also be a headwind on a year-over-year basis. As far as our tax rate, we expect that to normalize around the 38.5% range, moving forward.

These estimates represent management's best estimates based on current information available. Actual results may differ materially from these estimates. We would refer you to the risk factors section in the company's annual report for a discussion of the risks that may affect results. This concludes our prepared remarks. We'd like to remind you again, this call will end at 5:30 P.M. Eastern Time, and we will answer as many questions as time will allow. Please keep it again to one question. If we're not able to get to your question due to time constraints, please call 602-606-6315, and we will do our best to follow up promptly. Christina, we will now entertain questions.

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, press star then the number one on your telephone keypad. Your first question comes from Scott Group from Wolfe Research. Your line is open.

Scott Group (Managing Director)

Hey, thanks. Afternoon, guys.

Dave Jackson (CEO)

Hi, Scott.

Scott Group (Managing Director)

So Dave, I think you mentioned that you've seen demand improve in April, and maybe if you can just give a little bit more color where you're seeing that, and was that a sequential comment or a year-over-year comment? And maybe if you can kind of share what that means for utilization in the quarter. And then I know just a little bit separately, I know you're not giving kind of guidance for the back half of the year, but maybe just directionally, if we think about standalone numbers, when you think your earnings could inflect positive year-over-year, meaning third quarter, fourth quarter 2018, how you're thinking about that?

Dave Jackson (CEO)

Okay. Well, so I'll start with the first part of your question. April, you know, our, our comments about the strength we've seen in April are, we're looking at, at that on a year-over-year basis, but, but relatively speaking, because we, of course, had a Good Friday and an Easter holiday in April of this year that we didn't have in April of last year. So when we look at, the way that April started, really the first couple of weeks, we saw positive trends in utilization. And then, more towards the middle here of April, with the effects of, of a Good Friday, and then the effects a little bit into the following week, following Easter, we, those were tougher weeks for us from a utilization perspective.

Then, you know, this is, I guess, very fresh, but this week looks like we're off to a good start. We're seeing some strength in some markets that have been a little stubborn to kind of wake up. So, you know, all in all, because of Easter, utilization will probably be down year-over-year in April. But when we, when we try and factor that out, and we just try and get a sense for freight demand and how we're starting every morning from a load to truck balance, we're encouraged by it more so than what we saw last year. When you talk about utilization for the quarter, what Adam, I think, had just mentioned in his remarks about guidance where that we would expect to be, you know, best-case scenario would be closer to flat.

More likely, we would be off slightly in utilization. And so, you know, that will mean that both May and June probably are a little bit flat to a little bit better to make up for, you know, an April that has to deal with a holiday. And, you know, I'll remind you that a year ago, I believe utilization was up 1.6% year-over-year, one point.

Adam Miller (CFO)

Seven.

Dave Jackson (CEO)

1.7%, sorry, 1.7% year-over-year. So, you know, to be flat and to hold on to that would be, you know, would be a major accomplishment, we think. And then you, you asked, I think your second question had to do with more towards the back half of the year and when we saw earnings, peak and whatnot. Typically, we see earnings improve in the second quarter from the first quarter. Oftentimes, third quarter can slow a bit from where second quarter was. And then, you know, in a year that, like we saw in 2013, 2014, and 2015, you typically see a fourth quarter that outperforms the rest of the year. And so I think that this year is largely setting up to be that way.

Fourth quarter of 2016 didn't happen that way, but, you know, we would expect to see a decent second quarter, and then probably, then, third quarter would hopefully be in the range of a second quarter, but, but some years that doesn't happen. But fourth quarter should be the peak of earnings for the year for us. If you look, if you were to look at us just purely on a standalone, we would, we would definitely say that.

Scott Group (Managing Director)

Okay, that's helpful. Thank you, guys. Appreciate it.

Dave Jackson (CEO)

Okay.

