Earnings Call Transcript - KNX Q1 2026

Operator, Operator

Good afternoon. My name is Sarah, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Knight-Swift Transportation First Quarter 2026 Earnings Call. Speakers from today's call will be Adam Miller, Chief Executive Officer; Andrew Hess, Chief Financial Officer; Brad Stewart, Treasurer and Senior Vice President of Investor Relations. Mr. Stewart, the meeting is now yours.

Brad Stewart, Treasurer & Senior VP, Investor Relations

Thank you, Sarah. Good afternoon, everyone, and thank you for joining our first quarter 2026 earnings call. Today, we plan to discuss topics related to the results of the quarter, current market conditions and our earnings guidance. We have slides to accompany this call, which are posted on our investor website. Our call is scheduled to last 1 hour. Following our commentary, we will answer questions related to these topics. In order to get to as many participants as possible, we limit the questions to one per participant. If you have a second question, please feel free to get back in the queue. We will answer as many questions as time allows. If we are not able to get to your question due to time restrictions, you may call (602) 606-6349. To begin, I will first refer you to the disclosures on Slide 2 of the presentation and note the following: this conference call and presentation contain forward-looking statements made by the company that involve risks, assumptions and uncertainties that are difficult to predict. Investors are directed to the information contained in Item 1A Risk Factors or Part 1 of the company's annual report on Form 10-K filed with the United States SEC for a discussion of the risks that may affect the company's future operating results. Actual results may differ. Now I will hand the call over to Adam for some opening remarks.

Adam Miller, Chief Executive Officer (CEO)

Thank you, Brad, and good afternoon, everyone. So these are certainly interesting times, and there are now more reasons to be optimistic about our industry than we have seen in over four years now. We operate one of the largest fleets in the truckload industry, and roughly 70% of our fleet is deployed in one-way over-the-road service. It is true the one-way market has been the most difficult place to be over the past three-plus years as this market has felt the brunt of the influx of capacity over the last several years. Much of that capacity may not have been playing by the rules that we play by and therefore operating with a different cost structure with distorted pricing behaviors and cyclical patterns. The ongoing efforts of the FMCSA and the DOT to prevent and revoke invalidly issued CDLs, shut down noncompliant CDL schools and address service abuses are in the early stages and are already having an impact on the market. This cleanup effort should, in our view, have an outsized impact on not just the one-way truckload market, but on the lowest-price capacity in this market. The market that was the hardest hit over the past few years is now benefiting the most from the removal of capacity, a dynamic which we expect will continue. As we mentioned last quarter, the market has progressed to a point where even small changes can cause disruption. And we saw evidence of that during the first quarter as the severe weather in January led to acute tightness in an elevated spot market almost overnight. We were able to leverage our one-way over-the-road capacity at scale to provide solutions across multiple brands to help our customers recover from the storm when others in our space were not able. Following the recovery from the storm, the tightness in the truckload market has continued to build, largely due to declining capacity though some indications of improving demand are beginning to emerge. Broad truckload market indicators show improving trends for low tenders, tender rejections and spot pricing. Our business is experiencing even stronger levels on these metrics as our leading presence in the one-way market grows increasingly valuable to shippers. So late in the first quarter, we began to see the outcomes from early first quarter bids, which showed our volumes generally holding steady or growing while achieving mid-single-digit percentage rate increases. For reference, that is better than last year at this time when targeting slightly lower price increases often led to lower volumes. Price activity is very busy now. In addition to bid season being in full swing, many bid activities have increased, indicating incumbent carriers are unable to or perhaps unwilling to service right at existing rates. In addition, turn-back bids are happening more frequently as bid awards are being at least partially rejected by the awarded carriers as networks have shifted or the market has moved well past rates that were proposed even one or two months ago. Unlike the past few years, shippers are generally not issuing off-cycle bids opportunistically to improve service or drive prices lower; these actions are driven by a need to secure capacity. At the same time, previously deep discounts in the spot market have evaporated, further encouraging shippers to align with quality asset capacity. This is on top of a trend of shippers favoring asset-based relationships that have formed late last year in response to the regulatory enforcement efforts. Whether for these reasons or because of expectations of improving demand, we have already had a number of shippers initiate discussions about peak season demand support, which is not typical this early in the year. As we navigate a busy and rapidly evolving bid environment, we have shifted our bid targets to a range of high single to low double-digit percentage increases on current pricing activity as compared to our low to mid-single-digit target one quarter ago. Across our truckload brands, we are reviewing business that is not subject to current or near-term bids and addressing rates that are below market. Aside from the market developments and our position in one-way service, we believe our work over the past two years structurally cutting cost out of our business with ongoing opportunities for further progress sets us up for greater incremental margin as business conditions improve. As the market improves, recruiting and retaining quality drivers have and will become more challenging. We believe we have an advantage with our terminal network and academies to source and develop drivers. However, we expect this to be a challenge for the industry in the back half of the year. While the LTL sector is not seeing the same sharp tightening as truckload, we are seeing our freight mix improve and rate renewals continue at a mid-single-digit pace. Shipment volume trends have been directionally in line with normal seasonal patterns, though somewhat understated until late in the first quarter. However, we saw a notable improvement in weight per shipment for the first time in years with this measure progressively growing throughout the quarter. This is a result of bringing on more industrial customers who can leverage our expanded network footprint to move heavier and longer length-of-haul shipments. We believe we are in the early stages of our network transition from regional to national. We expect that over time, growing into our network investments on maturing freight mix, improvement in network density and continuously refining our operational execution will allow us to drive sustained methodical improvement in operating margin. We remain committed to thoughtfully deploying capital, intentionally leveraging our strengths and creatively unlocking synergy opportunities across our businesses. And with that, I will turn the call over to Andrew and Brad to review the results and our guidance.

