Knight-Swift Transportation - Q4 2015

Transcript

Operator (participant)

Good afternoon. My name is Julie, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Knight Transportation fourth quarter 2015 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, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key. 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, Julie, and thank you for everyone who has joined the call today. We have slides to accompany this call posted on our website at investors.knighttrans.com/events. As usual, our call is scheduled to go until 5:30 P.M. Eastern Time. Following our commentary, we hope to answer as many questions as time will allow. If we're not able to get to your questions due to time restrictions, you may call 602-606-6315 following the call, and we will return your call. Again, that number is 602-606-6315. The rules for questions remain the same as in the past, one question per participant, and if we don't clearly answer the question, a follow-up question may be asked.

More often than not, we end up with people in the queue that are not able to ask a question, so we ask again to keep it to one question per participant. To begin, I'll first refer you to the disclosure on page two of the presentation. I'll also read 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 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 begin by covering some of the numbers in detail, including a brief recap of the fourth quarter results, starting with Slide 3.

For the fourth quarter of 2015, we earned $0.36 per diluted share versus $0.40 in the same quarter last year. Net income decreased 11.2% year-over-year to $29.2 million, while our operating income decreased 17.3% year-over-year to $43.7 million. Revenue, excluding truck and fuel surcharge, decreased 2.8% year-over-year to $266 million, and our total revenue decreased 8.4% year-over-year to $290.7 million. Now on to Slide 4. We ended the quarter with over $738 million of stockholders' equity, and over the last 12 months, have returned over $65 million to shareholders through dividends and stock buyback. We did not repurchase any shares during the fourth quarter.

We currently have approximately 5.8 million shares authorized under our share repurchase plan, and we'll continue to evaluate buyback opportunities in the first quarter. We continue to maintain a modern fleet with an average tractor age of 1.7 years. In 2015, we generated $52.9 million in free cash flow, and we expect that number to nearly double in 2016, as we estimate our CapEx to be in the range of $85 million-$100 million versus the $149.4 million we spent in 2015. We currently have $112 million outstanding on our unsecured $300 million line of credit, which leaves us with a meaningful amount of capacity for additional investments. Now on to Slide 5. Our profitability, cash flow generation, and return on capital remain strong.

Knight has a proven track record of operating at a high level of profitability and success, successfully integrating acquisitions that have provided meaningful returns for our shareholder, shareholders. We have a deep appreciation for returns and continue to focus on incrementally improving our ROIC by being more productive with our existing assets, expanding our non-asset logistics offerings, and investing in high-return opportunities. Our free cash flow generation and strong balance sheet allow us to deploy capital towards growth opportunities, acquisitions, share buybacks, as well as pay consistent dividends to shareholders. Now on to Slide 6. Over the last several years, we've experienced meaningful growth in our consolidated revenue, excluding truck and fuel surcharge. This is a result of our ability to expand our logistics service offerings, improve yield, organically grow capacity, and successfully integrate acquisitions.

The exceptional fourth quarter of 2014, in which our revenue, excluding truck and fuel surcharge, grew 32.6% and our net income grew 63.9%, resulted in a difficult comparison for 2015. In a market not as robust as the same time last year, most of our freight opportunities were hauled at contract pricing compared to 2014, when we experienced significantly more non-contract opportunities. This led to our rate per loaded mile declining 1.5% year-over-year. Comparing our rates to a more typical year, such as 2013, our rate per loaded mile has increased over 10% over that two-year period. We also continued to expand our logistics offering.

During the quarter, our brokerage business, which is the largest component of our logistics segment, increased load volume by 49.7% and continues to expand gross margins. However, revenue per load has been negatively impacted as a result of lower fuel surcharge, a shorter length of haul, and less non-contract opportunities. With truckload capacity being challenged by a shortage of drivers, coupled with the pending host of regulatory changes, we see those companies that are well-capitalized and have already adapted to the soon-to-be enforced regulations, well-positioned to benefit in the longer term. With that being said, we remain focused on improving our lane density, increasing the productivity of our tractors, improving our yield, and investing in the long-term growth of our logistics capabilities as a means to continue to grow our business. Now on to Slide 7.

We continue to execute on our strategy of providing a high level of service while operating with industry-leading efficiency. We understand how critical it is to manage inflationary pressures in order to maintain the lowest cost per mile in our trucking segment and the lowest cost per transaction in our logistics segment. During the fourth quarter, driver pay, fuel, other income, and a lower rate per total mile year-over-year pressured earnings. Our service centers and departments maintain an intense focus on managing the costs associated with operating our business in order to drive significant value to our shareholders. This focus has led to earnings that have grown 75% since 2013. I'll now turn it over to Dave Jackson for additional comments regarding the fourth quarter.

David Jackson (CEO)

All right. Thank you, Adam, and good afternoon, good evening, everybody. I'll start on Slide 8. In the fourth quarter, our asset-based trucking businesses operated at an 80.7% operating ratio, which includes our dry van businesses, our refrigerated businesses, our drayage business, and our dedicated business. Contributing factors to the 320 basis point change year-over-year include lower revenue per mile for the reasons Adam discussed two slides previously. Despite lower absolute fuel prices this fourth quarter, the fuel expense net of fuel surcharge was up in the fourth quarter of 2015 versus the prior year, and driver pay continues to be up on a year-over-year basis. Our asset-based businesses remain focused on developing the type of freight in the specific lanes we desire at appropriate prices through the bid process that is currently underway with many customers.