Operator (participant)

Your next question comes from Ken Hoexter, from Bank of America Merrill Lynch. Your line is open.

Ken Hoexter (Analyst)

Great. Good, good afternoon. Dave, can you talk about your or Adam, I guess, your comments on rates inflecting positive in the second half, and why, at that point, are you talking kind of mid-year or just versus year-end? I just want to know if you're already seeing this kick up in the bid season, if we're, you're already starting to see kind of rate up upticks.

Dave Jackson (CEO)

Well, it, it's, it has more to do with just how we see supply and demand working its way through. So, this bid season, we're probably halfway through. We're a little over halfway through the bids received based on what we expect to receive, with probably just over a third of those actually being fully completed. On incumbent lanes, you know, we're seeing flat to up slightly. And then of course, there's, as any bid season goes, there's some network turnover, so you have some new freight coming on that can be hard to compare on a year-over-year basis. And so, you know, that's what things look like from a contractual perspective. We've had, you know, very little strong non-contract experience for some time now.

In fact, if you were to look at rates in general, first quarter of 2017 is the sixth consecutive quarter with negative revenue per loaded mile on a year-over-year basis. That's this is uncharted territory. You'd have to go back to the period of second quarter of 1999 to the second quarter of through the second quarter of 2000, when we saw five consecutive negative quarters. From 2009, second quarter of 2009 through first quarter of 2010, we saw four negative consecutive quarters. And so now, through the first quarter of 2017, we've seen six. And so this is, this doesn't happen very often. And we there have clearly been inflationary costs that have been that we've been digesting and that have been pent up, that could usually find their way to the market pretty quickly.

And so, you know, when you look at some of the larger macro indicators, things like loads posted versus trucks posted on some of the large aggregators and load boards, you know, what you're finding is that those ratios are up sometimes double what they were a year ago. And so we still have some room to go to hit where they've been at absolute peaks, but it's definitely changing. And so, the seasonality piece is about to pick up with produce and all the freight that changes when the temperature changes. And so, I think we're gonna see some opportunities, because the market rate is just simply gonna go up based on supply and demand.

And so when that happens, and the way that our business is organized and positioned, we're able to usually be pretty efficient at adopting those and moving with those market rates very rapidly. And so, you know, we think we're gonna see some of that here during a couple of the seasonal parts of the year, most pronounced in the fourth quarter.

Ken Hoexter (Analyst)

That's, that's great. Appreciate that. I think the operator said we can do a follow-up, or does it. If we can, let me just throw it out there. If not, you can come back to me later.

Dave Jackson (CEO)

If I didn't give a good answer to your question, yes, you can ask a follow-up. But if it's an unrelated question, we might let it go by this one time.

Ken Hoexter (Analyst)

All right. I'll throw it out there, and you can just maybe get to it later if you don't. Just, I just want to understand really simply, the net orders keep seeming to go up, yet you're talking about keeping your fleet flat. See most are keeping it flat. Just want to know, who's, who do you think is doing the ordering in this kind of a market?

Dave Jackson (CEO)

When you find out, will you tell us so we can get their, get their name and give them a call and understand what they're thinking? No, I think, I think that's a great question, Ken. And I think if you do look at the numbers, and you look at how long they were depressed, you know, you've got, you've got large private fleets with several hundred billion dollars in revenue, theoretically, on the private fleet side. And, and, you know, that's a group that, that may take advantage of the pricing opportunities given the weakness. I think another area that's maybe, that's maybe worth looking at is the retail inventory levels of Class 8 trucks.

And, you know, if you just were to look at February year-over-year, you know, February this year, it's just over 45,000 in inventory, versus a year ago, February, it was almost 67,000. And so, you know, that 21,000 plus pull down or drop down in retail inventory, perhaps that's, there's some replenishment that's moving that way that we might see in these numbers, but we don't know for sure. Certainly, you know, from the large public guys, you don't see the growth. When you look at the small players, we don't see it with the smaller carriers either.