Andrew Hess, Chief Financial Officer (CFO)

Thanks, Adam. The charts on Slide 3 compare our consolidated first quarter revenue and earnings results on a year-over-year basis. Consolidated revenue, excluding Truckload fuel surcharge was essentially flat and operating income declined by $38 million year-over-year largely due to the $18 million of expense for claim development in our LTL segment, primarily related to an adverse arbitration ruling on the 2022 claim; $4 million of expense in our Truckload segment for an adverse decision on VAT reimbursement in Mexico for prior tax years; warehousing project business deferred to future quarters; and an estimated $12 million to $14 million net negative impact for volume and cost headwinds from severe winter weather disruptions and sharply rising fuel prices during the quarter. Adjusted operating income declined $37 million year-over-year, primarily driven by the same items. GAAP earnings per diluted share for the first quarter of 2026 were a loss of $0.01 and primarily due to the items noted above. GAAP earnings per diluted share in the prior year quarter were $0.19. Adjusted EPS was $0.09 for the first quarter of 2026 and compared to $0.28 for the first quarter of 2025. Our consolidated adjusted operating ratio was 97%, up 230 basis points year-over-year. The effective tax rate on our GAAP results was 7%, and our non-GAAP effective tax rate was 28%. Slide 4 illustrates the revenue and adjusted operating income for each of our segments for the quarter. Overall, the relative shares of our various services and service offerings remains largely consistent quarter-over-quarter, with LTL gains slightly over the fourth quarter as it exits its seasonally weakest period of the year. Now we will discuss each of our segments, starting with our Truckload segment on Slide 5. Aside from the negative impacts to volume and cost from severe winter weather and fuel challenges in the quarter, most operational metrics were improving throughout the quarter. Revenue per loaded mile, excluding fuel surcharge and intersegment transactions, turned out stronger than we anticipated and even improved sequentially over our end-of-year peak season result, largely driven by spot opportunities that developed within the quarter. However, volumes and cost per mile for the quarter were both unfavorable as a result of the weather and fuel challenges. On the whole, our truckload adjusted operating ratio of 96.3% only degraded 70 basis points year-over-year as a reduction in empty miles and the strengthening rate environment largely offset the headwinds to volume and cost. Q1 marks the seventh consecutive quarter of year-over-year improvement in miles per tractor. Importantly, the strengthening rate backdrop and improving network efficiency have ongoing implications for our business, while the weather issues are not expected to reoccur. On a year-over-year basis, revenue excluding fuel surcharge was essentially flat as a 1.4% improvement in revenue per loaded mile, excluding fuel surcharge and intersegment transactions, largely offset a 1.8% decrease in loaded miles. Adjusted operating income declined $7.6 million year-over-year, largely as a result of the adverse decision in VAT reimbursement, as noted earlier, as well as the cost headwind from severe winter weather and fuel escalation in the quarter. U.S. Express made further progress on operating efficiency and trailed the legacy brands in adjusted operating ratio by approximately 300 basis points for the quarter. The ongoing progress at U.S. Express is encouraging, and we expect this business will continue closing the gap in margin performance with our legacy brands as the market improves. Moving on to Slide 6. Our LTL business grew revenue, excluding fuel surcharge, 2.6% year-over-year, driven by a 5.2% increase in weight per shipment, with an 8.5% increase in the length of haul. Tonnage trends showed momentum as the quarter progressed, ending with March average daily tonnage up 7% year-over-year. Our expanded service coverage and presence in new markets is helping us win business with new customers, gradually increase our industrial exposure and transition our network and freight mix from regional to national. Shipments per day were down 1% year-over-year for the quarter, largely as a result of winter weather disruption in January and the shift in freight mix to a higher weight per shipment. Revenue per hundredweight excluding fuel surcharge fell slightly by 70 basis points year-over-year, driven by the increase in weight per shipment, while renewal rates continued their trend of mid-single-digit increases. We continue to make progress normalizing operational and cost fundamentals following a period of significant change to our network and freight. Purchased transportation as a percentage of revenue, equipment rent and variable labor per shipment all showed improvement year-over-year in the first quarter, and we anticipate further improvements in efficiency as we refine our network and freight flows. As mentioned earlier, adjusted operating income and adjusted operating ratio were negatively impacted year-over-year by the adverse claims development. We are encouraged by emerging seasonal freight patterns, steady progress on rate renewals, accelerating volume trends late in the quarter and an improvement in weight per shipment for the first time in years as freight mix continues to develop into our expanded terminal network. Now I'll turn it over to Brad for a discussion of our Logistics segment on Slide 7.