Several cost reduction and efficiency improvement efforts are underway in every business, and every service center is focused on closing the year-over-year operating ratio gap. Although our operating ratio is industry leading, we and our people are focused on improving our results on a year-over-year basis. Our non-asset-based business, our non-asset-based logistics business, saw revenues decline 5%. Our brokerage business, which is the largest component of our logistics segment, saw revenues, including fuel surcharge, decrease 5.5%, despite a 49.7%, excuse me, increase in load volumes. Brokerage expanded gross margins by 90 basis points. However, revenue per load has been negatively impacted as a result of the lower fuel surcharge, shorter length of haul, and less non-contract opportunities year-over-year.

We're encouraged by the pace of the volume growth and believe that the growth momentum will continue and eventually yield growth in all three categories at the same time, revenue growth, volume growth, and margin dollar growth. We're pleased with the development of our people, the newly implemented software, and the increasing integration into our entire truckload service offering to our customers. In terms of profitability, our logistics segment operated at a 93.0% operating ratio. Our logistics performance continues to confirm the opportunities for growth, as well as the value provided to our customers through our offering of transportation management, brokerage, and intermodal services, in addition to our truckload services. Now I'll move on to Slide 9.

This graph helps us take a step back and put into perspective the growth both in revenue and income in 2015 and over the last few years. This growth is not top-down driven. That's not how our model works. Our growth in both revenue and income originate from the most fundamental building block of our billion-dollar-plus business, and that is each business and each service center. The real magic happens when the front lines capture the vision and set higher expectations of themselves than what we would have set. There's extensive support, intelligence, and experience to help with safety, service, pricing, equipment maintenance, et cetera. There's a uniqueness to the culture and environment that's fostered here that doesn't allow for barriers, empowers individuals, where the expectations for high performance are set by individuals and expected of each other.

Today, our people are working harder than ever to keep our driving associates moving safely, analyzing more data than ever before to make sure our capacity is committed to the best opportunities in the most efficient lanes for the right price. Our people also understand the importance of operating with the lowest cost per mile and why that is a significant differentiator for our company. Next, to Slide 10. We are excited with what we've learned about and by our exposure to brokerage and intermodal, and now that's broadening with our transportation management logistics platform. We believe there are things that we can offer because of our 25+ years now of being an asset-based carrier, that only a very select group can offer, that all centers around efficiency.

We believe our understanding of freight markets and supply chains, extensive customer relationships and customer portfolio, and most recently, our growing investment in logistics-related technology, can lead to sustainable growth. Our brokerage growth and profitability have been solid over the last few years, and we have more confidence than ever in our model. We believe we've demonstrated its scalability. We believe we have a long ways to go in terms of fully introducing the offering to our customers, to all of our customers. We've had good success in a hybrid approach with certain customers. We may be a couple of quarters away from seeing the revenue growth we want due to the factors previously mentioned, but as we grow the volumes, the revenue comparisons should work themselves out. Now on to Slide 11.

Over the last five years, we've incrementally improved our returns on invested capital, as demonstrated by the graph. We have an agile business model with, different segments that are all designed to yield double-digit returns, while providing a broader range of services and value to our customers. We'll move to Slide 12. Our focus is creating value for our 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 shareholders, we adapt and change, depending on the opportunities and challenges associated with whichever end of the market demand spectrum we're faced with or are anticipating. In stronger markets, we add trucks, often open new service centers, and explore acquisition opportunities. Growing logistics is always a priority.

The variable nature of that business makes it even more attractive in challenging environments. When we see less and less freight demand, we're less likely to add trucks organically. This usually results in significant free cash flow, which amplifies our focus on adding capacity through acquisition and also enables us to improve EPS growth through share repurchases. Our objective is to leverage our very diversified customer base, multiple service offering, and our non-asset complement to the truckload business and healthy capital structure to create value in both strong and sluggish environments. We move to Slide 13. Our team remains focused on executing at the highest level. Reducing cost is the most obvious item within our control that we have the most, that will have the most impact on earnings in the current term.

We're in an environment where contractual pricing seems to be in that 2%-3% range with limited non-contract opportunities. Several specific efforts have been underway to reduce costs. We expect to improve costs but not impair our long-term growth capabilities. We've been experiencing lower unseated tractor counts recently. We have meaningfully improved our pay and performance bonus for our driving associates over the last several quarters. We continue to invest in technology and our service centers to improve the experience our drivers have on the road. Now, we'll move to Slide 14 and talk about growth a little more specifically. We continue to evaluate and pursue acquisition opportunities to grow our company.

Our logistics segment continues to grow load count rapidly and has become a meaningful complement to our trucking segment. We're using more technology in this process and are pleased with the efficiency that we're seeing so far. Based on our current outlook for freight demand, we would expect minimal to flat organic growth, tractor growth in 2016. This should result in significant growth in free cash flow, as Adam mentioned earlier. And now I'll turn the call over to Adam to discuss guidance.

Adam Miller (CFO)

Thanks, Dave. Slide 15 is our final slide, and where we will discuss guidance. Based on the current truckload market, as well as recent trends, we're reducing our previously announced first quarter 2016 guidance range of $0.32-$0.35 per diluted share to $0.28-$0.31 per diluted share. Our expected range for the second quarter of 2016 is $0.32-$0.35 per diluted share. Our guidance is conservative with regards to fuel, as we do not expect to experience the same benefits of declining fuel prices we experienced in the first quarter of 2015. We remind you, last year, in the first quarter, we estimated about a $0.03 per share benefit from rapidly falling fuel prices. In the second quarter, we expect fuel to normalize and provide maybe a slight benefit on a year-over-year basis.