In fact, they've arguably been dealt the toughest hand through this whole process, as they seem to become more and more reliant on non-asset-based brokers, and particularly as customers have migrated to more of a trader pool, and in many cases, have moved to dealing with fewer and fewer large core carriers. And so, you know, if you add a middleman in that process, it makes it even tougher for the small carrier in the end. So, their economics would be particularly bleak, given this extended challenging rate environment. So, retail inventories would be my best guess, followed by private fleet. But I wouldn't know more beyond that.

Ken Hoexter (Analyst)

Appreciate that insight. Thanks, Dave. Thanks, Adam.

Dave Jackson (CEO)

Okay, thanks again.

Operator (participant)

Your next question comes from Brandon Oglenski from Barclays. Your line is open.

Speaker 11

Hi, this is Dan [Taggle] from Barclays, on for Brandon. Thanks for taking my question, guys, and good afternoon.

Dave Jackson (CEO)

You bet.

Speaker 11

I guess in light of recent events, and staying clear of any questions on guidance or anything related to Swift, just setting aside kind of the cyclical challenges that are facing the market right now, could you discuss what you think is a long-term sustainable margin for the business going forward?

Dave Jackson (CEO)

Well, to speak about Knight, you know, we think that long term, the low 80s or an 80 operating ratio is reasonable. We think it's sustainable. You know, you saw us perform throughout all of 2014, you know, and the asset-based business performed in the upper 70s. And when I say 80 OR, I'm talking about the asset-based, not the consolidated that includes brokerage. And so on the asset-based side, we don't have any reason to believe that we can't return to those levels of profitability. I think the fact that we've seen such a negative rate environment for so long, when historically, over the last 10 years, rates have averaged, on average, have gone up about 2.5%.

If that, if that were to just happen on its own, you would see much more consistent ORs, and you would see, we think you would see, an OR pretty close to 80 for our business. So, we think that that's not only realistic, but it also is, is roughly where you need to be in order to meaningfully provide a return that's greater than your weighted average cost of capital. And so very few businesses in our industry ever achieve a double-digit return on invested capital. And so, we think over time, that, that that's, that's really where the business needs to be. And, and we think that we provide a tremendous value with full truckload.

I mean, if you were to compare a full truckload rate, per hundredweight or per pallet, or however you wanted to measure it, if you were to compare us against an LTL alternative, you know, you would find we are at a significant discount. Certainly, if you were to compare us against parcel or air freight, it's not even close. And so, the flexibility that you get, the timeliness and the high level of service that one can receive for truckload service, I mean, the value is pretty, pretty compelling. And so, so we have no reason to believe we can't perform at those levels that historically we've performed at.

Speaker 11

I'll leave it at that. Thanks, Dave.

Dave Jackson (CEO)

Okay, thank you.

Operator (participant)

Your next question comes from Allison Landry from Credit Suisse. Your line is open.

Allison Landry (Analyst)

Good afternoon, thanks.

Dave Jackson (CEO)

Hi, Allison.

Allison Landry (Analyst)

Dave, it doesn't sound, like, you know, anybody really has a clear answer as to who is ordering these trucks, and, you know, particularly when the market is already oversupplied. So I guess my question is, if the industry really needs an uptick in demand to shore up the excess capacity, what happens if freight demand continues to soften from here? And, you know, thinking about ELDs a little bit, you know, down the road, end of the year, will, you know, in this sort of softer hypothetical freight environment, you know, would ELDs just offset weaker freight and sort of leave us back where we started, which is effectively with negative rates?

Dave Jackson (CEO)

Well, I guess you could paint such a draconian outlook. I mean, you can always make a case for a worst case scenario. I think, you know, we've never seen a period like we've seen here in terms of just aggressiveness with rates going down over this prolonged period of time and at such a pace. And so, and I think there's some factors for why we've seen that now, and we haven't seen that in the past. And I think part of it is the fact that brokers, non-asset brokers in particular, have grown pretty significantly over the last 10 years. And I think that they, they've played a very active role in making commitments through the bids, the bid process, instead of just maybe working with more seasonal or surge-type freight opportunities.

