Knight-Swift Transportation - Q4 2016

Transcript

Operator (participant)

Good afternoon. My name is Karen, and I will be your conference operator today. At this time, I would like to welcome everyone to the Knight Transportation fourth quarter 2016 earnings call. All lines have been placed on mute to prevent any background noise. Speakers for today's call will be Dave Jackson, President and CEO, and Adam Miller, Chief Financial Officer. Mr. Miller, the meeting is now yours.

Adam Miller (CFO)

Thank you, Karen, and welcome to everyone who's joined the call. So you know, we have slides to accompany this call posted on our website at investors.knighttrans.com/events. Our call is scheduled to go until 5:30 P.M. Eastern Time, and following our commentary, we'll hope to answer as many questions as time will allow. If we're not able to get to your call, or not able to get to your question due to time restrictions, you may call six zero two six zero six six three one five following the call, and we will return your call. Again, that number is six zero two six zero six six three one five. The rules for questions remain the same as in the past. One question per participant. If we do not clearly answer the question, a follow-up question may be asked.

Again, more often than not, we end up with people in the queue that are not able to ask a question. So again, we ask you to please keep it to one question per participant. Okay. On to the disclosure slide. So I'll 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 and details, including a brief recap of the fourth quarter, starting with Slide three. For the fourth quarter of 2016, total revenue decreased 0.6% year-over-year to $289 million, while revenue, excluding trucking fuel surcharge, also decreased 0.6% to $264 million. As a note, during the fourth quarter of 2016, we accrued $2.5 million of expense, which was $1.5 million after tax, related to expected settlement costs for two class action lawsuits involving employment-related claims in California and Washington.

We provided adjusted financial information that excludes these expenses from our results of operations, and we believe the comparability of our results is improved by excluding these infrequent expenses that are unrelated to our core operations. Our GAAP operating income decreased 24.4% year-over-year to $35 million, while our adjusted operating income decreased 14.8% to $37 million. Again, our GAAP net income decreased 24.2% to $22 million, while our adjusted net income was down 19% to just under $24 million. And based on GAAP, we earned $0.20 per diluted share compared to $0.36 in the same quarter last year, while our adjusted earnings per diluted share were $0.29 for the quarter. Now on to slide four.

We ended the quarter with $786 million of stockholders' equity, and over the last 12 months, have returned approximately $60 million to our shareholders through dividends and stock buybacks. Our average tractor age continues to increase and is up from 1.8 years in the second quarter of 2016 to 2.2 years in the fourth quarter of this year, or fourth quarter of 2016. With rising new equipment prices and a weak used equipment market, we extended the expected trade cycle of our tractors. 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.

For the full year of 2016, we generated $154 million in free cash flow, which we have used to repurchase shares and pay down our debt. We expect to continue to generate meaningful cash flow as we now have plans to grow our fleet until customer demand exceeds supply. We currently have just $18 million outstanding on our unsecured $300 million line of credit, which is down from $112 million, at the end of 2015. This continues to leave us with a meaningful amount of capacity for additional investments and acquisition opportunities. Now on to Slide five.

Our consolidated revenue, excluding trucking fuel surcharge, was down just 0.6% 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 essentially flat, despite exiting our agricultural sourcing business in the first quarter of 2016. During what has been a moderate 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 fourth quarter, when compared to the same quarter last year, we improved our miles per tractor 0.7%, which marks the fourth consecutive quarter with year-over-year improvement. Revenue per tractor, excluding fuel surcharge, decreased 0.4% year-over-year.

As a 1.2% decline in average revenue per loaded mile offset the improvement in average miles per tractor. Revenue in our brokerage business grew 6.3% as a result of an 8.2% increase in load count, offset by a 1.7% decline in revenue per load. We expect to truck capacity to continue to tighten as a result of low new truck orders, a weak demand for used equipment, and additional regulatory burdens expected to phase in over the coming quarters. With that being said, we remain focused on improving our lane density, 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, as well as continuing to assess acquisition opportunities as a means to continue to grow our business.

Now on to Slide six. We continue to execute on our strategy of managing 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, we faced several challenges that impacted earnings. Fuel prices steadily climbed during the quarter and led to a higher net fuel cost than originally estimated. Demand for used equipment remained particularly weak and resulted in gain on sale below our expectations. Other income was also a headwind on a year-over-year basis. We were able to partially offset some of these cost challenges across several departments, including our safety group. As mentioned in the previous slide, our revenue per loaded mile was down on a year-over-year basis, which also impacted our earnings.

We may face similar cost challenges in the first quarter as fuel and gain on sale may remain significant cost headwinds in the first half of the year. We remain highly focused on managing through the challenges our industry faces as we become more efficient with our non-driving employees and continue to find innovative ways to further increase that efficiency. 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 some additional comments on the fourth quarter.