Some assumptions, some additional assumptions made by management would include, as Dave mentioned, minimal organic growth from our current tractor count. We expect total rate per mile for the next two quarters to be relatively flat from the previous year. Now, in terms of contract rates, we expect to see a 2%-3% increase during the year. However, during the first quarter and part of the second quarter of 2015, we still had non-contract opportunities above normal contract rates, which we don't expect to have this time this year. Therefore, we expect to begin to see rates in the aggregate turn positive in the back half of the year.

We also expect miles per tractor to be positive, approximately 1%, and long term, we expect to continue to grow our logistics segment in that 25%+ range, while operating with a low- to mid-90s operating ratio. In the first half of 2016, we expect load counts to continue to outpace that 25% growth target, as we've seen in the past. However, we expect continued revenue per load headwinds that include lower fuel surcharge, shorter length of haul, and less non-contract opportunities. These headwinds will impact the revenue growth year-over-year, and more than likely result in a revenue growth below that 25% pace.

We also expect that driver wages will continue to be inflationary on a year-over-year basis, based on pay increases that we've already put in effect in the back half of 2015 that wouldn't have been lapped on a year-over-year basis. We also expect gain on sale in the first half of the year to continue to be a headwind, as we recorded gains of $4.7 million and $5.2 million in the first and second quarter of 2015, respectively. Other income will also be a headwind on a year-over-year basis. As far as our tax rates, we expect that to normalize in the next two quarters in that mid-39% range, excluding any unusual items, and this will be an earnings headwind for both the first and second quarter of 2016.

These estimates represent management's best estimates based on current information available. Actual results may differ materially from these estimates. We refer you to the Risk Factors section of 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 that this call will end at 5:30 P.M. Eastern Time. We will answer as many questions as time will allow. Please keep, 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. We will now entertain questions.

Operator (participant)

At this time, I'd like to remind everyone, in order to ask a question, it is star one on your telephone keypad. Our first question comes from the line of Scott Group. Please state your first and last name. Your line is open.

Scott Group (Managing Director)

It's Scott Group from Wolfe Research. Good afternoon, guys.

Adam Miller (CFO)

Hi, Scott.

Scott Group (Managing Director)

So wanted to just follow up on the pricing a little bit, and maybe if you can help us. So we've got pricing that was down 1.5% in the fourth quarter, and I know you're talking about contractual pricing of 2%-3%, but kind of all-in pricing of that's gonna stay negative. So maybe just like, how much of the business was spot in the first half last year? And maybe, like, how much above the contractual market was that business priced? And then kind of just separately, on that 2%-3% contractual pricing, I know Swift, earlier this week, talked about starting to see some pricing flatten out. How do you get comfort in that 2%-3%, given the kind of capacity environment we're in right now?

Adam Miller (CFO)

Yeah. Well, there's a lot of moving parts at the moment, as you can imagine, and we're, you know, there's several things where we priced, and we haven't received the award. There's others that haven't even started the bid. But from what we've seen, and the bid season, I would say, started maybe even as early as late October. We, you know, the end results have been in that flat to slightly positive range. So, it's still early to know, but our best guess from what we've seen and how we're approaching the bids would be that 2%-3%. So, it's very hard for us to calculate what percentage of the bids have we gone through versus where we were a year ago.

About the best we could maybe define it for you would be that the non-contract business that we had a lot of last year, in the back half of the year, particularly in the fourth quarter, didn't exist. It existed also for us in the first quarter of last year, first quarter of 2015, and it's not in existence today, and we don't expect it to be in the first quarter of this year. So, you know, that puts a lot of pressure on the year-over-year for us.

I think as we look at where we feel freight volumes to be today, and we made a comment about this in the press release, that the January volumes are positive for us. So, we're seeing more miles on a per truck basis right now so far in January than as compared from January of last year. So, you know, this isn't a situation where there's maybe a feeling of desperation, if you will. The increases we've paid the drivers are obviously very real, and I think all carriers have done the same, and we realize the challenges we have.

This year, next year, and for years to come, to find the number of drivers, driving associates that we'll need to meet our customers' needs and demands. And so I don't think that this is a time where carriers are taking big discounts. And so we don't sense that changing, and I think there's a bigger macro tone to that decision making, and it's not so much based on exactly how we feel in the here and now moment.

Scott Group (Managing Director)

Thanks. And just wanna make sure I understand. So you're saying that most recently, you've been seeing flat to slightly up, but you still think 2%-3% is where contractual pricing can be for the year. So is that view on that acceleration, is that ELD starting to have an impact? Is it maybe the guys that bid earlier were more aggressive about trying to get flat rates? Or what drives that relative improvement from flat to slightly to 2%-3%?

David Jackson (CEO)

What I'm saying is, if we're flat to slightly positive, I mean, that's not too far from 2%-3% already. Our feeling is the first two quarters of this year of 2016 are gonna be the most challenging. And if that plays out, we think that you're gonna have less capacity available come the back half of the year. So I think that if we're flat to slightly up now, there's a chance that as other bids and other opportunities, many bids that happen throughout the year, as those things come about and take place, you know, the pricing has a chance of being better as we move throughout the year.