Brad Stewart, Treasurer & Senior VP, Investor Relations

Thanks, Andrew. Logistics revenue for the first quarter declined 9.9% year-over-year as volumes were down 18.9%, while revenue per load grew 10.4%. Third-party carrier capacity grew more difficult to source during the fourth quarter, and this trend continued through the first quarter. Gross margin of 16.6% for the first quarter declined 150 basis points year-over-year but improved 110 basis points from fourth quarter levels as strengthening spot opportunities helped to offset pressure on contractually priced business. Despite the year-over-year decline in volumes and gross margin, our Logistics segment produced an adjusted operating ratio of 96.2%, only a 70 basis point degradation year-over-year. In addition to the increase in third-party carrier costs brought on by the regulatory pressures on capacity, our Logistics business experienced increased pressure on gross margin as we further enhanced our already rigorous carrier qualification standards in response to a sharp increase in cargo theft in the industry and the troubling carrier practices exposed by recent regulatory efforts. This affects not only new applicants seeking to join our carrier base, but also resulted in a reduction in the number of existing carriers we are tendering loads to. While such efforts were a headwind to capacity costs and caused us to eject more loads as unprofitable, as we reset contractual pricing through the bid season, we expect that load count will improve and pressure on gross margin should lessen. Given the complementary relationship between our Logistics and asset-based Truckload segments, we believe the improving market dynamics will ultimately benefit both our asset and logistics businesses over time. Our Logistics business has demonstrated its agility in navigating a volatile market in the past few years by maintaining its operating margin close to target levels through disciplined pricing and cost management. This team is now further leveraging technology to take cost efficiencies to a new level as well as to improve our responsiveness and our ability to capture opportunities in the marketplace, which we expect will contribute to our earnings in 2026. Now on to Slide 8 for a discussion of our Intermodal business. The Intermodal segment grew revenue 2.7% and improved its operating ratio 50 basis points year-over-year as a 1.6% increase in revenue per load and a 1.2% increase in load count offset headwinds from winter weather in the quarter. Load count and revenue per load improved progressively throughout the quarter, with March load count up 8.4% year-over-year. While the intermodal pricing environment is more competitive than truckload at this point, we are encouraged by ongoing opportunities to leverage our strong service performance and our truckload relationships to continue growing our volumes at improving rates. We remain focused on delivering excellent service and driving appropriate turns through growing our load count with disciplined pricing, cost control, network balance and equipment utilization. Slide 9 illustrates our all-other segments category. This category includes warehousing activities and support services provided to our customers, independent contractors and third-party carriers such as equipment sales and rentals, equipment leasing, owner-operator insurance and maintenance. Additionally, beginning January 1, 2026, all-other segments also includes the cost of our accounts receivable securitization program that was formerly reported below the line in interest expense in prior quarters. For the first quarter, revenue increased 13.5%, operating results declined to an operating loss, partially due to the inclusion of $5 million of costs for the accounts receivable securitization program as well as start-up costs on new contract awards in our Warehousing business, for which revenue is expected to ramp in the coming months. On Slide 10, we have outlined our guidance and the key assumptions, which are also stated in the earnings release. Actual results may differ from our expectations. Based on our assumptions, we project our adjusted EPS for the second quarter of 2026 will be in the range of $0.45 to $0.49. This range represents a larger-than-normal sequential increase in quarterly results. As the first quarter was negatively affected by events that we do not expect to recur and because freight market fundamentals are improving exiting the first quarter, our projections reflect recent trends in volumes, spot rates and bid activity as well as expectations for a continued seasonal build in freight demand for both truckload and LTL services. The key assumptions underpinning this guidance are listed on this slide. I won't take time to read through all of our assumptions here but I do want to highlight the point that the recent strengthening of the truckload pricing environment will generally impact our contractual rates beginning late in the second quarter and into the third quarter. This concludes our prepared remarks. And before I turn it over for questions, and everyone to keep it to one question, perfect discipline. Thank you. Sarah, we will now open the line for questions.