Dave Jackson (President and CEO)

Thanks, Adam, and good afternoon, everyone. Thanks for joining us. I'll start with slide number seven. In the fourth quarter, our asset-based trucking businesses operated at an 83.7% operating ratio, which includes our dry van businesses, refrigerated businesses, our drayage business, and our dedicated business. The 300 basis point OR increase year-over-year was because of three things, primarily, increased net fuel expense, lower gain on sale of equipment, and higher driver-related costs. Our asset-based businesses remain focused on developing the type of freight in the specific lanes we desire at appropriate prices. We've chosen to extend the average age of our fleet, given the weakness in the used equipment market. Given the challenging rate environment in 2016, we kept our fleet size flat. We continue to manage costs aggressively.

Miles per truck, again, saw meaningful improvement in the fourth quarter, being up 0.7% year-over-year, and our non-asset-based logistics segment produced an OR of 93.3%. As Adam mentioned earlier, our brokerage business, which is the largest component of our logistics segment, grew volumes 8.2%, while gross margins, gross margins contracted 50 basis points. Brokerage revenue increased 6.3% when compared to the fourth quarter of 2015. Next, on to slide eight. This graph shows two directional measurements of the freight markets. The graph on the top illustrates the sequential changes in average revenue per total mile.

It's noteworthy to point out the contrast in trajectory between the flat sequential rates between the third quarter of 2015 and the fourth quarter of 2015, compared with the 1.4% sequential increase from the third to fourth quarters in 2016. We view this as a sign of an improving market. The bottom graph illustrates the sequential increases in brokerage load counts over the last two years by quarter. We are encouraged by the load count growth, which represents increasing demand from our customers. It requires significant coordination and technology to be able to operate a successful asset-based business and a growing high returns, non-asset brokerage business. Now on to slide nine. This graph provides insight into each of our fourth quarters since 2002 for our trucking segment.

Each of these fourth quarters have been unique. Some, like the fourth quarter of 2015, benefited from strong spot-contract rates. 2014 saw meaningful non-contract premiums throughout the quarter. In previous cycles, we've seen rates promptly catch up for previous years' inflation. There is pent-up, unrecovered inflation over the last two years. We expect rates to inflect positively in the second half of 2017, with an increasing likelihood of materially stronger fourth quarter rates 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 would only accelerate things. Next, on to slide 10.

This graph is similar to the previous, but shows the logistics segment. Despite the challenging rate environment, overall logistics revenues were flat year-over-year in the fourth quarter, and we only gave up 50 basis points in the gross margin. In a strengthening environment, we believe we will see meaningful growth as we are successful at finding capacity for our customers when they need it most, with positive gross margins for our business. As an example, you can see that trend on the graph from the fourth quarter of 2012 to the fourth quarter of 2013, and again from the fourth quarter of 2013 to the fourth quarter of 2014. Next, on to slide 11. Our focus is on 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 demand spectrum we're faced with or anticipating. Stronger markets, we add trucks, often open new service centers, and explore acquisition opportunities. Growing logistics is always a priority. The variable nature of this business makes it even more attractive sometimes in challenging environments. When we see less robust freight demand, we're less likely to add trucks organically. This results in significant free cash flow, as we've seen in 2016. And now to slide 12. 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 new trucks for some time now, that improve safety, we're 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 have been helpful in the settlement of claims. Reducing costs continues to be the most obvious item within our control that will have the most impact on earnings in the current term. We expect to improve costs, but not impair our longer-term growth capabilities. Improving the driving job remains a significant priority, and we're investing in new technology to help in this effort. We continue our vigilance in understanding the freight market trends to best position our company. I will now turn it over to Adam to present our earnings guidance.

Adam Miller (CFO)

All right. Thanks, Dave. All right, slide 14 is going to be our final slide, where we'll discuss guidance. Based on the current truckload market and recent trends, we are adjusting our previously announced first quarter guidance of $0.26-$0.29 per diluted share to $0.24-$0.27 per diluted share. We're establishing our expected range for the second quarter of 2017 of $0.27-$0.30 per diluted share. I'll walk through some of the assumptions that management has made that goes into this guidance. No organic growth from our current tractor count. We expect revenue per total mile in the first quarter to be slightly negative as we work through the upcoming bid season and begin to renew much of our business.

We expect our revenue per total mile could turn positive in the second quarter as we begin to implement some of our bid awards. We also expect miles per tractor to continue to trend positively, but not to the same degree we experienced in 2016, as the comparisons have now become a little more challenging. Our assumption is that net fuel expense will continue to be a headwind in the next two quarters. However, I mean, that can be very volatile, and it can be difficult to predict. In our brokerage business, we expect to see close to double-digit growth in both load count and revenue. However, may experience some margin compression as tighter capacity in certain markets may result in purchased transportation expense outpacing revenue per load improvement.

As we've mentioned in prior calls, during the first quarter of 2016, we exited our agricultural sourcing business, which has historically accounted for approximately 8%-10% of the revenue reported in our logistics segment. So we'll lap this comparison in the second quarter of 2017, but that will be a headwind in the first quarter. Again, long term, we expect to be able to grow our logistics segment in that 25%+ range, while operating in a low- to mid-90s operating ratio. We expect driver wages will continue to be inflationary on a year-over-year basis, probably similar to what we experienced in the fourth quarter of 2016. We also expect gain on sale in the next two quarters will continue to be a significant headwind, as the used equipment market remains very challenging.