Now, are ELDs a factor to that? I imagine that that's in the back of the mind.I think it will, we would certainly expect that to be a factor in 2017. But, but it might be a factor, maybe not directly, but even indirectly, as carriers are kind of deciding what to do, with underperforming assets, that have been underperforming so far, almost, they're going on almost a year for those who brought on capacity. So, so if, if it's zero up slightly now, we like our chances of that maybe, if not getting worse, maybe being a little better, and so that, that sounds like 2%-3% for us.

Scott Group (Managing Director)

Okay, perfect. Thanks a lot, guys.

David Jackson (CEO)

Thanks, Scott.

Operator (participant)

Your next question comes from the line of Kelly Dougherty from Macquarie. Your line is now open.

David Jackson (CEO)

Hi, Kelly. Hello, Kelly, are you there? Julie, it sounds like we have a connection problem with Kelly.

Operator (participant)

All right, so we'll move on. Kelly, if you can hear, just press star one again. Your next question comes from the line of Allison Landry from Credit Suisse. Your line is now open.

Allison Landry (Senior Equity Research Analyst)

Thanks for taking my question. Good afternoon. So just, just following up on, the comments that you made about capacity, I was just wondering, just in terms of, how you're positioning for going after contractual versus spot opportunities this year, if you plan to do more on the, on the contractual side, based on what you were saying in terms of the first half not having, as many non-contract opportunities? Or do you think that, you know, we'll sort of reach a bottom in the spot market as we progress throughout the year? So any, any color that you could provide on, on how, how you're approaching that would be helpful. Thanks.

David Jackson (CEO)

Sure, Allison. So, you know, for us, we always want to be able to help a customer. And so it's hard for us just to be a high-quality service provider and to think that we would commit up all of our capacity, you know, at a year at a time or a year in advance. And then when our customers undoubtedly, invariably call us throughout the year, especially in times of seasonal peakness or their seasons, and ask for extra help, we want to be able to help them. And the alternative is, we send them down the road to some very large non-asset-based brokers, who then do their best to take very good care of them. And so we wanna be there. We wanna be able to provide that kind of service.

Obviously, in certain environments, helping out, that kind of service, you know, pays a premium. And other times, there's not as much of it or it doesn't pay to the same degree. So when we look at this year, we're probably likely to commit a little bit more of our business, but we'll still, and probably always will, maintain, you know, a decent amount of capacity available to be able to deal with the changing needs and surges of our customers.

Allison Landry (Senior Equity Research Analyst)

Okay, thank you.

David Jackson (CEO)

Thanks, Allison.

Operator (participant)

Your next question comes from the line of Kelly Dougherty from Macquarie. Your line is now open.

Kelli Dougherty (Analyst)

Hi, guys. Sorry about that. Can you hear me now?

David Jackson (CEO)

Yep, we got you. Thanks, Kelly.

Kelli Dougherty (Analyst)

All right, good, thanks. So I just wanted to see if I could get some thoughts as you look at M&A and, you know, what you might be most interested in acquiring, kind of weigh that against, you know, the opportunity to acquire your own stock at, at a pretty attractive valuation. So get some thoughts on maybe why that wasn't in the fourth quarter, how you're thinking about it, particularly as you think about, you know, allocating capital between buybacks and M&A, and maybe it doesn't have to be one or the other?

David Jackson (CEO)

Yeah, those were all good questions. I'll try and answer them all. So in terms of the acquisition world, I would say that we have a pipeline, and there's a big difference between having a pipeline and getting something across the finish line at the right price and with the right arrangement that works for both parties. So, we're in that and remain active there.

I would say that, you know, the concept that you bring up about investing, you know, in our own company or buying back our own shares, I would say that there are, there are probably, some deals out there that otherwise might have looked more attractive, but when you weigh, the risk and, current stock price, and, and forecast of future EPS, and you look at from an accretion perspective, there's kind of a high hurdle now, that we have to get over to not just buy back our shares, and, and, and what we would view as a much less, less risky transaction or investment than, than even to buy maybe a, a carrier of decent size that might come with a healthy amount of risk, even though it might look like a very fair valuation.

So it's a long way of saying that, sometimes the best acquisition in the short term might be buying back our shares. Now, in the fourth quarter, as you saw, and I think what your question alludes to, is the fact that we did not repurchase shares as we had in the second and in the third. And I, you know, I think in the fourth quarter, there was certainly a fair amount of market uncertainty, and we saw the collapse in commodity prices, oil prices, some of the global concerns. And so as we saw that, we coupled with the fact that, you know, we're optimistic about being able to find an opportunity to buy another company, we took a brief pause.

You know, the nature of being a public company, you have times where we block ourselves out and don't buy shares, and so that ends up impacting a fairly large window of the quarter as well, so that the actual time we have to buy back shares in a quarter is much smaller than you might think. So we took a pause, and we didn't do that in the fourth quarter. Clearly, we reserve the right to reevaluate that and relook at that here again in the first quarter. Did I answer all of the components of the question, Kelly?

Kelli Dougherty (Analyst)

You did. Thanks, guys. I'll jump back in, let somebody else get in the line.

David Jackson (CEO)

Okay, thanks.

Kelli Dougherty (Analyst)

Thanks.

Operator (participant)

Our next question comes from the line of Ken Hoexter from Bank of America. Ken, your line is now open.