Operator, Operator

Your first question comes from Chris Wetherbee with Wells Fargo. We are listed on this slide. I won't take time to read through all of our assumptions here, but I do want to highlight that the recent strengthening of the truckload pricing environment will generally impact our contractual rates beginning late in the second quarter and into the third quarter. This concludes our prepared remarks. Before I turn it over for questions, please keep it to one question each — perfect discipline. Thank you. Sarah, we will now open the line for questions.

Christian (Chris) Wetherbee, Analyst, Wells Fargo

I guess, obviously, the pricing environment in the truckload market is improving, probably materially versus what we talked about last time. So Adam, I was kind of curious as you think about the margin opportunities or maybe the earnings opportunity for the truckload business as we go through, I guess, this year, but maybe bigger picture. Do you think this cycle has the potential to be what you kind of hoped it could be in terms of the cyclical earnings of the Truckload business or the mid-scale margins of the truckload business? Any color around that and maybe timing towards getting there would be helpful.

Adam Miller, Chief Executive Officer (CEO)

Yes. Great question, Chris. It's early in the inflection here, so it's hard to know exactly the strength, the duration and the timing of how that will play out. But based on our experience in previous cycles, I don't think we've ever really seen the pressure on capacity come from regulatory forces versus just normal economics. So we could see more capacity coming out of the network than we typically would see in a cycle. I feel that could be a catalyst to really drive a strong bid season this year and into next year. The question is going to be: can we capture rates, and can we also improve the utilization on our equipment, which we've done now for seven consecutive quarters on a year-over-year basis. And then can we grow our seated trucks without necessarily investing in a lot more trucks immediately. If we can do all three of those, I do believe this sets up to be able to get back to a more normalized earnings or margin profile that we're accustomed to seeing in our businesses, and that includes even U.S. Express getting to the legacy performance that we've seen at Knight and Swift. It's early in the cycle, and we're just getting some feedback on bids, seeing how awards are coming in, how some of our customers are tendering those awards and what mini-bid activity looks like and what turndown business is looking like. So still a lot to read into the market. But it certainly feels like the setup is there for the industry to get back to sustainable rates that give quality, compliant carriers the ability to make enough margin to invest in their businesses, invest in drivers, invest in safety and invest in good quality equipment.

Operator, Operator

The next question comes from Richa Harnain with Deutsche Bank.