For reference, gain on sale in the first quarter in the first and second quarter of 2016 were $3.2 million and $2.7 million, respectively, while our fourth quarter gain on sale was approximately $700,000. So those are some of the example of the headwind we would face in the first half of this year. Other income will also be a headwind on a year-over-year basis for both the first and second quarter. As far as tax rate, we'd expect that to normalize the next two quarters around that high 38%-39% range. Again, excluding any unusual items that may occur. 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 of the company's annual report for a discussion of the risks that may affect results. Now, this concludes our prepared remarks, and we would 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, again, keep it to one question, and if we're not able to get to your call, or if we're not able to get to your question, you may call six zero two six zero six six three one five, and we'll do our best to follow up promptly today. Karen, we're open for questions.

Operator (participant)

To ask a question, please press star one on your telephone keypad. If your question has already been answered or you would like to withdraw your question, please press the pound key. Your first question comes from the line of Tom Wadewitz of UBS.

Dave Jackson (President and CEO)

That would be Tom Wadewitz, right, Tom?

Tom Wadewitz (Senior Equity Research Analyst)

There you go. Hey, Dave, Adam, how are you guys?

Dave Jackson (President and CEO)

Good.

Tom Wadewitz (Senior Equity Research Analyst)

Let's see. So I guess the question around, you know, kind of view on supply-demand always comes up, and, you know, you try to figure things out. Sounds like you guys are constructive about some improvement later in the year, but what do you think about, you know, kind of the bid season and the contracts that get repriced in first quarter, second quarter? Do you think that's up a couple points, you know, a point or two positive, or what would your best view be on that? And how much, you know, kind of visibility do you think you have for that at this point?

Dave Jackson (President and CEO)

Yeah. Well, we'll start with a disclaimer that we don't have a tremendous amount of visibility because we are early on in that process. I would say that since kind of the mid to early fall, we've seen, you know, probably 100 bids so far, which I would say is typical of what we would have seen at this point. And they start, and there's usually a bit of a process and time that goes through before it's all done. Based on what little we've seen, but what we kind of expect looking forward, we would say that we would expect the outcome to be in the low single digits.

When we look at 2017 as a whole, where we expect to end up from a rate perspective, we would see that, you know, still in the low single digits. So that might suggest that, you know, a portion, a portion of the rates gonna come through contracts. And then potentially we'll see some spot activity at the very end or towards the end of the year, that helps us a little bit more. So, that I know that's a little bit vague, but we're talking about, we're talking about positive rates, but probably not significantly positive.

I think if you look at where our rates have been and how we would maybe compare on a year-over-year basis, you know, we've got a stiff challenge here, probably in the first quarter, when we look at where rates ended in the fourth and kind of where they were a year ago in the first. So, you know, that's. We're probably gonna continue to see rates trend negative in the first quarter, but then flattening out, and then we would expect to start to turn positive, as we move through the back half of the year. So, I hope that's helpful, Tom.

Tom Wadewitz (Senior Equity Research Analyst)

Yeah. Yeah, that's great. Thank you, thank you for the response.

Dave Jackson (President and CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Matt Brooklier of Longbow Research.

Matt Brooklier (Senior Equity Research Analyst)

Good afternoon.

Dave Jackson (President and CEO)

Hi, Matt.

Matt Brooklier (Senior Equity Research Analyst)

How are you doing, Dave? So another pricing question, if I may. The sequential improvement that you saw on fourth quarter was at a faster rate than Q3. Can you talk to what contributed to that improvement? I'm assuming most of it was the spot market, but maybe provide a little bit more color in terms of how much of the improvement was related to the spot market. Did you have more trucks in spot market during fourth quarter versus Q3? And were contract rates any part of the improvement that we saw in yields during the quarter? Thanks.

Adam Miller (CFO)

Hey, Matt, this is Adam. Maybe I'll walk through how that quarter played out and hopefully answer your question through my commentary there.

So as we began the fourth quarter, October actually started out fairly decent. We saw some spot market activity, which we hadn't seen really in the third quarter, which resulted in some sequential rate improvements from September to October, and also began to see some healthy miles per tractor improvement. So we're fairly optimistic, you know, going into November, where in November, we did see some continued spot market activity, but maybe didn't see the acute tightness that we were expecting. That was certainly better than 2015, but maybe not as strong as 2014 or 2013. But pricing did continue to improve from October to November, really driven by the spot market activity. But we also started to feel some of the cost pressures from fuel and gain on sale.

They became a lot more evident as we were looking through November's results. And then in December, that spot market began to loosen up a little bit, and we didn't have nearly as many opportunities as we were hoping for. Now, miles were still improved, and the cost pressures certainly were still there in December that we had begun to feel in November. And so really, that sequential 1.4% sequential improvement really has been a result of the spot pickup that we saw in October, and then in November, and the tail end in December.