Kenneth Hoexter (Managing Director)

Great, thanks. Hey,

David Jackson (CEO)

Is that Ken Hoexter?

Kenneth Hoexter (Managing Director)

Yes, Dave Jackson. Thank you.

David Jackson (CEO)

Hi.

Kenneth Hoexter (Managing Director)

Dave, Adam, you know, maybe just, you talked about drivers not being an issue. As the market rates pay enough, along with economic fear that they're returning to the trucks, or are you chasing away non-compliant carriers? I guess, I want to phase that into the ultimate question of, what's driving the average miles per tractor targets? You've accelerated down, but you said they're going to go up, so I want to understand the driver along with the mileage component of that. Thanks.

David Jackson (CEO)

Okay, so I want to be clear I understand your question, Ken. You're wondering what's driving maybe us in January being able to haul more miles? Or...

Kenneth Hoexter (Managing Director)

Yeah, because you said it's, it's going up now, right? Which, but you've accelerated down, so is... what's making that shift? Because it sounds like you weren't having trouble getting drivers anymore. So how are you...

David Jackson (CEO)

Yeah. Well, I’m not sure I would ever say we’re not having trouble getting drivers. There’s a lot of effort, a lot of work, and frankly, a lot of expense and investment that goes into that. I think what we are experiencing is fewer unseated tractors, which would help. The way we measure our miles per truck is we include all trucks, whether they’re open or not, and it brings full accountability into our business. So that would be a part, but the improvement we’re seeing is a little bit beyond just having more trucks. And so, you know, I think it speaks to an environment that and the diversification, the effort of our folks to get out there and find opportunities.

I think my main point in talking about such early or premature data is just that, you know, the world's not falling apart. And we think there's a chance that we see some strengthening happen, mainly, mainly because of continued challenges in the supply side. I mean, for example, you have, you know, you have Don Broughton's good research, who goes into great detail, and I won't steal his thunder. But the bottom line, you've seen failures continue to grow in the fourth quarter, and that's despite the fourth quarter being typically the highest volume quarter. You might understand it a little bit more in the first quarter, but you have that coupled with the fact that you had consistent, precipitously falling fuel prices that still weren't enough to offset that.

I think that there's a lot of fresh capacity, if you will, the most recent capacity to come into the space, that come April, will hit the anniversary mark of a full year of going from what was a double-digit premium in that load board non-contract market to what's now become for almost a solid year, a double-digit discount in that load board type world. And that's just insurmountable, even with, you know, the huge, huge break that everybody that uses fuel has had with dropping fuel prices. It's just, it's a long time to hold your breath, even for the most resilient of small carriers. So and I think if you look at this a little bit bigger, we just take a step back.

I mean, it's kind of like, we've all been to the theater, we've seen this same play before, and it's now just a matter of when, not a matter of if. You know, when you look at the players who have already, the large carriers who have already reported, one thing we see in common is that fleet additions in that group have ended, and the outlook is basically to be flat, it sounds like, over at least the next year. I think even the best operators have gone backwards a little bit. I would, you know, I would, I would add us to that group, going backwards a little bit in the average fleet count from third to fourth quarter.

And so then you look at the balance sheets of several of those companies, at least the ones who sell some of their own used equipment instead of just trading it all, and what you see is that their assets held for sale have begun to bloat relatively quickly. And as equipment's coming off, it's not moving as fast. When we go back to 2010 through 2012 or 2009 through 2012, there were so few new tractors purchased that that used market really is not very big. And so and a recent index came out that showed that used equipment pricing was off 8%.

And so to have the price off, the inventory not moving, the expectation that new truck orders are probably going to be more like November and less like December's numbers as we move into this year, you know, that just we see what's going on with the just the sheer number of trucks that are out there, out there and available. So, so we think that supply piece continues to rationalize itself out, especially as we have, you know, maybe a first and second quarter that don't have a lot of non-contract spot opportunities that that newest capacity would benefit from. And, and then, and then things start to, start to turn, maybe head in a different direction. And then before we know it, we're possibly on the heels of enforcement for ELDs, which continues to change the game a bit.

Kenneth Hoexter (Managing Director)

Great. I, I truly appreciate the, the time today, Dave, and Adam, thank you.

David Jackson (CEO)

Okay. Thanks, Ken.

Operator (participant)

Our next question comes from the line of Jason Seidel from Cowen and Company. Jason, your line is now open.

Jason Seidl (Managing Director)

Thank you, operator. Hey, guys,

David Jackson (CEO)

Hi, Jason.

Jason Seidl (Managing Director)

Right. You mentioned about driver pay and that you would expect that it to go up a little bit based on some of the increases that you pushed through last year. Once you lap those increases, where do you think driver pay is going to go maybe in the back half of the year for you?

Adam Miller (CFO)

Well, Jason, I'll, I'll speak to that a little bit, and Dave can add any color for you if I miss something. You know, based on what we're seeing today, with our ability to find drivers, again, it's not easy, but we're able to reduce our open tractor count. We've done quite a bit on the driver pay side, in terms of their bonus and their base pay. We've done more in the last two years than we've done in the history of our company. I think our peers have done it as well. We don't feel inclined on what we see today that we have to do much on driver pay.

But look, that could always change. That's something that we're constantly monitoring. We're looking at that every month. But, at least for the, at least for the first half, we feel fairly good about where we, where we stand from a driver pay perspective. We feel we're pretty competitive. Back half, it, you know, it, it's, it's to be seen, and we'll, and we'll see what the market bears.