And so they've gone to, in essence, compete with the very capacity that they rely on to help them. And so, but that can quickly be reversed and usually is very quickly reversed, as they're some of the most nimble in the market in switching gears when there's tightness in capacity. I think for what you said, if the freight demand were to deteriorate from where it is today, clearly that would not be a good thing. I think, if you look at the levels of where they are now, if you look at where the economy is going, I mean, to suggest that would suggest that the economy is headed to a really, really bad place. And it seems as though construction is showing the positive trends.

In fact, they may be, they may be somewhat to blame for some of the Class 8 purchases, frankly. But you have construction that's picking up. You have consumer confidence numbers that are coming in very, very positive. And so you have, you have we could see a massive infrastructure bill. So you have things that move truckloads, and I don't. We just don't see on the horizon a deterioration in freight demand. Now, what I will tell you that we have had to suffer through is, you know, a California drought that has been very difficult on the West Coast. We had drought conditions there a couple of years ago throughout the Texas and Midwest area that had wreaked havoc in the beef world.

We've had disease and illness that's gone through the poultry world over the last couple of years. And so, knock on wood, for right now, chicken seem to be healthy, and cattle getting fat, and, and produce is, is bountiful. So, you know, that would suggest maybe a little different, demand outcome, and output than what we maybe have been used to most recently.

Allison Landry (Analyst)

Okay, that was helpful, and I didn't mean to, you know, necessarily paint such a dire outlook. But I guess really what I was getting at is, you know, is there something, you know, maybe structural going on with, with, you know, freight itself, you know, perhaps driven by e-commerce, where, you know, it's sort of the freight intensity in the economy has lessened?

Dave Jackson (CEO)

I think, I mean, certainly e-commerce has been a major role. I would say every major carrier has their hand in some kind of e-commerce. The good news is, as I mentioned a minute ago, that full truckload is inexpensive, and so it's the least expensive by far, and yet can provide amazing service, and we can be there very quickly. If you think about the growth that we've seen in e-commerce, it's created significant concentration of products moving into major markets, which allows truckload to be in the game. Whereas initially, when it wasn't so concentrated or there wasn't the volume, you had no choice but to rely on parcel or to rely on even LTL.

And so, there's a lot of opportunity, a lot of truckloads that come with, with e-commerce, particularly efficient e-commerce, and I, and every major retailer is in the, is, is developing their, their capabilities there. I think, I think something that's been a factor, Allison, has been that, that the country has, has become very, very good at finding every possible spare scrap of capacity in the market. And load boards and the 12,000 brokers, most of which have never bought a truck, have become very effective in using the internet, sometimes even using apps, to be able to find every potential truck that's out there. And so, I'm not sure that in prior cycles there's been quite as much visibility to this.

I mean, if you were to go back to the 2004, 2005, 2006 timeframe, it seemed like C.H. Robinson was the only one that had the comprehensive rolodex to track down a lot of, the majority of the capacity. And today, you know, it's kind of all out there. And so, you know, the challenge and the drawback to that is you have a lot of middlemen that have created that have gotten in between and that are all trying to collect a 15%-20% gross margin, and there just probably wasn't that much to begin with for the carrier. So there are long-term negative effects to the short-term visibility and the short-term ease of being able to find capacity. And then that issue gets further exacerbated come ELDs, when in some cases you have small carriers that make capacity available because of flexibility that they have in not using an ELD. And so that begins to change, which I think just further exacerbates the issue, so.

Allison Landry (Analyst)

Okay. Really appreciate your thoughts. Thank you.

Dave Jackson (CEO)

Thanks, Allison.

