Earnings Call Transcript - KNX Q3 2023

Operator, Operator

Good afternoon, my name is Ludie and I'll be your conference operator today. At this time, I would like to welcome everyone to the Knight-Swift Transportation Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. 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

Thank you, Ludie. I appreciate that. Good afternoon, everyone, and thank you for joining our third quarter 2023 earnings call. Today, we plan to discuss topics related to the results of the quarter, provide an update on current market conditions, and update our 2023 guidance. We have slides to accompany this call, which are posted on our investor website. Our call is scheduled to last one hour today and following our commentary, we'll answer questions related to these topics. In order to get to as many participants as possible, we're going to limit the questions to one per participant. If you have a second question or a follow-up, please feel free to get back into the queue, and we'll answer as many questions as possible. If we're not able to get to your question due to time restrictions, you may call 602-606-6349 following the call, and we'll answer as many questions as possible at that point. So to begin, I'll first refer you to the disclosures on Slide 2 of the presentation, and I’ll also note 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 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. Before we get into the slides, I want to turn the call over to Dave for a few opening remarks.

David Jackson, President and CEO

Thank you, Adam. And hello, everyone, and thank you for joining our call today. As has been widely reported, we continue to be in a depressed truckload freight market where rate expectations from shippers are often close to, if not, below operating costs. Spot rates are at levels that are not sustainable and are proving not to be survivable for those that are dependent on that type of freight. When we did our last call a quarter ago, there were rumors of Yellow closing. Obviously, since that call, that has indeed taken place, and the already resilient LTL market has seen more strength. On the truckload side, the announcements of failures and rumors of more seem to be increasing by the week as of late. It has taken a lot to get to this point, so deep along the bottom of this current cycle. But the market is beginning to show signs of sensitivity to when supply leaves suddenly or when our providers cannot perform with freight lanes that were awarded by offering the cheapest price, and shippers may find themselves quickly seeking a quality provider at a higher price than the original award. However, we are not seeing enough of that kind of activity or enough supply leave and/or enough strength in volumes to move rates to a meaningful inflection position right now. But it does appear that the stage has been set for positive rate pressure in the next bid season. In the meanwhile, here at Knight-Swift, we are focused on three specific objectives. The first one is improving the performance of our truckload businesses. There is much in our control that we can do, including being better at cost, running more miles safely, and in hiring and retaining driving associates. Our people are digging in and working hard. We're grateful for that. The truckload operating ratio excluding US Xpress was 91.5%, and we are just simply not comfortable with an OR that starts with a nine. Our people are working with urgency to do all that we can. Another objective is to grow our LTL network, AAA Cooper and Midwest Motor Express seamlessly operate on one operating network while maintaining their local identities. We've opened 14 LTL service centers organically since the acquisition of AAA Cooper and MME in 2021. We've already purchased 11 additional terminals that have not yet launched service centers, and we'll continue to pursue acquiring additional terminals that fit our nationwide plan in addition to other strategic forms of growth for LTL. We have found synergies between LTL and Truckload businesses while not getting in one another's way. The third objective that I would point out is the turnaround of US Xpress. We feel like we had good momentum going into the close of the transaction with the goal of being able to hit the ground running, and it feels like that's what's happened. We've had positive sequential rate improvement while lowering cost per mile in the first quarter of our ownership despite strong market pressure in the contrary. Still, we have a long way to go, but we are ahead of schedule. The people at US Xpress have been great, and we're so excited about where that business is headed, and with some help from the market, we will get there even sooner. Now we'll turn our overview to Slide 3. The charts on slide three compare our consolidated third-quarter revenue and earnings results on a year-over-year basis. These results now include the results of US Xpress for the full quarter. Revenue excluding fuel surcharge increased 7.6%, while our adjusted operating income declined by 60.8%. Market conditions in the LTL business were strong while soft demand continues in the truckload space. GAAP earnings per diluted share for the third quarter of 2023 were $0.37 per share, and our adjusted EPS came in at $0.41 per share. These results were negatively impacted on a year-over-year basis by a $20.4 million increase in interest expense and the $22 million reduction in operating income in our third-party insurance business within the non-reportable segments. Also, the third-quarter GAAP results were positively impacted by a $14.6 million income tax benefit from the partial release of a tax benefit valuation allowance held by US Xpress associated with net operating losses and the tax credit carry-forward benefit at the time of the acquisition. This benefit was recognized post-closing due to the ability of Knight-Swift to utilize those tax attributes, which had the effect of reducing the consolidated effective tax rate at Knight-Swift to negative 2.1% for the current quarter. Our adjusted EPS of $0.41 is calculated using a normalized 23.2% effective tax rate for the quarter and excludes the $0.09 per share benefit of the lower tax rate.