Richa Talwar, Analyst, Deutsche Bank

So just following up from that previous question, Adam, when you say normalized margins, maybe you can highlight kind of what that is mid-cycle — is it sort of low teens that we're talking about here? And then Brad, when you ended the segment, you said the impact of this high single-digit, low double-digit rate improvement will really be seen towards the end of Q2 into the back half of the year. But if you can just kind of like give us a sense of the level of magnitude of margin expansion as we move through the year, you're already calling for 100 to 200 basis points of year-over-year improvement in Q2 before we really start to see the evidence of this type of rate environment, I think in Q2, you just caught a low single-digit improvement, right? So I'm just trying to get a sense of how we should flow through this in the model near term and maybe more longer term, if you could help things.

Adam Miller, Chief Executive Officer (CEO)

Okay. I'll hit on the first portion and Brad can dovetail on the rest. We've been asked about normalized margins multiple times in recent calls, so I'll be consistent. In a normalized market, the truckload business typically operates in the mid-80s operating ratio, which equates to mid-teens margin. When the market is really good, we've operated below the mid-80s; in a difficult market you can be in the upper 80s. This cycle has been more challenging, but I think the setup in this bid season and going into next year could enable us to achieve that mid-80s operating ratio. We also have the LTL business that's been growing and doesn't follow the same cycles as truckload; we expect to methodically improve margins in LTL over time. We had the anomaly with the claim development in Q1, but we expect that to be put behind us and that we'll continue improving margins as we grow into the network and reduce the operating ratio into the 80s. I feel we can achieve a sub-90 operating ratio during the year and continue to build upon that. When the truckload business is healthy, the logistics business can grow strongly; early on logistics can feel pain because third-party capacity rates haven't adjusted yet and you can see a reduction in load count because you can't take freight you can't make a margin on. As rates reset — both contractual and backup rates — we can be in a position to take more loads with our own trucks or with qualified third-party capacity through our logistics business. Intermodal we believe is on a path to profitability, and we outlined expected sequential improvement that would mean profitability; volumes are starting to build. So that's how we're viewing normalized performance. In terms of timing for the high single to low double-digit rate increases, a lot of our business is in contracts that start to be implemented mid to late Q2 and then flow into Q3; some large customers' contracts hit in Q3. So while you may see activity in Q2, it may not flow through to the P&L immediately. We expect margin to start to flow more fully in Q3 and then build into Q4.

Brad Stewart, Treasurer & Senior VP, Investor Relations

And just one thing I would add is regarding our contract versus spot mix: we came into the first quarter in the 10% to 12% range for spot exposure, where we had been for the last couple of years. We exit the first quarter a couple of points higher than that, perhaps low to mid-teens. As we navigate pricing, jumping into spot exposure is one lever to manage yield. Our first priority is our contractual recurring relationship business, and we have expectations for where the market is on price. If we can't come to agreement on price with certain accounts, we may end up with less contractual exposure and more spot exposure, which will change realized rate per mile. That's something we'll manage week by week as we work through bid season.

Operator, Operator

Your next question comes from Ken Hoexter with Bank of America.

Ken Hoexter, Analyst, Bank of America

And I guess, Brad, just to extrapolate on that a bit, right? It sounds like in the prepared remarks, Adam, I think you might have mentioned you're revisiting contracts that are longer in nature. Are you already starting to give those notices to get out of the contracts and start to renew? Is that how tight the market has got? I just want to understand kind of the comments around that. And to clarify on the LTL, did you say the delay but the weights are ramping, the delay in getting pricing, but you're seeing weights ramping given the industrial move. How long does that delay get until you get that pricing?

Adam Miller, Chief Executive Officer (CEO)

Let me clarify. We're not saying we're getting delayed pricing on LTL. For LTL renewals, we're seeing mid-single-digit increases right now, and we're seeing a freight mix change toward longer length of haul and heavier shipments that we believe will improve yield. The revenue per hundredweight comparison can be skewed by that freight mix change, but there's no meaningful delay in LTL pricing. Regarding rate reviews, we're going through our network looking at rates that may be stale — if it's beyond a year, it's something we'll look at. We're reviewing the bottom 20% performing rates and determining what we need to do to get those rates closer to market. If there's no active bid to address them, we're being proactive in having discussions with customers around those rates. This is an active process in early stages because while we're in the heart of about 70% of RFPs, we have the remaining 30% we need to address as the market moves quickly.

