Earnings Call Transcript - KNX Q4 2022

Operator, Operator

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

Adam Miller, CFO

Thanks, JP, and good afternoon, everyone. We appreciate you joining our fourth quarter 2022 earnings call. Today, we will discuss the results from the fourth quarter, update you on current market conditions, and provide our guidance for the full year 2023. We have slides accompanying this call that are available on our investor website. The call is scheduled to last until 5:30 PM Eastern Time. After our commentary, we will answer questions about these topics. We will address as many questions as possible, and if we cannot get to your question due to time limitations, please call (602) 606-6349. To start, I’d like to point out the disclosure on Page 2 of the presentation. This conference call and presentation may contain forward-looking statements made by the company that involve risks, assumptions, and uncertainties that are hard to predict. We encourage investors to review the information in Item 1A Risk Factors or Part 1 of the company's annual report on Form 10-K filed with the SEC for a discussion on the risks that may influence the company's future results. Actual results may vary. Now, moving on to Slide 3, this slide compares our consolidated fourth quarter revenue and earnings results year-over-year. Revenue, excluding fuel surcharge, dropped by 9.5%, while our adjusted operating income fell by 39.3%. GAAP earnings per diluted share for the fourth quarter of 2022 was $0.92, and our adjusted EPS was $1. These results included a $15.4 million pretax charge, which negatively affected EPS by $0.07 due to an actuarial insurance adjustment related to third-party carrier risk in our iron insurance business. The lack of a holiday peak season resulted in lower volumes, which adversely impacted earnings. On to the next slide; Slide 4 shows the revenue and adjusted operating income for the fourth quarter and year-to-date periods across our segments. Despite an unusually weak fourth quarter, our largest segments demonstrated their operational efficiency. Our Truckload segment operated in the low 80s, while LTL and Logistics remained in the mid-80s. The Intermodal segment was affected by weaker demand and increased availability of truckload capacity with superior service levels. Freight demand in the fourth quarter was significantly below typical seasonal trends. Spot opportunities were rare as expected, and general freight demand was weaker than anticipated. We attribute this mainly to the early pull-forward of holiday goods in 2022, a lingering inventory overhang from last year with some products arriving too late for the season, and general caution from retailers concerning consumer demand. The weak demand pressured both volumes and pricing, while persistent inflation further hindered operating income across most segments. The chart on the right illustrates the revenue percentage during the fourth quarter of 2022 from each of our four segments, in addition to the revenue percentage from our other services which include our rapidly growing insurance, equipment maintenance, equipment leasing, and warehousing services. We are committed to enhancing customer service and reducing costs as we navigate this challenging operating climate. We are also focused on diversifying our business and developing complementary services that deliver strategic value to our customers and partner carriers. The next few slides will cover the operating performance of each segment, starting with Truckload on Slide 5. On a year-over-year basis, our Truckload revenue excluding fuel surcharge declined 7.2%, while our operating income declined by 36.5%, reflecting the comparison of an unusually weak fourth quarter of 2022 against perhaps the strongest fourth quarter we've ever experienced. Our Truckload business navigated the softness well and operated with an 82.7% operating ratio. Our efforts to reduce spot exposure and secure more contractual committed freight since the beginning of 2022 helped us maintain an adjusted operating ratio in the low 80s. During the quarter, revenue per tractor fell 8.6% driven by a 3.9% decrease in revenue per loaded mile and a 4.5% decrease in miles per tractor. The decline in revenue per tractor, combined with inflationary pressures