Adam Miller, CFO

Thanks, Dave. For the Truckload segment, the ongoing soft demand, further rate pressure, and a recent sustained increase in fuel prices were headwinds to operating margins in the third quarter. However, our actions to reduce costs offset these challenges to produce a slight sequential improvement in adjusted operating ratio for our existing truckload business, excluding the results of US Xpress. The inclusion of US Xpress negatively impacted the adjusted operating ratio for this segment by 340 basis points. On a year-over-year basis, our truckload revenue excluding fuel surcharge increased 21.9%, reflecting a 15.5% decline in the existing truckload business prior to the inclusion of US Xpress. Revenue per loaded mile fell 14% in total or 11.8% before including the US Xpress truckload business as the spring bid activity is now fully realized. Excluding the results of US Xpress, miles per tractor increased 1% for the first year-over-year increase in 2023. Including the results of US Xpress, miles per tractor increased 5.1% year-over-year. The decline in rates, partially offset by the improvement in miles per tractor, produced an 8.2% decrease in revenue per tractor year-over-year. Now we'll move to Slide 6. The benefits of our diversification into LTL really stood out as this segment continues to perform well, aided by the recent disruption in the industry. Our LTL business grew revenue excluding fuel surcharge nearly 7% year-over-year and delivered an 84.9% adjusted operating ratio. Pricing growth strengthened as revenue per hundredweight excluded fuel surcharge increased 10.7% year-over-year. Volumes built throughout the quarter as shipments per day increased 4.8% year-over-year, which reversed the trend of decline seen in the first half of the year. As Dave mentioned, we've brought on 14 new service centers online since entering the business in late 2021, and efforts are underway to continue growing this number with properties in various stages of procurement, development, or reconditioning. Filling out a super-regional network in the short-term and creating a national network in the long-term will allow us to participate in more freight and enable us to find opportunities to further support our existing truckload customers with LTL capacity. This remains a key strategic priority for us. Now on to Slide 7. The logistics market is in a difficult phase, where freight demand has been soft for over a year, producing top-line price pressure that is no longer being offset by corresponding declines in purchased transportation costs. Despite these challenges, our existing logistics business remained disciplined and nimble, maintaining a low-90s adjusted operating ratio before the inclusion of US Xpress. The US Xpress logistics business is already showing sequential improvement in adjusted operating ratio since the acquisition, closing it within 300 basis points of our existing logistics business, as we improve the cost structure and pricing even in a difficult environment. Overall, revenue was down 24.5% year-over-year as revenue per load declined 15.8% and load count declined 10.3%. Excluding the US Xpress logistics volumes, load count was down 29.7% year-over-year in the existing business. Now if you move to Slide 8. I'll cover our intermodal segment. Revenue declined 22.6%, which was driven by a 26.6% decrease in revenue per load, which was partially offset by an increase of 5.5% in load count. The operating ratio improved 190 basis points since the second quarter as a result of cost reductions, which offset a slight sequential reduction in revenue per load. This business improved during the quarter, reaching breakeven in September, and we expect modest profitability in the fourth quarter. Now on to Slide 9. This slide illustrates our non-reportable segment, which includes insurance, maintenance, and equipment sales and rentals under the Iron Truck services brand, as well as equipment leasing and warehousing activities. For the quarter, revenue declined 14.2% year-over-year, largely as a result of our actions to address the recent challenges within our third-party insurance program, including significantly reducing the exposure basis. The $5.4 million operating loss within the non-reportable segment is modestly improved from the $7.1 million operating loss in the second quarter as improvement within other services provided a greater offset to the ongoing losses within the third-party insurance business. We are evaluating strategic alternatives for the insurance business, including potential reinsurance strategies for the outstanding liabilities in order to help insulate our business from the volatility primarily arising from prior loss years. As noted previously, it will take some time for the changes in the insurance business to fully materialize in the results, but we are making progress by raising premiums and improving the quality of risk as we work to mitigate volatility.