Jason Seidl (Managing Director)

Okay, guys, that was great color. I appreciate it. That's my one. I'll get you back on.

David Jackson (CEO)

All right. Thanks, Jason.

Operator (participant)

Your next question comes from the line of Ben Hartford. Ben, please state your company name, or sorry, company affiliation. Your line is now open.

Benjamin Hartford (Senior Research Analyst)

Ben Hartford, Piper. Thanks for taking the question.

David Jackson (CEO)

Hi, Ben.

Benjamin Hartford (Senior Research Analyst)

Dave, when you, when you think about this first half of the year with not a lot of contract business, you, you made the comment about, excuse me, not a lot of non-contract business. You made the comment about gross margins in the, in the brokerage business expanding in the fourth quarter, obviously in Texas. Spot capacity, are you seeing anything unusual in the bid environment on the brokerage side here in the front half of the year? And how quickly would you expect some of the, the tailwinds experienced on the brokerage side during 2015 to unwind and, and shippers benefit from, from what appears to be a very active bid environment?

David Jackson (CEO)

Well, you know, our brokerage business is they're impacted, as we've noted, on the decline in revenue per load. They're largely associated with that non-contract side. And so, we feel like that's a very good place for a non-asset-based business to be, to be able to flex up and down. So, you know, we're not inclined to go overly commit that. I would say that in prior periods, going back to, you know, 2011, 2012, 2013, I think we saw the third party or the non-asset brokerages maybe get more aggressive, and we would feel that on our asset-based fleet.

I don't think that we're experiencing or feeling that to the same degree, like in previous years. I'm not sure if that was part of what you were alluding to in your question, but, we don't see the disruption there, in the bid process, from the brokers. But am I approaching or answering your question, the right question?

Benjamin Hartford (Senior Research Analyst)

Yeah.

David Jackson (CEO)

Or did you...

Benjamin Hartford (Senior Research Analyst)

Yeah, yeah, that's helpful. I guess, you know, just some perspective on, on the intensity. Are you seeing more intensity in terms of the bids on, on the non-asset-based broker, kind of pure brokerage type bids relative to some of the more traditional asset-based contractual businesses? Is there more intensity in, in, kind of one mode versus the other?

David Jackson (CEO)

Not really. Not really. And there aren't very many customers that I'm aware of that want to just talk exclusively brokerage. And so we have a lot who entertain brokerage as a complement, but not just brokerage exclusively. As I think we've mentioned before on other calls, maybe belabored the point, the ability to own a fleet of trailers is pretty valuable and can create a lot of efficiency in their business. And now they have the surges and the seasonality, where sometimes they can't always do that. But there's typically an underlying decent chunk of their business where they like to do it at the most optimal level, and that usually requires some kind of a commitment from an asset-based player. So, at least for our company, we don't have a lot of exposure to those brokerage-exclusive type customers.

Benjamin Hartford (Senior Research Analyst)

Okay, that's helpful. Thanks.

David Jackson (CEO)

Thanks, Ben.

Operator (participant)

Your next question comes from the line of Todd Fowler from KeyBanc Capital Markets. Todd, your line is now open.

Todd Fowler (Analyst)

Great, thanks. Good afternoon. Dave...

David Jackson (CEO)

Hi, Todd.

Todd Fowler (Analyst)

Just on the guidance... Hi, Dave. Just on the guidance for the first half, you know, it really sounds like that the fleet's going to be relatively consistent. It doesn't sound like utilization's that bad, and the revenue per mile is going to be at least flattish. But the earnings guidance at the midpoint kind of implies a mid- to high-teens drop.

And I get that there's the challenge on the equipment gains and the fuel, but is there something else, I mean, that... Is it the driver pay increases? I guess I'm surprised at the magnitude of the falloff in earnings. And then just as far as growing earnings, again, is it that you really need that spot market to reaccelerate or the levers, I know you've talked about some things on the cost side, but just how do you think about the ability to grow earnings, absent maybe a tighter spot market?

Adam Miller (CFO)

Hey, Todd, this is Adam. Maybe I'll talk a little bit about the guidance to start with, kind of the first part of your question. And I tried to touch on a little bit when I gave the guidance, some of the areas where we feel that there's going to be some pressure on earnings. I alluded to tax, and our tax rate in 2015 was lower than it normally was, and we did some things with some amended returns and different positions that helped that. But we wouldn't expect to see that in 2016. So if you looked at the first quarter of last year as well as the second quarter, we had a much lower tax rate.

So that'll be one headwind, particularly in the second quarter, we'll have to face. Certainly alluded to fuel in the first quarter will certainly be a headwind, but we feel like that will no longer be a challenge when we get into the second quarter. Other income is another line item that isn't core to our business, but you know certainly will provide a little bit of a headwind from an earnings perspective as well. And then, as you alluded to, gain on sale, we had some really solid quarters in the first and second quarter of last year.

As Dave spoke to, we see pricing down, inventory is not moving, which we feel is a good sign from a capacity standpoint, but has some short-term impact from an earnings standpoint when it comes to the gain on sale that you recognize. And then driver pay. Until we lap the driver pay increases, and which is the last increase we did was mid-fourth quarter in certain areas of the country, until we lap that, that's going to continue to be a headwind. So with rates, call it rates flattish, those are just challenges that we'll have to try to overcome.