across our business, caused the reduction in Truckload operating income. Most notably, we see ongoing cost pressures in equipment, maintenance and insurance. We continue to take steps to align our cost structure with the reduction in volumes. Having a diverse group of brands and services, including nearly 5,000 dedicated trucks, provides us with flexibility and strategy. For example, as over-the-road truckload volumes have softened year-over-year, our dedicated business has grown top line revenue and improved margins on a year-over-year basis. Despite the soft market, our customers still value trailer pool capacity at scale, and we see this expressed to both our Truckload and Logistics segments. We continue to invest in our already industry-leading trailer fleet, which grew sequentially to nearly 79,000 trailers. We believe our scale in trailers is a competitive advantage and provides our customers capabilities that are extremely difficult to replicate. Now on to Slide 6. Our LTL segment continues to perform well and make progress on yield and network initiatives. For the quarter, revenue excluding fuel surcharge was $204 million, and we operated at an 85.5% adjusted operating ratio. This represents a 480 basis point improvement from the fourth quarter last year and only a 100 basis point sequential degradation despite demand softening for more than a typical seasonal step down from the third to fourth quarter in LTL. Pricing remained strong as revenue excluding fuel surcharge per hundredweight increased 13.3% year-over-year. The leadership at both AAA Cooper and MME were able to complete the system integration during the fourth quarter, less than 12 months since the acquisition of MME. This creates seamless connectivity for our customers while maintaining the culture and brands of each company. We believe this positions us to provide additional services to existing customers as well as create new customer relationships. Our Knight and Swift brands have deep relationships with large shippers who in many cases deal with larger LTL providers. Creating a super-regional network in the short term and a national network in the long term will enable us to find opportunities to further support our existing truckload customers with LTL capacity. Now we'll move to Slide 7. Our Logistics segment continues to perform well with an adjusted operating ratio of 86.4%. Gross margin also expanded to 22.1% in the quarter compared to 20.7% last year. Overall, revenue was down 42.2% driven by a 28.9% decrease in revenue per load from lower spot market rates and a decrease in load count of 18.6%. Load volumes were negatively impacted by lower import volumes, particularly over the West Coast ports. Our customers continue to value the power-only services we provide, which resulted in our power-only volumes feeling less pressure than our traditional live load, live unload activity. Our vastly growing trailer network allows our customers the ability to optimize their warehouse space and labor costs. Third-party carriers prefer power-only business because it saves them hours at each load and unload location, lowers their capital investment and risk, reduces their operating costs and gives them access to freight that historically wouldn't be able to participate in. We continue to be excited about this business and have several technology initiatives ongoing that will improve the experience for our third-party carriers as well as provide more seamless information internally and to our customers that will lead to more opportunities to utilize our equipment. I'll now touch on intermodal on Slide 8 before turning the call over to Dave. Revenue decreased by 8.6% driven by a 6.3% decrease in load count and a 2.5% decrease in revenue per load. Intermodal volumes are being pressured by the general freight environment and the current competitive position of the truckload alternative. Customers are leveraging the extremely low spot rates, quicker transit times and better service in the truckload market. Labor within the rail network appears to be improving as we enter the first quarter, leading to improving transit times and more predictability for our customers. These improvements should help close the service gap between intermodal and Truckload and support future growth for this business.