Operator (participant)

Your next question comes from Brad Delco from Stephens. Your line is open.

Brad Delco (Managing Director)

Good afternoon, Adam.

Dave Jackson (CEO)

Hi, Brad.

Brad Delco (Managing Director)

Dave, how are you?

Dave Jackson (CEO)

Great.

Brad Delco (Managing Director)

Dave, seeing 750 basis points of OR deterioration at Knight is something that I would consider somewhat unprecedented. I was just curious, is there anything else going on on the cost side here? If you broke down your asset-based operations between dedicated, dry van, refrigerated, drayage, where did you see the most pressure between those, you know, call it subsegments of your asset-based business?

Dave Jackson (CEO)

Yeah. So our I mean, it was a challenging environment for both our dry van and refrigerated business, no doubt. The 750 basis point slide, it just makes us sick. And I will tell you in when we got our January numbers, we were extremely disappointed. I mean, January was one of the worst performing months that we've ever had. And so you know, we didn't wait around, and we began to address every issue that we knew of, that we could within what we could control. And so we've made several adjustments in February and in March that continue to move going forward.

You know, in any given quarter, you've usually got a few things going right for you, whether it's gain or whether it's utilization or rate or, or perhaps one of our businesses is doing really well. Reefer might do well and dry is maybe not so much, and they kind of can help move the needle and help protect. Very rarely, if ever, do all of those major cost factors and businesses all go great in the same month or quarter. Rarely, if ever, does that happen, but also very rarely do we have where you basically have almost no gain on sale, and you don't have any help from fuel. Sometimes, you know, obviously, you get help sometimes, and that's one of those factors that helps you.

But it's just if you go through the list, you know, everything was a negative for us. And so, you know, clearly, we have felt the effects of the prolonged, challenging freight environment. And, as you know, we primarily live in that irregular route environment, as opposed to maybe a more safe, multiyear contract, dedicated market. We do dedicated, but it's a smaller portion of our business. And so, at this stage of the game, and as market rates improve, we wouldn't trade our position, and we expect to be positioned in a way to recover as market rates move and recover previous quarters' unrecovered inflation at a pretty good clip. So, you know, we're looking forward and working hard to aggressively manage this current environment now in the second quarter.

Brad Delco (Managing Director)

Great. And then the—if I can get the follow-up. Can you give us just a sense of, within your asset-based business, the size or scale of dry van versus dedicated versus reefer and dray, just to help us kind of understand the exposure you have within each of those segments?

Dave Jackson (CEO)

Do you want to give a rundown, Adam, maybe?

Adam Miller (CFO)

Well, I don't have it all right in front of me, at my fingertips here, Brad, but just roughly speaking, of just looking at the asset side of our business, dry van would probably represent about 60% of our asset-based business, while refrigerated would be close to that 30%-35%. And drayage would, well, let me add to that, bar none would put dry van, if we include bar none, so that's probably closer to 70%.And then you have refrigerated, which is probably about 20%, and drayage is about 10%, I'd say.

Dave Jackson (CEO)

There you go. On the asset base, on the asset-based side, if you were to look at, if you were to look in just consolidated, where you're going to see close to 20% of revenue come from the logistics side of our business.

Adam Miller (CFO)

Right. Yeah, I was just breaking out the asset side for you, Brad.

Brad Delco (Managing Director)

Okay, let me, I got a little confused there. With Barr-Nunn, dry van is 70%, refrigerated.

Dave Jackson (CEO)

Yeah.

Brad Delco (Managing Director)

And dedicated and dray would obviously be 10. Is that correct?

Adam Miller (CFO)

Dedicated, I would roll that up into the dry van.

Dave Jackson (CEO)

Yeah, and I.

Adam Miller (CFO)

We don't break that out separately. We operate that within our service centers. But dedicated is probably a total of 10% of our asset.

Brad Delco (Managing Director)

Okay, great.

Adam Miller (CFO)

That would come, that would be primarily dry van. Sorry, that's a little confusing.