Matt Brooklier (Senior Equity Research Analyst)

Okay. Just a quick follow-up, did you have more trucks in the spot market during fourth quarter versus third quarter?

Dave Jackson (President and CEO)

Yeah, we did, and I would say we had a few more than we had a year ago in the fourth quarter. You know, we were not a tremendous amount more, but we would have seen spot as a percentage of the total in that upper single-digit percentage range for us, which was up slightly from where it had been the previous year. And you know, we would've done everything we could to increase that more if we saw more widespread strength.

So, which you know, it's encouraging that when you find pockets of the country that are exceptionally tight, which we did see that, but it was just for too short a period, in too few places to move the needle as much as maybe we would have hoped for. But, but we think that'll—we think that day is coming, so.

Matt Brooklier (Senior Equity Research Analyst)

Okay. Appreciate the time.

Dave Jackson (President and CEO)

Okay, thanks.

Operator (participant)

Your next question comes from the line of Brandon Oglenski of Barclays.

Brandon Oglenski (Senior Equity Analyst)

Good afternoon.

Dave Jackson (President and CEO)

Brandon.

Brandon Oglenski (Senior Equity Analyst)

Thanks for getting us on. Dave, can you just talk about how the environment's shaping up this year? Because I know there's been a lot of investor expectations that ELDs are gonna really constrain capacity come the end of the year. I mean, from an industry perspective, do you think a lot of folks are already starting to adopt to this new rule? Are we gonna see a lot of folks potentially exit the business, or is it just not shaping up maybe quite as draconian as we might have thought?

Dave Jackson (President and CEO)

Well, I think if we talk about the facts that we know, what we know about ELDs are that they're still in a minority of the trucks, and at least at the last thing I saw that seemed to have a handle on the couple million trucks in the space, how many actually have an ELD, and it's still less than half. We know, or at least the data suggests that somewhere approaching 60% of all the capacity in the country is provided by carriers with less than 50 trucks, and it's the carriers with less than 50 trucks that have been the slowest to adopt those.

So, what we also know is that, back in 2004, January of 2004, when the hours of service rules had a dramatic change in how the clock starts and that doesn't stop. That is very, very difficult to enforce with a paper log, and particularly when you have small fleets that don't have electronic equipment that leaves a breadcrumb trail that would make auditing, log auditing, reasonable or feasible.

So, if we take those facts into play, and you consider fleets that might not be fully compliant with the 2004 rule, let alone have limited to no wiggle room, if you will, in implementing, going from paper to the electronic log, you're talking about a meaningful change in the number of hours that a driver can drive in a day, and so, and in a week. So, that number, you know, in our experience, has proven to be somewhere close to 10%. So, that's a meaningful number when you think about, you know, half the trucks that don't have these yet. So, this will be. It'll be interesting to see how this all goes through.

We don't have a whole lot of insight into the rate of adoption, although from some of the surveys we've seen, from some of the companies that are for sale, we see a lot of fleets that seem very ill-prepared and seem to be basically just putting it off for some reason, and maybe underestimating what's involved in implementation and ultimately what the impact on their business might be. So, we continue to have conviction that this is gonna be meaningful, because, and that conviction is based on our own personal experience. I don't think it's based on wishful thinking. So we'll have to see how all of that plays out. Now, we know when the regulation is going to take effect. We know what's involved in the regulation.

We don't know how the enforcement will go, but it's our belief that there are a multitude of interested parties in this regulation that will aid in the enforcement beyond just law enforcement. So, for example, insurance companies will have great interest in whether or not a company truly is complying, and may not be willing to write coverage to a fleet that they can't validate is compliant. And/or the carrier may not be able to afford the insurance if they can't validate that they're compliant.

Without insurance, the brokers, and in some cases, customers, get immediate notification that an insurance certificate has expired, and therefore it becomes virtually impossible to haul a load, at least in the traditional route, through a broker or through a 3PL, or in some cases, directly with the customer. So, that's a group, the group we're talking about, less than 50 trucks, is highly dependent on brokers and third parties for their loads. So, the insurance piece could be a big deal. And then customers are interested in it. Customers, we know that it's on their radar, and so we'll have to see where that goes. I think a big question is brokers. Where do brokers stand?

To what degree do brokers take a leadership role in validating and ensuring that third-party carriers are compliant? So we'll have to see how that plays out. So, all of those factors, I think we begin to feel those as we go throughout the year and as customers make decisions, as carriers have difficulty renewing insurance policies without adopting. Then, in addition to some carriers not being able to run as many miles, some may not be able to make the economics work and might find themselves not surviving. So, you know, I don't know that it's gonna be that draconian for most.

It's just probably gonna create some tightness that might, that will hopefully make it a little healthier for, for those of us in the business, and maybe most importantly, give our drivers an opportunity to get to see an increase in pay, that I think is long overdue. So...