David Jackson, President and CEO

Thank you, Adam, and good afternoon, everyone. Slide 9 illustrates the growth in our businesses that make up the non-reportable segment, which include insurance and maintenance under the Iron Truck Services brand as well as equipment leasing and warehousing activities. For the full year of 2022, we reached $517 million in revenues, representing 69% year-over-year growth. For the quarter, we had a 32% increase in revenue year-over-year. As previously mentioned, the results of the other services were negatively impacted in the fourth quarter by an actuarial adjustment of $15.4 million pretax related to third-party carrier risk in the iron insurance business, which resulted in the $11.6 million operating loss for this segment. We are already taking steps to enhance our insurance program, which include a recent conversion to a new platform that we expect will lead to improved collections and more timely cancellations. We've applied rate increases to various lines of coverage that will bring underwriting results in line with expectations. These service offerings have found tremendous interest from small carriers, especially as we help them improve their cost structure. But later in 2022, we have observed the pressure of the weaker environment impacting these carriers as seen through their difficulties in paying insurance premiums and the practice of extending maintenance service intervals on their equipment. We expect to continue growing the revenues and income from these other services over time and believe this effort supports our ongoing diversification objective. Next on to Slide 10; this slide illustrates the progress of the intentional changing of the composition of our business into an industrial growth company. The chart on the left shows the percentage of adjusted operating income from each of our segments and our other non-reportable services since the Knight and Swift merger in 2017. We're pleased to report meaningful contributions in earnings from each area. These diversification efforts are intended to make us a less volatile company and we expect will help us mitigate the downside through truckload freight cycles. Our Truckload earnings now represent approximately 65% of consolidated earnings, which is a meaningful shift from where we were in 2017 following the merger. This reduction in the percentage of our earnings coming from Truckload has been achieved while we significantly improved our Truckload earnings from a 2017 full year combined pro forma Knight and Swift earnings of $319 million to $748 million for 2022. The chart on the right shows our annual adjusted earnings per share since the merger. Our adjusted EPS has moved from $2.16 per share in the first 4 quarters following the merger to $5.03 per share in 2022. Moving to Slide 11; strong earnings have driven increases in our free cash flow since the Knight-Swift merger, reaching $819 million in 2022. Year-to-date, we've used cash to increase our dividend to shareholders by 20%, repurchased $300 million worth of shares and paid down $395 million in long-term debt and leases. Since the 2017 merger, we've invested $1.6 billion in acquisitions. Making acquisitions remains a high priority, and our strong cash flow generation and a leverage ratio of less than 1.0 provide us with ample capacity for M&A opportunities. Our balance sheet is strong and we're well positioned to invest in organic growth, pursue acquisitions, purchase more shares, increase dividends and/or pay down debt. We are constantly evaluating market conditions to maximize our use of cash to create value for our shareholders. On Slide 12, we demonstrate the return on net tangible assets, which remains a key measurement for us. In 2022, we achieved a 19.0% return on net tangible assets. Our goal is to improve this measurement by focusing on 3 key areas: growing our less asset-intensive businesses; two, acquiring and improving businesses; and three, expanding margins in our existing operations. We've achieved synergies and improvement in every business we have acquired, be they warehousing, asset-based truckload, less than truckload, or truckload brokerage. We believe our focus in these 3 key objectives will leverage our core competencies in areas of opportunity that are unique to us and will allow us to continue to generate significant returns to our shareholders in the long run. On Slide 13, we provide an outlook for market conditions as we begin 2023. We expect the current softness will persist through the first half of 2023 based on indications from shippers that are working through their inventory overhang. This soft environment combined with ongoing inflation in equipment, maintenance and insurance and rising interest rates will increase the pressure on carriers, especially smaller and less well-capitalized carriers. These factors will most likely accelerate capacity attrition in the coming quarters. I'll now turn it back to Adam to cover our 2023 guidance.

Adam Miller, CFO

Thanks, Dave. On to our last slide here, Slide 14. For the full year 2023, we expect adjusted EPS to be in the range of $4.05 to $4.25. Last year, we expected the first half to be strong and then cool off in the second half, which is largely what happened. In 2023, we expect the opposite: more challenging environments in the first half before we start to see a recovery to a more typical freight demand, leading up to an improving Q4 peak season. Over-the-road truckload contract rates will be pressured with few noncontract opportunities until the latter half of the year. We expect these noncontract opportunities, combined with some return of peak season volume, to result in rates inflecting positive year-over-year in Q4. Overall Truckload revenue per mile should be down mid- to high single digits in Q1 and trending to be positive by low single digits in Q4. Dedicated rates should increase in the low single digits for the year. Truck count should remain sequentially stable throughout the year with miles per tractor reflecting positive year-over-year by the middle of the year. Our LTL segment is expected to see slight improvement in revenue with relatively stable margins. Sequentially, Logistics revenue per load should drop in the first quarter before increasing sequentially throughout the year. We expect volumes to follow a similar trend. Gross margin will compress as the freight market picks up, pushing logistics OR to climb into the high 80s to low 90s. Intermodal revenue per load in margin will deteriorate in the first half before improving again in the back half. For the full year, we expect the operating ratio to be in the mid-90s. Revenue and op income in our other services will increase driven primarily by improvement in rates and new customer growth in our insurance business and increased volumes in warehousing. Inflationary pressure will decelerate as labor loosens and equipment availability improves. Gains are expected to be in the range of $10 million to $15 million per quarter, and our CapEx is expected to be in the range of $640 million to $690 million, and our tax rate is expected to be around 25%. Interest expense is also projected to increase from where we were in the fourth quarter as rates continue to climb. So that concludes our prepared remarks. And so JP, we will now open the line for questions.