David Jackson (CEO)

And Todd, maybe I'll take the last part of your question, which was, if I understood it right, had to do with, hey, do we really need non-contract to come back to grow earnings again? And I would just point to the fact that—go ahead, you can clarify before I...

Todd Fowler (Analyst)

Yeah, and Dave, I wasn't trying just to simplify and say that that's the only piece. But I mean, I guess as I just think about, you know, the ability to grow earnings, you know, kind of what are some of the things that we should be thinking about? So I wasn't trying to narrow it down just to one bucket, but go ahead.

David Jackson (CEO)

Yeah, I was just going to point out that, you know, we reacted very quickly in a strengthening environment. You know, one of the slides we showed there was that adjusted net income over a two-year period was up 75%. And so, if you look at, or you just look year-over-year in the fourth quarter, up 63.9%, and it feels like we gave back 11% of that in the fourth quarter. Well, and that was with no non-contract. So, yeah, with the kind of growth that we've had over the last two years and how efficient we were in that non-contract space, having it go to virtually zero, puts a little short-term pressure. We don't expect it to stay at zero, in for the long term.

And, you know, and as we look out just a couple of quarters, certainly to the back, starting with the back half of the year and then moving into 2017, I mean, I think we, we'll find ourselves in an environment that, on top of the kind of contractual improvement we're seeing, even in this kind of an environment, where, we should be able to manage our cost at, at a level that we see year-over-year improvement in growth and earnings in, in a, in a very not, not too distant future. And, and so this concept of giving up a little bit here for a quarter or two, a tough time after really getting a lot over two years, we don't expect that to be a long-term trend, so.

Todd Fowler (Analyst)

Okay. Yeah, that helps, as last year shows that what a difference a year can make. So thanks for the time, guys.

David Jackson (CEO)

Yep. Thanks, Todd.

Operator (participant)

Your next question comes from the line of Matt Brooklier from Longbow Research. Matt, your line is now open.

Matthew Brooklier (Senior Equity Research Analyst of Industrial Transportation and Manufacturing)

Hey, thanks. Good afternoon. So my question...

David Jackson (CEO)

Hey.

Matthew Brooklier (Senior Equity Research Analyst of Industrial Transportation and Manufacturing)

How you doing? At the end of fourth quarter, can you provide us, and you have in the past, with what percentage of your total truckload business is you would classify as spot-centric? I think we've talked about a 25% number in 2015, and maybe it was a little bit bigger than that in fourth quarter 2014. But I'm just trying to get a sense for where do you stand today in terms of your exposure to spot business? And then how should we think about that number as we progress through the year, if the first half is a little bit weaker, and hopefully, things pick up and tighten up into the second half?

David Jackson (CEO)

Yeah. Well, Matt, I would say that that, the number would be down a little bit, but not, not dramatically. And, you know, the, it, it becomes a subtle measurement for us because the spot loads, we don't have just purely spot customers and contractual customers, we have customers. And there, there are some loads where we ask them for, there are times where we've set more loads than what our commitment was, and to us, that would represent, non-contract. Those would represent non-contract loads. And so, so there's, it, it's a sometimes a blurry line. And so we've worked very closely with our customers to get additional loads and where we needed lanes. And so the truth is, those loads typically come to us at whatever the contractual rate would be.

And so, the reason for the tough comparison is last year, those loads would come to us, usually at the customer's request, and with a willingness to pay a premium as they were, they were really in need. In some cases, because we had already accepted more than we normally would have, under the contractual agreement, and we were going to find a way, a way to give them even more capacity. So my best guess would be that it's less than a year ago, and somewhere in that probably 18%-20%, if I had to make a best guess, that would be non-contract in the fourth quarter.

Matthew Brooklier (Senior Equity Research Analyst of Industrial Transportation and Manufacturing)

Gotcha. Okay, very helpful.

Operator (participant)

Your next question comes from the line of Tom, sorry, Tom Wadewitz from UBS. Tom, your line is now open.

Thomas Wadewitz (Senior Equity Research Analyst)

Yeah, good afternoon. Thanks, Dave. Thanks, Adam.

David Jackson (CEO)

Hey, Tom.

Thomas Wadewitz (Senior Equity Research Analyst)

Well, let's see. So I want to go back. You were talking a little bit earlier, Dave, about, I think a, you know, more constructive view on a, maybe a tighter market in the second half and some of that being related to, rationalization of capacity. Can you give some more thoughts on how you think that may play out? I mean, it seems to me that once the equipment's around, even if a carrier is not being that profitable with it, the new equipment doesn't necessarily go away that quickly.

So you know, what do you need to see in terms of, you know, if it's monthly Class 8, orders, that, you know, at a certain level, you'd have more conviction that this market tightens up in six months? Or, you know, what would you really look for to say, "Okay, this, you know, this capacity rationalization is happening, and I've got confidence that it's going to take place in six months, as opposed to being, you know, a year or two years or, or whatever?

David Jackson (CEO)

Yeah, yeah. You know, well, the number I've heard and believe is that somewhere around 20,000 trucks a month just decide to give up the ghost. And so to the degree that we don't have new Class 8 builds in excess of 20, you're not keeping up with the normal attrition. I think, you know, different than virtually every other mode of transportation, our trucks are not very long-lived assets. The asset values just, they obviously don't compare to a plane or a barge, and even the LTL guys rebuild things a few times, I think, before they're done. And so the lifespan of a truckload truck is really not that long.