Brad Delco (Managing Director)

I'm going to go back and listen to the replay and see if I can make sense of it. But thanks. Thanks, [Jesse].

Dave Jackson (CEO)

Hey, Brad, let me just, sorry to, I kind of put Adam on the spot there. Let me just back up. So of our asset-based business, the dry van business is going to be roughly 70%. And about 10% of that 70% of the dry van business is going to fall into the dedicated category. And then, about 20% of our asset-based revenue is going to be refrigerated, and then that last 10% is going to be roughly our drayage business.

Brad Delco (Managing Director)

Gotcha.

Dave Jackson (CEO)

Okay.

Brad Delco (Managing Director)

Thanks. That's like, I'm clear now. Thank you.

Dave Jackson (CEO)

Okay.

Operator (participant)

Your next question comes from Tom Wadewitz from UBS. Your line is open.

Tom Wadewitz (Senior Equity Research Analyst)

Yeah, good afternoon. I wanted to ask you about the, I guess you had some nice discussion on, you know, some of the secular, potential secular factors. And one thing you didn't mention was the retail store closures. So, you know, it seems like every day you read about more store closures. I guess it's, you know, it's hard to get a, you know, clean assessment of the net impact if you have growth in e-commerce store closures. So what would you say about that in terms of having a negative effect on freight demand? Do you see that as a net negative in your customer base, or you think it's just kind of, you know, evens out with e-commerce growth? How would you view that as a factor we ought to consider on overall freight impact?

Dave Jackson (CEO)

Yeah. No, it's a very good question. I think it's a complicated question to try and answer. Obviously, store closures are a negative for freight demand, but e-commerce is growing at such a pace, you know, from a high level, it seems to be outpacing store closures, or the effects from store closures. But it's hard to try and compare those two at the same time. They function in different ways, and so I think ultimately where you have to get to is looking at what's going on with GDP, and that just gives you a general sense.

And as long as people are purchasing goods and food, you're going to see truckloads involved in as many of those as can possibly be. be done because of the value that's created with truckload. So, I mean, I don't have data in front of me to try and compare those apples and oranges between one's growth and one's decline, but clearly, it has a regional effect to some folks. So sorry, I don't have a better answer to that.

Tom Wadewitz (Senior Equity Research Analyst)

No, but okay. But it sounds like you don't think that, you wouldn't blame that for the weakness. One other kind of short one, if you don't mind. The fleet age has gone up a bit, and I don't remember the last time you were at, what are you at, like 2.4 years old for the tractors? Is there a point where you say, "Well, maintenance costs go up, we don't like to run an older fleet," are you kind of close to that, or can you keep aging it if the, if the market remains soft?

Dave Jackson (CEO)

Yeah, there definitely is a point at which we decide that it's not worth it. And so it's not just looking at maintenance costs, it's also looking at what does the used equipment market have to offer us at the same time, and where do we forecast that? So, we see that market is very, very soft. We see it as continuing to be soft for a while. So, but that's something we watch really, really closely and try and make the best decision based on what the options are.

Tom Wadewitz (Senior Equity Research Analyst)

It doesn't sound like you're there yet, I guess.

Dave Jackson (CEO)

I would say we're, I don't think we're there yet, but boy, we're clearly closer than we've ever been. So, you know, we were 1.8 a year ago, and we're 2.4 today. So, you know, weather played a factor in the maintenance costs, but clearly, the average age being up would, would play a factor as well. And so, it's something that we're watching, we're watching very closely, so.

Tom Wadewitz (Senior Equity Research Analyst)

Okay, great. Thanks for the time. I appreciate it.

Dave Jackson (CEO)

Okay. Thanks, Tom.

Operator (participant)

Your next question comes from Ravi Shanker from Morgan Stanley. Your line is open.