Operator, Operator

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

Jack Atkins, Analyst

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

David Jackson, President and CEO

Thank you, Jack. I would say that the decline from the fourth quarter to the first is notably less than what we typically see. The freight market is showing some positive signs as we move through January. Normally, the fourth quarter experiences significant seasonality, which shifts following the holiday season into the first quarter. We expect the first quarter to be seasonally weaker than the fourth, as is usual. However, there is a good possibility that once the first quarter concludes, we might reflect on this as the least impactful transition from the fourth to the first quarter. One indication of how this may unfold comes from our customers, who noted that a substantial amount of their holiday inventory had arrived as early as 10 to 11 months prior, leaving it positioned by the start of October. This provided clarity on the fourth quarter freight dynamics. Consequently, we wondered how long this inventory surplus would persist. Customer feedback suggests that by spring, they will have managed to catch up with their inventory. This aligns with the notion that freight was returning to normal flow by the summer of 2022, without the typical import delays, indicating earlier than usual arrival of shipments. We anticipate that the first half of this year will experience softness due to previously moved freight, after which we expect to revert to a more regular cycle. Despite market uncertainties, consumers are holding up, and it's impressive that our industry, including our company, performed well in the fourth quarter without the usual seasonal boost. This performance highlights the lack of oversupply that typically characterizes past cycles; we didn't witness such a surge in 2021 and 2022, nor in much of 2020, which remained solid. Thus, our asset-based Truckload division achieved an 82.7% operating ratio in a fourth quarter that followed a peak in 2021, driven by tight supply rather than demand. Looking ahead, as we deplete this inventory, we expect to see normal goods flow resuming in the latter half of the year without the anticipation of additional supply. In fact, we believe that supply is diminishing and will continue to do so over the next two quarters, which gives us confidence in a significantly different environment in the second half of 2023.

Adam Miller, CFO

Yes, Jack. When we review historical trends, it's uncommon for rates to decline year-over-year for more than four quarters. This gives us confidence as we approach the fourth quarter of this year, where we anticipate a positive shift in rates. We've engaged in extensive discussions with many of our customers, including some of the largest retailers and CPG shippers in the country. These conversations indicate significant changes in their buying habits during the fourth quarter and extending into the first quarter. Overall, there's an expectation that ordering patterns will start to normalize, leading to increased volumes around June and July. This outlook is supported not just by historical data and our own insights, but also by feedback from our customers.

Operator, Operator

Your next question comes from the line of Tom Wadewitz from UBS.

Tom Wadewitz, Analyst

Dave, you talked a bit about this in your response to the first question, but just really on the cycle and how you see it playing out. I guess another kind of angle on that topic, do you think there are reasons why shippers may behave differently in the current freight downturn compared to other downturns? And I mean truckloads are highly fragmented. It's kind of hard to get my arms around the industry behaving differently, but maybe like the largest trailer pool players behave differently. I'm just trying to get a sense of if there's not a bigger downturn on rates or what could be partly shipper behavior is different or even large carrier behavior is a bit different. So yes, that's the question.