Ken Hoexter, Analyst, Bank of America

And same for the LTL, does that gap close? If you're already at high single, low double in truckload, can you see that transfer to the LTL market?

Adam Miller, Chief Executive Officer (CEO)

I don't know that they align directly right now. In LTL renewals, we're getting mid-single digits at present.

Operator, Operator

Your next question comes from Ravi Shanker with Morgan Stanley.

Ravi Shanker, Analyst, Morgan Stanley

Adam, last quarter you very helpfully walked through what you saw were upcoming catalysts on the supply side. Obviously, lots of moving parts here, everything from Derailleur's Law, the Montgomery case and the brokerage side, your proposal for a $5 million minimum insurance as well as all of the rules we saw last year. How do you see this evolving over the next few months and potentially the market tightening up more?

Adam Miller, Chief Executive Officer (CEO)

You hit the key elements, Ravi. These pressures should deter bad actors from entering the space and push out capacity that isn't operating at sustainable rates or in a compliant manner. When spot rates jumped in 2021 and immigration dynamics led to rapid growth, many entrants didn't have much trucking experience, safety backgrounds or proper training. Chameleon carriers and others exploited the system, often paying rates well below what sustainable wages would be. The push to eliminate improperly issued non-domicile CDLs, potential laws like Delia's Law, higher minimum insurance, language proficiency requirements and stronger drug testing will reduce capacity that doesn't meet safety or compliance standards. We think the administration is committed to cleaning up the industry, and while legislative support would make changes more durable, the actions by regulators and enforcement can be effective on their own. Importantly, the improvement we're seeing and the ability to get rate is driven largely by capacity reduction versus demand. If demand also picks up alongside these enforcement actions, the market could become considerably more favorable for compliant carriers.

Andrew Hess, Chief Financial Officer (CFO)

Ravi, I would add that we think it's clear through our conversations that the administration is committed to the cleanup that needs to happen in our industry. We think legislative support would help make that more durable through future administrations, but we don't think regulatory actions are dependent on legislation; we think the actions of the administration will be effective over the next few years as enforcement continues.

Operator, Operator

Your next question comes from Scott Group with Wolfe Research.

Scott Group, Analyst, Wolfe Research

So Adam, what are you seeing with seated tractor counts and drivers generally? And then just big picture, if you think back last cycle, just massive growth in everyone's brokerage business, but with all the things you talked about — nondomicile CDLs, chameleon carriers, Montgomery, all these sorts of things — I'm wondering, as you're having these big conversations, is there a sense from shippers that they're less willing to do a brokerage offering right now and maybe are they willing to pay more for asset-based this time versus maybe prior cycles?

Adam Miller, Chief Executive Officer (CEO)

On seated trucks and driver sourcing: hiring drivers has always been a challenge in our industry. You either have drivers or loads, and it's about aligning both. We're investing in marketing, increasing the number of recruiters, leveraging AI to respond quickly to leads and using our Academy network to train and develop drivers. Those investments are starting to build momentum across our brands, and I'm more bullish on our ability to improve rates, utilization and grow seated trucks. The challenge is that others in the market may have loosened hiring standards; as enforcement tightens, the quality drivers we seek will be more attractive. We believe our terminal network, equipment and training give us an advantage to hire and retain high-quality drivers. Regarding brokerage and asset-based preferences: I think shippers are showing a bias toward asset-based carriers already. We're seeing some bids limited to asset-based carriers and caps on broker participation. We view our logistics business differently because we have asset solutions such as power-only, and we've tightened carrier qualification standards dramatically — since the beginning of this year we've reduced carriers by about 30%, after a large reduction earlier last year. We're now verifying how long carriers have been in business, evidence of logs and, importantly, who is actually driving the truck. A challenge has been brokers not knowing who is driving; we're taking steps to ensure we know and can provide that to customers. We don't expect the same explosive growth in brokerage we saw during the pandemic, but high-quality logistics providers that do things right and have an asset solution will have the ability to grow in a strengthening market.

Operator, Operator

Your next question comes from Jonathan Chappell with Evercore ISI.