Brandon Oglenski (Senior Equity Analyst)

All right, I appreciate that.

Dave Jackson (President and CEO)

Yep.

Brandon Oglenski (Senior Equity Analyst)

How proactive are customers being about this, though?

Dave Jackson (President and CEO)

You know, since we've been compliant for so many years, you know, it's not, it's not an issue where we have, you know, customers putting us, putting an ultimatum for us. So it, it's hard for us to totally know. I can tell you with some of the visits I've made with customers, they... Usually, they can tell you how many, if any, of their carriers that they're using, don't have ELDs. And the one exception to that is, sometimes they might discount the fact that they use brokers, and they kind of count that as different kind of capacity for some reason, rather than, considering whether the carriers they deal with directly have ELDs. And so, you know, that's going to have to get addressed and reconciled somehow. So we'll, we'll...

That's, that's something to be seen later, and we'll have to see what happens.

Brandon Oglenski (Senior Equity Analyst)

All right. Thank you.

Dave Jackson (President and CEO)

Thanks.

Operator (participant)

Your next question comes from the line of Ravi Shanker of Morgan Stanley.

Adam Miller (CFO)

Hi, Ravi.

Ravi Shanker (Managing Director)

Good evening, Adam. A couple of questions. One is, I'm sorry if I missed this, but did you comment on conditions in January so far, and whether the looseness that I think you said you saw in late December continued in January? And second question is on ELDs. What's your latest thinking in terms of timing of when you start to see that tightening coming up? I think most people on the carrier side expect a midyear impact. And are you hearing any delay from either shippers or carriers, just given the new administration, kind of hoping that the mandate doesn't get enforced?

Dave Jackson (President and CEO)

Okay. Ravi, Ravi, I will try and answer your three questions.

Ravi Shanker (Managing Director)

2.5.

Dave Jackson (President and CEO)

2.5, huh? So, first, talking about January, yes, I think we've seen the December, the kind of, some of the looseness, if you will, in December, continue into that we saw in late December, continue into January. And, so I would say that January has not been overly robust. Now, a couple of things to take into consideration, in that is, I think that the way that the holiday fell started the new year off to a pretty slow start. When you have a Sunday New Year's Day, with it recognized on a Monday, we got off to a little bit of a slow start. And then we've had a heavy dose of weather so far in these first few weeks of January.

So, when we measure kind of the freight market from a load volume perspective and a miles per truck perspective, it's been a bit challenging. Now, as weather gets out of the way and you don't have the holiday effect a little bit, that's in the numbers on a year-over-year basis, then maybe we'll start to feel a little bit better as we leave January and into the rest of the quarter. But that's kind of what we're seeing there. As for ELDs and when we see that take effect, you know, I don't... I wouldn't say, I don't think I would even say midyear.

I would say, towards the back, certainly the back half, and probably not till closer to the back quarter. Maybe towards the end of the third quarter, we start to see that a bigger role, but I don't know that you might have some fleets that are implementing that might be a bit of a distraction, but that may not necessarily mean that they're wholesale, you know, in and enforcing themselves, enforcing it within their own companies the way that they need to. But I think you'll see that happen as the year goes on a little bit more. Now, there's other factors that could lead for us to feel things a little bit stronger when the seasonality of the second quarter hits and beverage season hits and summer weather hits.

And that would have everything to do with just how many carriers are able to muscle their way through the unfavorable fuel comparisons, which we've now had two quarters, third and fourth quarter, both were unfavorable from a fuel comparison perspective, as compared to what we had seen over the last probably couple years. So that's been a little bit of a challenge. I think that they're going to find the insurance market with the renewals that oftentimes happen towards the end or beginning of the year. I think they'll find some inflation there, particularly in the workers' comp world. So carriers still have quite a bit to digest, to say nothing for where the used market is at the moment.

And so, as capacity if it gets the best of them, and we have less and less trucks, and we have nice seasonal pickup, and maybe even the economy starts to come alive a little bit, then we could see pickup in the freight market sooner, with ELDs being kind of an encore in the back half of the year. And then, on your last point about with the new administration and changes, you know, the hours of service rule was not an executive order or a department regulation. It was a law that was passed by Congress. It's been challenged in the courts, been appealed unsuccessfully, with additional attempts to appeal that were turned down. So, it seems like it's in pretty firm footing.

And when you look at the level of deregulation in that this industry is and how free market this industry really is, one thing that we cannot compromise is safety, and we need very strong, but good, sensible safety regulations. And I think that the data would suggest that ELDs fit that criteria. And I think not only do you have it passed as a law by Congress, but you also have an industry that where it is largely supported, particularly from those that have the best safety ratings and use it and wholesale recommend it as well. So, we feel pretty good that that's going to continue as planned.

Ravi Shanker (Managing Director)

Great. Thank you.

Dave Jackson (President and CEO)

Thanks.

Operator (participant)

Your next question comes from the line of Ken Hoexter of Merrill Lynch.