David Jackson, President and CEO

Thanks for your question, Tom. One notable difference in this cycle compared to past ones is the resilience of contractual rates and the demand for trailer pools. This stability is reflected in our strong rate per mile. We strive to anticipate market trends well in advance, ideally 6 to 12 months ahead. Last year, we increased our commitments and started to move away from the spot market, which has positively impacted our results. In our Logistics business, for instance, we achieved an 86.4% operating ratio despite a nearly 19% drop in load volumes. Typically, our asset-based operations would provide some support during downturns, but the situation remains complex. Our power-only volumes decreased by 14%, yet we maintained a robust gross margin of 22.1%. This indicates a significant value created as customers are giving us opportunities even as competitors struggle. We are able to maintain margins and volumes, largely thanks to the value provided by our trailer pools. Historically, during downturns, shippers would lean towards large non-asset-based brokers who slashed rates and secured substantial volumes. These brokers often found carriers willing to accept discounted prices in a difficult market. Smaller carriers sometimes circumvented restrictions by running more miles to survive tough times. However, now that we have Electronic Logging Devices (ELDs) regulating hours of service, these tactics are no longer feasible. Shippers cannot depend on flexible arrangements with carriers and have to adapt their unloading processes for deliveries from us. The ELD regulations mean carriers must be compensated for any delays beyond two hours, significantly altering the economics of freight. These factors contribute to the unique value we offer, which we're starting to see reflected in market trends. Over the past 12 months, contract rates across the industry have remained relatively stable, with only mid-single-digit declines, whereas spot rates fell sharply throughout 2022—a pattern we've never seen before. Currently, spot rates seem to be stabilizing at the bottom, raising the question of when they will begin to rise again. In previous cycles, like in 2017, spot rates increased around July or August and peaked by August 2018. In the post-ELD environment, this trend was observed in June and July of 2020, with spot rates starting to rise after hitting their lows. As it stands now, spot rates may be on the rise while contract rates remain stable, predominantly due to the value of trailer pools. Once spot and contract rates intersect, we typically enter a phase of rising rates. The duration of this uptrend will depend on overall economic demand and how supply is managed within the industry, particularly considering that new equipment purchases remain on allocation and the rising costs due to interest rates. So, while that's a lengthy response to your concise question, I hope it provides some clarity.

Operator, Operator

Your next question comes from the line of Todd Fowler from KeyBanc Capital Markets.

Todd Fowler, Analyst

Could you elaborate on your thoughts regarding revenue per mile, particularly in light of the initial high single-digit declines at the start of the year followed by a positive trend? How do you differentiate this between contract and spot pricing? Additionally, what are your observations regarding contract renewal pricing and how does it factor into your revenue model assumptions for the year?

Adam Miller, CFO

Yes. Tom, there are very few spot opportunities expected in the first half of this year. Most of the decline will be due to contract renewals. It's still early in the bid season, so we haven't received many final awards yet. The declines are more anticipated than actual at this point, and we are still in the early phases of this process, maintaining good communication with our customers. We expect that in the second half of the year, improvements in rates will come from contract renewals, alongside improvements in spot rates and some typical projects we engage with in the fourth quarter.

Todd Fowler, Analyst

And Adam, just a follow-up on that comment. So on the contract side, what is a reasonable expectation for contracts this year, I mean, just given the spread right now between spot and contract?

Adam Miller, CFO

Yes, we're still evaluating the situation, so I'm not ready to provide a specific number at this time. It really depends on when we renewed the contract with that customer. I anticipate that early in the bid season, the number will be higher, likely in the lower double digits. As the bid season continues, that number is expected to decrease.

David Jackson, President and CEO

Yes. Todd, it's hard for us to just generalize the whole thing because we have pieces of business that still need to be increased in rates because of how it works and how it fits into our network and the fact that we continue to see inflation. We do have other parts where sometimes we have an opportunity to maybe make a concession, help a customer who's trying to hit a budget target or goal if things are working in a super-efficient way and perhaps, to Adam's point, the time in the cycle when that rate was renewed. But this is not an across-the-board answer that the rates are automatically down. That's just not the case.