Jonathan Chappell, Analyst, Evercore ISI

Adam, I know you don't go into the monthly detail on LTL as some of the pure plays do. But is there any way to help give a cadence on how the first quarter and maybe April transpired as we think about weight's been good, you're finally getting that turn there. Are we going to start to see more consistent shipment tonnage growth? And importantly, if you do get that demand or tonnage tailwind behind you, do you feel your costs are now appropriately aligned given the national network build that if there were to be a demand pickup that would go right to margin improvement as opposed to still chasing that with resources?

Adam Miller, Chief Executive Officer (CEO)

That's a long question, John — I'll try to hit each part. On LTL, we were a bit slower on volume to begin the quarter but saw a good build with March being the strongest, and those trends continued into April. We only had a couple of weeks into April at the time of the call, but we aren't seeing a slowdown. Q2 is typically one of our strongest quarters for LTL. We believe there's significant operating leverage in the business with only a few pinch points where we may need to open locations this year, but not at the scale of prior years. That allows us to focus on fundamentals — labor efficiency and purchase trends. Because the freight mix is shifting to higher weight per shipment, you may not need a huge lift in shipment count to generate better yield. As we see tonnage improve, we expect operating leverage to flow to improved margins and we could begin to see the operating ratio move from the 90s to the 80s in the back half of the year. We're continuing to work on freight flows and network adjustments but feel very confident in the LTL team and our path to consistent improvement in freight mix and cost structure.

Andrew Hess, Chief Financial Officer (CFO)

Let me add a couple of data points on momentum within the quarter. The Southeast was heavily impacted by weather and is our highest-density volume area. If you look at tonnage, January was up 1.6%, February up 2.6%, and March up 6.9% — we ended the quarter roughly 4.1% up on tonnage year-over-year. So we saw that build as we moved out of the weather and new contract wins took effect. On costs, below the surface, the arbitration liability impacted our core results, but we're seeing steady progress in cost efficiency. Variable wage per shipment improved from Q4 to Q1 and we expect that to continue. We've seen the most improvement in dock wages per shipment, and line haul is the next area where we'll see meaningful improvement. The work we've done to combine businesses and right-size equipment is showing positive trends. We're pausing building new locations broadly, but there are specific pinch points where increasing door counts will improve flow and cost efficiency. Those location improvements will help costs more than they will create substantial volume increases.

Operator, Operator

Your next question comes from Dan Moore with Baird.

Daniel Moore, Analyst, Baird

A lot of questions have been asked and answered, but one that was not addressed yet that I think is definitely worth a little bit of time is the leverage around U.S. Express. I can't imagine a rate environment beginning to realize momentum in that business. I think we've argued for a while now that's really what was needed. I know you guys have done a lot of cost repair and management repair. In terms of the business, can you talk to us about the size of the business today generally? And maybe talk to the potential earnings leverage of U.S. Express as we move forward.

Adam Miller, Chief Executive Officer (CEO)

Dan, you're right. When we purchased U.S. Express we expected a more favorable environment sooner than we've seen, which put pressure on margin and how quickly the acquisition would be accretive. That delayed some of the margin recovery, but we're finally in a place where we can work on improving their freight network and rates to sustainable levels. We have a strong team there, including the leader who was instrumental in sales at Swift and in improving margin profile at Swift. They understand what it takes to make the necessary changes, and many rates will need to move up significantly. They're equipped to leverage network information across our brands to close the gap. Last quarter they trailed legacy brands by roughly 300 basis points in operating ratio; some of that is a cost delta, but much of it can be addressed through improving rates. We have the right team there and are getting good feedback in early bid activity; we expect to see rates continue to grow and develop.

Andrew Hess, Chief Financial Officer (CFO)

From a cost perspective, there are four areas of opportunity ahead on U.S. Express. First, insurance and safety costs: we've had to change culture and how we manage safety and insurance. Crash basic metrics are over 60% better than at acquisition, and we expect safety improvements to reduce insurance and claims costs over time. Second, equipment costs: we are still working through some high-cost equipment leasing and expect opportunities as we roll through that equipment. Third, hiring costs and advertising: we expect opportunities to bring those costs down as we get better at recruitment. And fourth, the biggest opportunity is rate. Adam talked about having a larger-than-normal amount of rate progress to make. Much of our recent cost work has focused on fixed overhead costs; we believe those reductions are structural and will be sustainable as volume grows.