Ravi Shanker (Analyst)

Thanks very much. So I have two follow-up questions to the previous comments you made, so I guess that counts as one question combined, maybe, I don't know. The first one's on logistics. I think you said before that, you know, there was a time when C.H. Robinson was the only one that had the Rolodex, but that's probably no longer the case. What does that environment, what does that do to your logistics margins longer term? How are your logistics margins kind of go up from here, if you will? Is it primarily gonna be a cost thing, or do you guys still have some element of pricing power? And what do you think, some of the new entrants coming into the space, and what kind of impact they'll have on your margins longer term?

Dave Jackson (CEO)

Okay. Well, I think that, I think what typically happens is, we'll see purchased trans costs go up first, and then rates will follow purchased trans costs going up. And so we're in an environment now where we've seen purchased trans costs go up and rates not be able to keep pace. We've seen that, and virtually every broker that I've seen released has had similar compression in the margin. And then, what will eventually happen is the market pricing will go up because the demand and the cost for trucks goes up with purchased trans going up, and those brokers who have committed to 12-month rates will find themselves with significant compression in their margins, and sometimes may not have much of a margin as a result of very competitive contractual 12-month pricing.

And then those brokers that are a little bit more on the transactional side and aren't as locked in will be able to move with what is a very efficient market as pricing demand goes up. And so, we're clearly in an environment where the price needs to be going up, should be going up faster because purchase trans costs have been going up, and that's always been the predictive indicator. And so now it becomes a matter of what does your exposure look like in terms of where are you locked in at rate, and where do you have the ability to kind of move variably with the market. And so our approach to brokerage has been one of being much more variable and less of commitment, that's, you know, in our logistics brokerage arm. Did I answer your question, Ravi?

Ravi Shanker (Analyst)

Yes, and if you just address the kind of new entrants and kind of what kind of impact they'd have in the space.

Dave Jackson (CEO)

Yeah, well, I think with the new entrants, we've seen that many of the smaller brokers that are trying to aggressively grow their business, they do so with discounted rates. And oftentimes, due to lack of relationship with third-party carriers, they end up sometimes paying a little bit more into the market than maybe more established carriers might. So they're probably even more margin challenged than the larger, more established players.

Ravi Shanker (Analyst)

Okay, and just as a quick follow-up to the other question I had was, you said that the third quarter guidance would be kind of in the same range as the 2Q guidance. Is that kind of literally that, the 24-27 that you've given for 2Q, or do you mean kind of in the ballpark? Because.

Dave Jackson (CEO)

Yeah, Ravi, I didn't intend to give, provide any guidance into third quarter of 2017. My comment that I had made earlier in this call just referenced in typical years what we've seen from a second to a third quarter. I didn't mean to infer explicitly anything about third quarter 2017. We're just. There's too many moving pieces at the moment for us to put guidance for third quarter.

Ravi Shanker (Analyst)

Great. Thanks for the clarification.

Dave Jackson (CEO)

Okay, thanks, Ravi.

Operator (participant)

Your next question comes from Brian Konigsberg, from Vertical Research Partners. Your line is open.

Brian Konigsberg (Analyst)

Great, thanks for taking my question. Good afternoon.

Dave Jackson (CEO)

Good afternoon.

Brian Konigsberg (Analyst)

Since we just had a lot of news on tax proposals today, maybe I'll just ask on that one. So to the extent we do get a corporate rate cut, just curious your thoughts on the ability for truckload carriers like yourself to be able to sustain the benefits of the tax rate. Do you think it's likely that it'll be given away in rates fairly quickly? Or do you think you're positioned to hold on to something like that for your own benefit? And if not, maybe it's just my follow on, do you anticipate maybe longer term, if you cannot hold on to those benefits, might that just result in lower operating margins through the cycle?