And so when you look at the average age still being north of six years old, and the fuel efficiencies that are there with the newer equipment, I'm not saying the newest, but that obviously has the best, but some of the really old equipment that's out there is really inefficient, even with these low fuel prices. And so I used a four-year-old truck is a huge trade-up in many cases. And so, the challenge with trying to time or guess that, based on just orders and builds, I think is very, very difficult because, once a carrier pulls the truck out of service...

It's very easy for that truck to become the collection, a parts collection vehicle to get other trucks up and running, and then pretty quick things change. So, I think I guess my bottom line is, I think that that has a way of happening faster than you might think. I think that if the normal trend continues through, call it May timeframe, where we hit a full year of the market, that I believe most of that small capacity came into the space for and has largely been hauling. When they hit a full year of just discounted, unprofitable business, I just don't see that making sense. I don't see those trucks sticking around.

Now, the one, the one piece that might have an impact on that is, you know, if you look at kind of what's going on a little bit in intermodal, and fuel is becoming more and more of a factor, I think, in that load, load selection. You got national average fuel prices right now at $2.07, and in another week or two, we could see that go under $2. I mean, that would be- that would take us back to 2005, the last time we saw a national average price that low, that, of course, fuel surcharge is based on. You got intermodal, obviously, have that multiyear, almost decade of, gaining market share, and, and where length of... They were getting shorter, into shorter and shorter length of hauls.

And now that kind of came to an end in 2014, where it leveled off, and we've now seen two consecutive quarters where length of haul is now rising significantly in the intermodal space. And so what that means to me is that truckload is kind of getting back in the game, particularly in some of the longer length of hauls. We're certainly finding that including fuel surcharge, our truckload rates can be very competitive, to say nothing of the fact that we can do it in less time. I mean, we average 45 mi per hour versus, you know, the rail's 20-something. And this might be controversial, but our trucks are cleaner than what they would do, especially when you include the dray, the pickup and the delivery.

So, so in today's e-commerce and more e-commerce economy, I think what we're finding is that there might be a place where for trucks to haul some of these loads that have been lost. And so I bring that up in this conversation of trucking capacity, that if that continues at a faster pace, especially with fuel where it is, there's a chance that that acts as a little bit of a lifeline to some of the, some of the smaller carriers. So personally, I'm not so sure that you're going to see that get so good so fast before time runs out on the small carriers. But just a couple of dynamics I thought worth mentioning.

Thomas Wadewitz (Senior Equity Research Analyst)

I mean, are you actually seeing some, where you're taking some loads away from intermodal? Do you think that you're seeing that directly?

David Jackson (CEO)

We think we're seeing a little bit of that. But, you know, fuel has really dropped off. I mean, we talk about how intermodal, the intermodal length of haul has risen significantly in the last two quarters. I mean, that's not including what we've seen happen to fuel prices in the last 30 days. So, I think it's I think it may be just beginning. You know, the fuel, coupled with the fact that the intermodal pricing has continued to go up at a pretty healthy clip, faster it's outpaced truckload, even though truckload did well in 2014 and 2015. And so, so I think, I think we're we, we've seen some. I think we're poised maybe to see more of that, so we'll have to stay tuned.

Thomas Wadewitz (Senior Equity Research Analyst)

Right. Okay. Thanks for all the perspective. Appreciate it.

David Jackson (CEO)

Okay, thanks, Tom. Looks like we have time for one more quick question. Probably a quick answer, not a quick question. That's where the problem is.

Operator (participant)

Our last question comes from the line of Chris Wetherbee from Citi. Chris, your line is now open.

Christian Wetherbee (Senior Research Analyst)

Hey, great. Thanks for squeezing me into the wire here. Wanted to ask just quickly about sort of the sequential cadence, I guess, of the guidance. Want to sort of understand. It seems a little flatter first quarter to second quarter than we're typically seeing, you know, in previous years. I think you've explained some of those reasons behind it, but want to make sure I'm sort of not missing anything about that cadence. And then when you think about sort of maybe 2Q to 3Q and into 4Q, if sort of historical changes would still hold, or maybe it's a little bit more of a higher inflection, given sort of your view on maybe a softer first half and then better second half. So just kind of thoughts around the cadence of the guidance would be helpful. Thank you.

Adam Miller (CFO)

Yeah. So, Chris, I'll take that. You know, we see the guidance is up sequentially about $0.04 from first to second, which, quite honestly, looking at historically, isn't that unusual. Second quarter, you know, sometimes that bears a decent spot market, and other times it may not, depending on, you know, what happens with, you know, the produce and the weather. You know, as that heats up, sometimes water moves at a pretty rapid pace.

So second quarter can sometimes be a much stronger quarter, and other times, maybe not as robust. And so we took a very conservative approach in our guidance, and, you know, we see a normal, you know, the normal uptick from what we feel to is a reasonable uptick from first to second. But again, if you look historically at the way we give guidance, we're always fairly conservative.

Christian Wetherbee (Senior Research Analyst)

No sort of implication of how maybe 2Q to 3Q would then trend as a result of that?

Adam Miller (CFO)

No, I wouldn't read into anything there.

Christian Wetherbee (Senior Research Analyst)

Okay, great. Thanks for the time, guys. Appreciate it.

David Jackson (CEO)

Okay. Well, that will conclude our call. We appreciate everybody joining us. Be safe.

Operator (participant)

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