Adam Miller, CFO

Yes. I believe we mentioned that some of our dedicated business, which David referred to, will need to increase due to its performance. That's a typical hedge in the environment we are dealing with, where over-the-road and dedicated services perform differently under these circumstances.

Operator, Operator

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

Ravi Shanker, Analyst

So I think, Dave, you said, I think it was about a year ago now, that you think trough EPS has a $4 on it, and clearly, your guidance for the year implies that you're comfortably above that level. But if I were to kind of just like take a step back and listen to what you've been saying on this call so far, kind of talking about the cycle actually not being as bad as prior cycles and a midyear inflection and everything else, it doesn't really sound that bad. And in that context, kind of the guide seems kind of punitive at this point, especially given that you have a really easy fourth quarter comp in '23. So I'm just thinking of like are there any puts and takes in some of the non-TL segments that we need to keep in mind? Or kind of what are some of the kind of the moving parts and maybe the bull case or the bear case that can get you to a higher number than what you've guided to or a lower number at the cycle turned out to be much worse than you expected?

David Jackson, President and CEO

Yes. The full Truckload still accounts for two-thirds of our earnings and has the biggest impact on our overall performance. For the first half of the year, we are expecting earnings to be less than 50% of our annual guidance. It could be around 45% in the first half and 55% in the second half. However, achieving more than $4 a share would be a significant achievement, especially after earning over $5 a share in 2022 under favorable conditions. Our performance is not typical for a cyclical company, which usually doesn't reach higher earnings in a downturn. It won’t be easy, but our model supports this goal, or we wouldn’t have set it. One positive aspect is our LTL business. Although the LTL industry is experiencing some pressure, it's not as volatile as the full Truckload rates. We are steadily making progress in this area. In the fourth quarter, our operating ratio improved to 85.5%, significantly better than the previous year’s 90.3%. We successfully integrated a new back-end system at MME, enhancing our operations while continuing to run the business. This modernization began in October and is still being refined, leading to ongoing synergies. Revenue from that business increased nearly 15%, and adjusted operating income rose over 70% year-over-year. This diversification is why we value LTL, and we keep looking for ways to create synergies with the TL business while expanding our geographic presence for nationwide offerings. However, there are concerns that some may doubt our ability to earn $4 based on the current guidance and stock performance. Nonetheless, we have conducted thorough assessments to establish our guidance based on the best available information and are optimistic about the range we've projected.

Adam Miller, CFO

Yes. And Ravi, I think last quarter, I went into greater detail of how each segment would need to perform to achieve that $4 mark. And I think as we look at our guidance, we're not going to that detail in our guidance today. But fairly aligned there. I think maybe the one outlier is the intermodal. We talked about that being a mid-90s operating ratio. We've just seen some challenges there on volume, especially with the better availability of truckload capacity and the service that, that performs at versus intermodal. And so that would be one area that would be maybe off from what we would have called out last quarter. But generally speaking, our segments will perform as I laid out. And we'll still have to see how everything plays out in this bid season, but we just have a tremendous amount of confidence based on how these cycles have developed historically and the communication we're having with our customers.

Operator, Operator

Your next question comes from the line of Ken Hoexter from Bank of America.

Ken Hoexter, Analyst

If I could follow up on the $4 floor and the stress test, could you discuss the Truckload side and if it could move back into the mid to upper 80s? Specifically, how confident are you in the projected gains of $10 million to $15 million? It seems like those targets might put some pressure on that floor. Additionally, regarding the intermodal side, do you have any comments on the transition of Schneider to Union Pacific? They have experienced some service issues; how has your service been? You mentioned the mid-90s; do you foresee any deterioration if they gain better access to the yards, and what are your thoughts on intermodal?