Dave Jackson (President and CEO)

Hey, Ken.

Ken Hoexter (Managing Director)

Good afternoon, Adam and Dave. So Adam, just on your outlook, I just want to understand what changed in the outlook from when you set it. Is it mostly rate, or you noted earlier, purchased transportation is going to outpace revenue per load when you look forward? Is that? I just want to understand kind of what changed in your outlook that not only brings your Q1 down, but kind of your caution on Q2 as well?

Adam Miller (CFO)

I think it's more on the cost side, Ken. You know, we as we mentioned before, fuel has been, you know, a pretty significant headwind for us, and I think we've seen the early trends in January. We're expecting to probably see that continue. And then from a gain on sale perspective, I mean, we knew the environment was weaker, but you know, we only had $700,000 of gain in the fourth quarter, and that number could come down even from there in the first quarter. So we just have a pretty big headwind from a cost per mile standpoint, and so that's why we're more cautious there. But from a revenue standpoint, we're fairly similar to where we were originally projecting.

Ken Hoexter (Managing Director)

So if I can just get a follow-up to clear that up, I guess, on the expense side, I mean, you've always been so religious on focusing on costs. When you look at that purchased transportation you mentioned, what is driving that? I mean, I would presume if that's trucking capacity for you, is that then just solely on your brokerage side? Because I'd imagine that if you're getting charged more, you're also able to charge more, or is that the delay, what you're saying, a delay in able to get those rates through?

Adam Miller (CFO)

Right. When we talk about purchase trans, if we're looking at purchase trans for the fourth quarter, that's higher as a percentage of revenue. But our logistics business makes up a larger portion of our revenue this year than it did last year. So as that grows, the purchase trans line grows, because that's the primary expense associated with that revenue. And so we made the comment that we expect to grow that business from a load count and a revenue perspective, but to see probably some contraction in gross margin. We saw 50 basis points in fourth quarter, and we'd expect to see a little bit more on a year-over-year basis in the first half of the year.

That's given the fact that capacity is a little bit tighter in certain markets, but rate has not caught up to that yet. You know, one of the factors there is contract rates. You have to go through a bid cycle before you really are able to move the numbers there. So I think there's a little bit of a lag that we may feel on the logistics side.

Ken Hoexter (Managing Director)

Great. Appreciate the insight.

Operator (participant)

Your next question comes from the line of Bascome Majors of Susquehanna.

Bascome Majors (Senior Equity Research Analyst)

... Yeah, thanks for getting me in here, guys. You look at a lot of potential acquisitions, and I'm just curious from you guys' perspective, why haven't we seen more large truckload mergers across the industry in recent years? And, you know, what, if anything, might change that over the next, call it, 12 months-18 months?

Dave Jackson (President and CEO)

Well, you know, this is a tough business, and so, if you're gonna do acquisitions, yeah, you probably have to have a good handle on your business and have to have a good handle on earning an adequate return on invested capital. So to answer the question on why we haven't seen more of these in the industry, is I think far too often you have firms who don't exceed their weighted average cost of capital. And so, we happen to be one who does. It's not easy to get there. And we fight our way to get the kind of efficiency and earnings that we get.

When it comes time to acquiring another company, you've got to really have conviction that you can take that business and improve their returns, and that you can do it in a way that doesn't, that you're the better for it, and you can create a lot of value. Those kind of opportunities don't present themselves probably as often as one would like, but I wouldn't say that those opportunities can't exist or won't exist. That's my best guess on why you haven't seen that happen more often.

Bascome Majors (Senior Equity Research Analyst)

Okay, I appreciate that color. And, you know, just as an aside, can you comment, the private multiples that you're seeing on deals, do they resemble the public multiples, higher or lower? Just kind of curious what you're seeing.

Dave Jackson (President and CEO)

Well, our experience with the private have been lower. And, you know, obviously, multiples have had to step up here over the last few months in our space. But... And so our most recent experience with those kind of multiple- with private multiples have been, you know, have been a little while ago, but they were lower, and, often because of unique situations. It might be because a customer or that, that carrier has, maybe a higher concentration of customer, of just a few customers or, or some other part of their business that maybe sets it up to not be quite as well-rounded as some of the larger public guys. But, but by and large, I would say that we've seen it lower.

Bascome Majors (Senior Equity Research Analyst)

Thank you for the time.

Dave Jackson (President and CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Chris Wetherbee of Citi.

Dave Jackson (President and CEO)

Hi, Chris.

Chris Wetherbee (Senior Research Analyst)

Hey. Wanted to stick on the used truck pricing topic for a minute. So you had highlighted that in the quarter as being, that and a couple of other items, as sort of that $0.05 year-over-year headwind when you're doing your earnings bridge. And it sounds, Adam, like that's gonna be something that maybe sticks around for maybe a bit longer, as we go through this year. I guess in the context of ELD, how do we think about the duration of this headwind? I guess I want to get a sense of will ELD make it better or worse, and do we think that maybe then the sort of headwind from, you know, lower gains or maybe even losses at some point, you know, it sticks around beyond just maybe the first couple quarters of 2017?