Daniel Moore, Analyst, Baird

A lot of tailwinds emerging, a good look for the remainder of the year, guys.

Operator, Operator

Your next question comes from Brian Ossenbeck with JPMorgan Chase.

Brian Ossenbeck, Analyst, JPMorgan Chase

Maybe just to come back to some of the more topical ones here we've been discussing for a while. Just in terms of the work you did with carriers in the logistics business, down 30% in accepted carriers, that's a pretty significant number. Is that something you feel like the rest of the industry has to go through as well and maybe have an even higher number of carriers they will have to squeeze out of their networks? Adam, we've heard for a long time about hair follicle testing and things of that nature. It sounds like there's some momentum. What steps would we have to see for that to get more progress and when should we expect that to begin?

Adam Miller, Chief Executive Officer (CEO)

I won't speak for what other logistics companies will do. We've decided to be proactive and remove capacity we don't feel comfortable with to ensure we're putting quality carriers on our freight and trailers. We expect customers will become more concerned about who hauls their freight and who is driving. Some companies may be forced to change as the capacity environment tightens and enforcement increases; others may continue to take the cheapest carriers if they can find them. Regarding hair follicle testing, Brad can add specifics, but we've used hair follicle testing for over a decade in addition to required urine testing because it identifies substantially more drug users than urine testing alone. We pay incremental cost to do that testing because it works and helps us avoid hiring unsafe drivers.

Brad Stewart, Treasurer & Senior VP, Investor Relations

Just to give perspective from our experience: we perform both the federally recognized urine testing and hair follicle testing because the hair test detects many more instances of drug use. Over thousands of tests a year, hair follicle tests have identified roughly 14 times the drug use that urinalysis has. That prevents those individuals from being hired, but it doesn't prevent them from driving in the industry if other carriers do not use the test. There appears to be some openness in Washington to engage on this topic. Congress passed provisions years ago, but Health and Human Services has not written the rules to put this into practice. We would ask that if companies pay for hair testing they be allowed to report those results to the registry because we believe it's important for safety and public protection.

Operator, Operator

Your next question comes from Ari Rosa with Citigroup.

Ariel (Ari) Rosa, Analyst, Citigroup

Adam, you mentioned shedding a few thousand tractors since the U.S. Express acquisition. It made sense in the downturn when it was hard to find loads. But now as we think about the up cycle, is there any dimension in which that decision could hold back the ability to get the same level of upside you might have seen if you had retained those tractors? Can you discuss the decision to shed those tractors and put it in context of today, where you're at a larger tractor count on an absolute basis than prior cycles? How do those dynamics play out as we think about upside?

Adam Miller, Chief Executive Officer (CEO)

Ari, we don't enter an acquisition intending to shrink capacity. When we reviewed U.S. Express, 40% of their loads were coming from brokers, which didn't support a sustainable network. We had to adjust their network to find direct relationships and loads that could support their operations. In doing that we turned business they were dependent on and changed hiring standards to ensure good drivers, improved safety and productivity. That process naturally created some open trucks that we sold or exited because they didn't fit the healthier long-term foundation we were building. Today we feel stable and we're investing in recruiting and leveraging training capabilities across our brands to develop drivers. As the freight market improves, they'll be able to repair the network and grow back trucks. We want to fill the empty trucks we have before investing in more capital, but we're in a much better position today than if we had kept all trucks and not adjusted hiring or safety standards. We believe it was the right move.

Brad Stewart, Treasurer & Senior VP, Investor Relations

To add context, despite the op income profile coming out of the down cycle, we are running more miles than we were prior to the last up cycle. So we have more of a basis to work with in this new cycle.

Adam Miller, Chief Executive Officer (CEO)

Appreciate the question, Ari. I think that now concludes our call. I think we're beyond the time here. So appreciate all the questions and interest from everyone. And again, if we weren't able to get to your question, you can call (602) 606-6349, and we'll try to return your call as quickly as possible. Thank you, everyone.

Operator, Operator

This concludes today's conference call. Thank you for joining. You may now disconnect.