Adam Miller, CFO

Sure. To address your question about truckload, last quarter I mentioned that in a tough environment, the Truckload segment, which includes our over the road and dedicated business, was operating in the mid-80s. We expect that to be the case for the entire year, with some challenges in the first half but an improvement in the second half, particularly in the fourth quarter. Regarding your intermodal question, there hasn't been a significant impact from Schneider's conversion from BN to UP so far. We are monitoring our service closely, and while there are areas for improvement, I don't attribute these issues to the Schneider transition but rather to ongoing challenges with some of our rail partners. However, rail fluidity appears to be improving, labor is becoming more available, and we are optimistic that this trend will continue. Our customers have noticed improvements, and we have significantly enhanced service for certain customers, where we anticipate receiving substantial awards this year. Thus, we are confident in building that low count in the latter half of the year, though the first half will still pose some challenges given the current environment.

Ken Hoexter, Analyst

And Adam, can you just wrap up on the gains on sale, right? Because that's such a big, I guess, swing factor in that range.

Adam Miller, CFO

Yes. We had the gains coming off meaningfully from where they were last year. And we have a good purview into the used equipment market. And even in the first quarter when the spot market has been as slow as it has been, which would typically mean that you've got small carriers not buying equipment, we're still seeing activity. And I think that's a result of just very lean inventories because the OEMs have still been challenged to fill everyone's orders. And I think most of the large carriers have continued to age their fleet out. And so that's just limited the inventory of used equipment. And so what we are selling is still at healthy margins. And we don't see that changing dramatically throughout the year.

Operator, Operator

Your next question comes from the line of Bert Subin from Stifel.

Bert Subin, Analyst

Dave, if I look at Slide 14, I don't want to belabor the point, but I think it's obvious thinking about your $4-plus earnings guidance, that implies about 100% earnings power expansion, which is obviously a tremendous feat. And so I think people are trying to get their arms around that. If I look at Slide 14 in those guidance assumptions, where would you say the greatest uncertainty is in your mind as you go through them?

Adam Miller, CFO

Yes, it's difficult to determine. Our guidance represents our best estimate based on the current market knowledge. I wouldn't categorize it as either aggressive or conservative; it feels like a reasonable approach given what we know today. Therefore, it's hard to identify one data point as being more uncertain than another.

David Jackson, President and CEO

Well, if Washington somehow messes with tax rates, that would be the biggest. So we'll start there, if we can't stay at close to 25% tax rate. Does that help you, Bert?

Bert Subin, Analyst

Yes, I think that moves the needle. Yes, go ahead.

David Jackson, President and CEO

Realistically, Bert, the rate per mile can fluctuate significantly. It’s an important factor for us, but we're not observing a market that is about to slow down. Spot rates reached their peak 13 months ago, so we are already deep into this cycle. If you can forecast the changes in rates, you can anticipate many other aspects of the business. However, it's difficult to predict exactly how this will unfold. This year, we've experienced considerable resilience in our rate per mile due to the way we've structured our business and the value we provide compared to others. It’s rare to find a previous cycle where the period from peak to trough exceeded 18 months. Typically, you don't observe double-digit declines over 12 consecutive months either. Yet, we are already more than 12 months into this cycle, which has not been driven by an oversupply of equipment like previous cycles. This gives us some insight into our expectations for both contract and spot rates, which we believe will recover in the latter half of the year. This would likely be the most significant factor in our guidance.

Bert Subin, Analyst

Logistics, how it operates now is definitely different from a few years ago. LTL is an entirely new business for Knight-Swift. My question is about how you become comfortable with those assumptions since you imply margins in the low double digits to high single digits for Logistics, which would be excellent, especially in a down year. For LTL, margins in the mid-low teens would also be favorable, but we haven't really seen that scenario during a downturn in their current format. You've mentioned that your models are consistent, but I'm curious if you face a lot of uncertainty or if it mainly hinges on how contract rates evolve.

David Jackson, President and CEO

No. I would say there's less uncertainty in the LTL world. It performs much more consistently than full Truckload. Additionally, we have a favorable long-term trend in the industry related to the synergies and opportunities we have. This includes developing a super-regional network that connects large areas of the country, allowing us to compete in some national markets. Furthermore, wages in the LTL industry are expected to increase by about 5% for drivers, which is different from the full Truckload segment. As a result, we can expect LTL rates to rise due to ongoing inflation affecting their largest expenses. In terms of Logistics, it will be volatile. However, in the most recent quarter, our Logistics business produced $23.5 million in operating income, which we appreciate. Nevertheless, it does not significantly impact our nearly $8 billion parent company.