Dave Jackson (President and CEO)

Well, that's a great question. I think that what may have... When you look at what impacts the used truck market, you have the appetite for growth is part of that, which is inseparably connected to the rate and pricing environment. And so it's no surprise that when rates turned negative in 2015, by the second half of 2015, we saw, you know, we saw the used equipment market significantly cave. So, so you have a couple things. So if you- if we were... The other factors, clearly, would be the ability to get financing, and that's hard to predict entirely, what and how that might look. And then you have the supply of equipment.

So if what we expect to happen is that ELDs might lead to some trucks that find their way to the sidelines, well, that would exacerbate a bad or a weak used equipment market and would, you know, potentially set it back even from a further amount of time, with more equipment to be worked through, more used equipment to be worked through. Now, as a result of that kind of tightness, it probably begets improved pricing. And so eventually, pricing will improve to a level that certain fleets, assuming they're able to find drivers, might go back into growth mode. And hopefully, we've all learned from the cycles, and we're not, we're deliberate and careful on how that works.

I know we will be, but I will tell you that the day will come where folks will want to add trucks again and have an appetite for equipment, whether new or used, because they can get the returns. And so, I think that you will see that happen. I think you'll see that happen, not very far after the tightness comes, probably, probably ELDs playing a big factor in that. And then, you know, the question will be, who, who can grow? Who can participate in that? And it'll probably be a more limited group than what we've ever seen before.

Because in the past, we've seen we seem to see a lot of growth with the very small fleets, and they can go buy up a lot of used equipment real fast and grow really fast. Well, in an ELD world, where they've got some challenges of their own, the group that can grow is probably the group that's already digested the ELDs and their impacts, and then can find ways to add drivers, which, you know, is a much smaller number than what we normally see. So hopefully, what that leads to is maybe a little bit more balance and a little less feast or famine, as we normally see in these cycles when we go from peak to trough so quickly.

Maybe it can be a little bit more orderly, and last for a period of time. But those are all, I mean, those are all, I think, the key factors we just have to watch and be close to.

Chris Wetherbee (Senior Research Analyst)

Okay.

Adam Miller (CFO)

And just, I think, to add on to Dave's comment, though, I mean, we have two options, and when we dispose of equipment, we could sell to third parties, in which we typically do when the environment is stronger, or we also have the option to do a trade back, in which we're buying new equipment. And so the trade back kind of provides us a put in terms of the, you know, the exposure we would have to a very weak environment. So we try to position ourselves so that we don't have, you know, we're never in a position to take a loss on our equipment.

Chris Wetherbee (Senior Research Analyst)

Okay. That's really helpful color, guys. Thanks for the time.

Dave Jackson (President and CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Allison Landry of Credit Suisse.

Danny Schuster (Equity Research Analyst)

Hi, good afternoon. This is Danny Schuster on for Allison. Thank you for taking our question. I know you're anticipating net fuel expense may continue to create a drag in Q1 and Q2. We were just wondering if you could explain what's causing the divergence between your fuel expense and fuel surcharge, and, and perhaps how significant it might be in Q1 and Q2, compared to what you just saw in Q4, or, or what potentially might swing it one way or the other in the fuel environment, that could change it?

Dave Jackson (President and CEO)

Yeah. Well, you know, it's the direction of fuel has a big impact on our P&L. And so, given the nature of how we charge fuel surcharge, which is typically adjusted on a weekly basis, tied to what the national average does, we end up in a rising fuel price environment. We end up always behind, because it would mean for the current week, we're charging a fuel surcharge that's based on a stale fuel cost number, and we're actually paying higher.

And so when we see a quarter or a prolonged period of time within a quarter, where you continue to have these step ups, and then only for it to kind of flatten out but never come back down and allow you to catch up, then then that's when we get, that's when we feel it on net fuel expense on the P$L. And so we were on the unfavorable side, if you will, in the third and fourth quarter.

It's not uncommon when you have four consecutive weeks of rising prices, for us to see that lead to a negative to the tune in our business of about $1 million, oftentimes, with the kind of steady increase that we saw happen in the fourth quarter, $1 million in a month, after four weeks of increases. So, now, if you have a quarter where it stairsteps up and then stairsteps back down at the same time, then you're kind of neutral, and you kind of come out okay. But if you continue to digest the increases, which is what has been the case, then it becomes problematic. The second side to that is, the higher the absolute price of fuel, clearly, the more your empty miles cost you. So, that's...

So, one of the factors that we have is on 11%, give or take, of our miles here in the first quarter that we're running without, that are empty, without any fuel surcharge being paid, you know, we're going to pay a higher price than what we would have paid a year ago.

Danny Schuster (Equity Research Analyst)

Okay, great. That's very helpful. Thank you for the color.

Dave Jackson (President and CEO)

Okay. Thanks, Danny.