Adam Miller (CFO)

Well, Brian, hey, I'll take a, I'll take a stab at that question. You know, when you look at the average trucking company, there, for most, there's just not a lot of profit. It's a very low margin industry. And so the lowering of tax rates for most companies don't provide the same benefit as it would for the larger public companies who have been more profitable, or at least for those who have been more profitable. So for, for us, for instance, it would have a meaningful impact on our earnings, but for many of the, the smaller carriers, it just wouldn't have as big of an impact, and therefore, they wouldn't be able to share on as much with the, with the customer in terms of a price discount. So we do feel that we'd be able to hold on to a meaningful amount of that, of that benefit.

Dave Jackson (CEO)

Yeah, Brian, I would just point out, we have historically been a 38.5%-39.5% taxpayer. I mean, this quarter was an anomaly. We saw a little lower tax rate than that, but we have been nearly a full statutory state and federal taxpayer. And of course, that's in addition to the registrations and fuel and mileage tax and heavy highway use tax that we pay, everything else. So we're definitely proud Americans, and we feel like we've been paying our part, maybe more so. So I just felt I needed to get that out, Brian. Thanks. I felt it felt good to get that out.

Brian Konigsberg (Analyst)

Sounded good. Thanks.

Dave Jackson (CEO)

Thank you.

Operator (participant)

Your next question comes from Chris Wetherbee, from Citi. Your line is open.

Chris Wetherbee (Senior Research Analyst)

Hey, thanks, and good afternoon, guys.

Dave Jackson (CEO)

Hi, Chris.

Chris Wetherbee (Senior Research Analyst)

Hey, wanted to touch back on some of the expense management initiatives that you talked about a little bit, and I think you mentioned that you're getting a little bit of traction as you move from 1Q to 2Q on that. I guess I just wanted to get a, maybe get a little bit more color on some of the specifics that you're kind of working on, and, and maybe how that can impact the cadence of earnings as you move throughout the rest of the year, presumably with some freight, and you get some of these cost dynamics, maybe you could get the incremental margin dynamics are shifting a little bit more in your favor. But, but any help or color you can give around that would, would be greatly appreciated. Thank you.

Adam Miller (CFO)

Yeah, so Chris, maybe I'll take a stab at that, then Dave can add any color if I miss anything. So, as Dave said, you know, we got our results in January, and obviously, we're not very pleased with them. So there were several areas across the company that we felt like we needed to do better on from a cost perspective. We worked with our leaderships, we laid out plans, and that was probably mid-February when we did that, and we started to get some traction. I'd say as we look at the first quarter, you know, January did not play out very well. It was very difficult, probably one of the worst months we've seen.

February, made a little bit more progress, but March was probably the one month of the quarter that played out almost like you would have expected March to play out in the first quarter. And so we felt good about that progress. We're headed into April. We still feel we have some momentum on the cost initiatives. And, you know, we hope to see some additional traction there, and for that to improve our results meaningfully. And so if you look at our guidance, we're showing an incremental increase in EPS from first to second quarter. That would be higher than normal if you look back at historical, you know, changes in EPS, sequential changes from first to second. So that's kind of baked into some of the guidance that we've laid out.

Chris Wetherbee (Senior Research Analyst)

Just to follow up, just to be clear, in terms of, you know, the second quarter, so we should assume that sort of full run rate of some of these cost dynamics that you've sort of layered in, as opposed to it's still growing throughout the second quarter, maybe third quarter being the run rate? Just want to make sure I'm clear on sort of where that run rate kind of kicks in.

Adam Miller (CFO)

Yeah, we have more progress to be made. We're not at a full run rate at this point. We still have work to do in order to get some of these cost pressures in line.

Chris Wetherbee (Senior Research Analyst)

Perfect. Thanks for the time, guys. Appreciate it.

Dave Jackson (CEO)

Thank you, Chris. Well, this, it's 5:30 P.M. Eastern Time, and so, this will conclude our call. We appreciate your support in joining our call today. Christina, I'll turn it back to you.

Operator (participant)

This concludes today's conference call. You may now disconnect.