David Jackson, President and CEO

Thanks, Adam. The team at US Xpress has really rallied around the goal of making significant improvements to this business and is currently running ahead of plan, as previously mentioned, on our projected path to reach an operating profit within the first half of next year. As noted in previous slides, the US Xpress Truckload and Logistics businesses have already made meaningful progress improving their operating ratios. Coming out of the third quarter, we have already reached a $100 million annualized run rate of realized synergies with a target of increasing that to a $120 million run rate by the end of this year. We highlight some of the progress on this slide. You'll notice these are fundamental areas of the business, some of which are critical levers to pull through cycles. Ultimately as we lower the cost per mile and increase rate per mile, we will make operating ratio progress, and that has begun. US Xpress is rolling out a decentralized terminal-based operating model similar to Knight-Swift, where there is P&L accountability at the local level with far more personal driver interaction. Nine out of the 10 locations have been converted from places to park to operating terminals. Understanding where rates need to be for a proper return has led to the elimination of brokers as the business is now dealing directly with shippers, while significantly reducing exposure to spot rates versus contract rates, which has improved from approximately 45% at the beginning of the year to approximately 15% today. This is an uphill battle as we closed this transaction at the end of the spring bid cycle in July, but the team has made progress and we'll continue as we will soon begin the 2024 bid season. We are excited for this early progress and for how this consequential truckload business is positioning for the future. We have been impressed with the effort and attitude of our new fellow teammates at U.S. Xpress and appreciate their hard work. Next to Slide 11 for our outlook. Slide 11 contains our updated outlook on market conditions for the remainder of 2023. The LTL market should continue to see solid demand as the recent capacity disruption in the industry continues to be sorted out over the next several months. This should support further yield improvement as the new business is increasingly repriced through bid activity. In the truckload space, we believe we are moving past inventory destocking. Those shippers are cautious about the direction of the US consumer behaviors governing freight demand for the time being, it feels. We continue to expect a modest peak season, including a return of some typical seasonal activity and project opportunities with opportunities continuing to materialize. Spot rates seem to have bottomed but have yet to inflect positively. As a result, contract rates continue to be pressured. The soft demand, unsustainably low rates, ongoing inflation, and restrictive financing conditions will keep pressure on carriers, especially smaller and less well-capitalized carriers. These factors should serve to accelerate the ongoing capacity attrition and limit immediate capacity expansion upon recovery. The pace of cost inflation should ease, though plentiful work alternatives in the general economy will pressure hiring and utilization until freight conditions improve. New equipment availability continues to improve and the used equipment market weakens further as small carriers struggle with capacity exits.

Adam Miller, CFO

All right. Thanks, Dave, and this will be our final slide. For the full-year 2023, we now expect adjusted EPS to be in the range of $2.10 to $2.20 per share, which is an update from our previous guidance of $2.10 to $2.30 per share. This is based on our expectation that truckload rates have stabilized at current levels for the fourth quarter. The truckload tractor count will be down modestly with miles declining sequentially similar to the prior year in the absence of a strong peak. The LTL revenue excluding fuel surcharge increases in the mid-teens year-over-year, with a relatively stable sequential margin profile. The LTL shipment count in revenue excluding fuel surcharge per hundredweight improves at a high single-digit percentage year-over-year. The U.S. Xpress EPS estimated dilutive impact in the fourth quarter expected at less than or around $0.05, I believe, as performance continues to improve. Logistics volumes and revenue per load remain under pressure in Q4 with OR stable in the low 90s. The intermodal operating ratio is slightly profitable with volume stable sequentially. The non-reportable operating income declines roughly $10 million to $15 million sequentially as third-party insurance stabilizes while other businesses experience their typical seasonal slowdown in the fourth quarter. We expect some easing cost pressure in the fourth quarter as we realize further cost-containment efforts on some of our cost initiatives. We expect gains on sale to range from $8 million to $12 million, which includes now disposals at U.S. Xpress. And we expect minimal increase in interest expense from Q3, assuming the rate hiking cycle is largely complete. Our net cash CapEx is expected to be between $770 million and $750 million for the full year 2023, and we expect our tax rate to be approximately 26% for the fourth quarter. So that now concludes our prepared remarks. And so Ludie will now turn it to you to open the line for questions.