Operator (participant)

Your next question will be coming from Ben Hartford of Baird.

Ben Hartford (Senior Equity Research Analyst)

Taking the question. Dave, just curious about your perspective on maybe the logistics side and the opportunity on, you know, outside of the core truckload business and the core truck brokerage business, fulfillment and capturing B2C. I know you guys have been deliberate building out logistics and have been creative with that, and there's a lot of growth opportunity there. To what degree can you use that on the small package, B2C fulfillment side to complement your core truckload, the asset side and the asset light side?

Dave Jackson (President and CEO)

Yeah. Well, we've seen very healthy growth in what we consider to be expedited business. And so that could be, you know, your traditional full truckload, but that is under an expedited circumstance, maybe tied to e-commerce of some sort. Or sometimes you'll have an expedited load be one where it's kind of a Zone Skipping type scenario, where you're actually full of parcel deliveries, and you're getting those 300, 400, 500 miles down the road to be dropped to a parcel delivery to save significant amount of money. So, you know, there's continues to be more and more demand for that type of those types of deliveries.

It seems like, if we, if it can't be ordered online and delivered within two business days, we, we just don't order it online. We maybe go find it in the store, or most likely, we just keep looking online until we find somebody who can get it to us in two days. So that seems to be kind of like the new, the new norm is, is for, for e-commerce, is to figure out how to get there in two days. Well, that's not so bad for us because that creates a significant amount of truckloads when you think about, the kind of staging and positioning of inventory that has to happen in order for inventory to be spread throughout the country in a way that it could be anywhere within two days via parcel. So we like that.

and then there's—when there's really a need, and you've got to even use an airplane or, and there's enough concentration of those kind of moves, it used to be just, you know, a particular customized part that was holding the plant up, that would get overnighted or, you know, things that would tie up a manufacturing line. And today, we kind of have everything, everything moving at those kind of paces. And so there's enough of it that we're starting to see enough concentrations that you could, you can go pick those up at a consolidated warehouse, perhaps, or sometimes even at an airport. And so, ultimately, the moving loads via a full truckload carrier is by far the least expensive way to move freight.

And, you know, we can do it smooth. We don't have to deal with multiple dray carriers, and we don't have track that creates limitations. We can go pick something up and get it delivered, and at significantly lower rates than what parcel would bring. And still, some people don't realize this, but at a significant discount to what LTL rates would be. So, we're doing everything we can, and there are some very innovative shippers out there that are doing everything they can to maximize the number of full truckloads. And so we're... One way we find is within our logistics group; oftentimes they have more flexibility.

We can be more flexible because of the ability to use third-party carriers that, you know, really allows us to experiment and continue to find more ways to drive deeper value into supply chains by using the most efficient way to move, which is full truckload.

Ben Hartford (Senior Equity Research Analyst)

Okay, that's great. Thanks.

Dave Jackson (President and CEO)

Thanks, Ben. Well, we'll do one more, Karen, one more question, if we could.

Operator (participant)

Your last question comes from the line of Brian Ossenbeck of JP Morgan.

Brian Ossenbeck (Managing Director)

Hey, thanks for squeezing me in here at the end. Maybe I'll just stick with the quick, high-level one. The impact of ELDs, you talked a lot about today already, but on the asset light, on the brokerage side, Dave mentioned that, you know, it's going to be up to them to kind of enforce that. So how do you see that playing out in your own business? And do you think that the brokers will be able to maintain the supply base overall? And will there be a bigger shift than people might be expecting towards the asset-heavy carriers?

Dave Jackson (President and CEO)

Yeah. Well, we do think that you will see a bigger shift. We're feeling that already. We've through what we've seen in the bid season thus far, is there has been a push towards more asset and dealing directly with more asset providers, so, which seems to make a lot of sense for us. There's a lot less uncertainty there. And then, you know, and as for the third-party carriers we use, you know, we're working with them and working to develop ways that they can be compliant and successful in their business at the same time. And, one thing we bring is several years of experience of using ELDs, adopting ELDs.

And so, in the end, this may create an opportunity for us to develop a maybe even stronger bond and relationship with some of the third-party carriers that we use as we, as somewhat peer-to-peer, we help them through their learning curve. And, you know, it kind of takes a trucker to know a trucker. So that might be a little bit more difficult for somebody who's yet to buy their first truck or hire their first driver or buy their first gallon of fuel. And so it's not our first rodeo, so we hope to be able to help and add some value different than what a, maybe a non-asset-based broker might do. So-

Brian Ossenbeck (Managing Director)

Mm-hmm.

Dave Jackson (President and CEO)

Hope that answers your question. About all I had time to give you anyway, so.

Brian Ossenbeck (Managing Director)

Yeah, thanks for the thoughts. Appreciate it.

Dave Jackson (President and CEO)

Okay. Thanks for the question. That, that concludes our call. We appreciate you joining, joining us this afternoon and appreciate your interest. Take care.

Operator (participant)

This does conclude today's call. Thank you for joining us, and you may now disconnect.