Adam Miller, CFO

Yes. Regarding Logistics, we are moving up from the mid-80s that we achieved in 2022, and our guidance reflects a shift to the high 80s and low 90s. When we consider the absolute performance for 2023, it will be quite strong compared to competitors in the market. However, we recognize that we are starting from a very robust position in 2022, so we do anticipate a decline in that performance. As you know, the largest cost in Logistics is related to purchase trends, which are variable and fluctuate with rates. Typically, when dealing with power-only loads, those rates tend to be less volatile, holding up better due to reduced competition in the brokerage market, even as you purchase capacity in the open market. Consequently, the gross margins in those scenarios are generally more resilient than in pure live load and live unload situations.

Operator, Operator

Your next question comes from the line of Amit Mehrotra from Deutsche Bank.

Amit Mehrotra, Analyst

I have a couple of quick questions. First, Dave, how likely do you think it is for Knight to make another significant acquisition this year, similar to AAA, that could really impact earnings? Then Adam, looking at the fourth quarter results, I want to revisit Jack's question about the first quarter. In the fourth quarter, we didn't see a decline in yield on a loaded-mile basis; it was down by 1% sequentially. It seems like it may drop by 10% sequentially in the first quarter. I'm trying to understand how that fits with Dave's earlier comments about expecting minimal seasonal changes from the fourth to the first quarter. In the fourth quarter, we didn't observe the yield decline we anticipated for the first quarter. It would be helpful, Adam, if you could clarify the expected decline in Truckload profits from the fourth to the first quarter given this yield dynamic.

David Jackson, President and CEO

So Amit, from a mergers and acquisitions perspective, we currently have a leverage ratio of about 0.97. This puts us in a strong position to take action. Our top priority is clearly less-than-truckload services, which do require the right timing to succeed. In the meantime, we are considering a range of companies. As mentioned in our last quarterly call, we find truckload carriers appealing because we have a significant level of confidence in that area. We have a strong track record and a passion for it, so we would not hesitate to pursue truckload deals as well. We believe we have the capacity to engage in both opportunities and remain very interested and active in the mergers and acquisitions space.

Adam Miller, CFO

Regarding your second question, Amit, when I compare 2021 to 2022, the fourth quarter of 2021 was exceptional, which resulted in a significant decline of about $0.25 to $0.26 per share as we moved into Q1, although Q1 remained strong. In the current year’s Q4, we are handling freight through our regular operations without any projects or spot opportunities. As we transition from Q4 to Q1, the freight dynamics remain relatively stable. We have bids in progress, but many of them won't take effect until early or later in the second quarter, and the bid season should wrap up by mid-third quarter. Therefore, will rates be pressured from Q4 to Q1? Likely, but I'm uncertain about the extent you mentioned. I don’t observe the typical decline that usually occurs when Q4 features project business and a strong spot market, followed by Q1 where we primarily manage freight as usual. The overall dynamic has not changed significantly.

Amit Mehrotra, Analyst

Adjusted profits in truck cracking decreased by 18% from the fourth quarter of 2021 to the first quarter of 2022. Are you suggesting that the decline will be significantly less as we move from the fourth quarter of 2022 to the first quarter of 2023?

Adam Miller, CFO

I would say overall for the business, I wouldn't expect to see the same percentage decline in profit from Q4 to Q1.

David Jackson, President and CEO

Yes. Thanks, Amit. Well, JP, we appreciate your help as our operator. Everyone, thanks for joining our call today. We apologize to a little more than a half dozen who were in the queue to ask questions that we didn't get to. Welcome to reach out to us directly and hope everyone has a great evening.

Operator, Operator

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