Operator, Operator

Thank you. Your first question comes from the line of Ravi Shanker from Morgan Stanley. Your line is open.

Ravi Shanker, Analyst

Thanks. Good evening, everyone. So, Dave, I think you said at the top of the call that you do expect to see some positive pricing momentum going into 2024. It seems hard to fathom with spot and contract rates where they are right now, but you also have spoken of cost inflation a fair bit. Can you unpack that a little bit more kind of what's the early signs on bid season looking like? Are we looking at flat first half and a positive second half or something even better than that?

David Jackson, President and CEO

Yes. That comment is mainly based on the current economic situation of full truckload transportation providers. Reports from the second quarter and the early third quarter indicate very tight margins in the full truckload sector. This is occurring while driver wages, which are our biggest expense, have not increased since 2021. We may experience a delayed wage increase as truckload capacity struggles to recruit vocational labor. Consequently, we don't have the opportunity to be aggressive with pricing; in fact, we need some assistance. As we noted last quarter, this is a unique freight recession, differing from typical prolonged downturns that align with broader economic recessions where we usually see cost reductions in fuel, labor, and equipment. Instead, we are experiencing the opposite situation, with fuel shifting from neutral to a headwind for truckload. It seems some pricing lanes are awarding contracts to carriers at rates we find difficult to comprehend. We see that some of these contracts have come back around, often through mini bids, due to service level issues or delivery failures. We're noticing signs that conditions may have stretched to their limits. We're working diligently to be as efficient as possible, as we currently have very little margin for error in truckload operations. We don't believe we're alone in this situation. Our outlook for bid season might not align with shippers' expectations at this point. Truckload generally does not employ cost-based pricing, unlike LTL, which we have learned. Our focus is on essential needs rather than elective actions, and we will have to observe how things develop. If bid season started today, we would struggle to see positive outcomes, but as conditions evolve, we believe natural dynamics might push us in a favorable direction.

Adam Miller, CFO

And Ravi, I'd like to add that the bid season hasn't started yet, but we've had some early discussions with shippers who will be releasing bids in the next quarter. The sentiment is that many of our customers are benefiting from the low rates they've been experiencing in the spot market and even in some contract rates. It seems they've shifted a significant portion of their volume to brokers to take advantage of those discounts. Our shippers, much like the carriers, understand that the market will change—it's not a question of if, but when. They are concerned about maintaining sustainable capacity. Some of the feedback indicates that even though the market may not be favorable today, they recognize that in six months, they could face challenges without capacity from asset-based carriers, especially given some recent market failures. We are actively communicating with our customers and view ourselves as partners with them. We understand the need for sustainable capacity and believe we can navigate towards what we consider to be fair rates as we move forward.

Ravi Shanker, Analyst

Very helpful. Just a quick follow-up. Speaking of failures in logistics, we've seen headlines that a large digital player may have paused or stopped operations today. What impact do you think this has in the marketplace? What does this indicate about where we are in the cycle and the future of the brokerage model? Is this a positive or negative development, and what does it mean for the industry?

Adam Miller, CFO

We will address that question, Ravi, as I believe everyone on the call would like to understand the comment. However, I want to emphasize that we are only allowing one question. Last fall, the first analyst asked two questions, and then others followed suit, so please keep it to one question.

David Jackson, President and CEO

Ravi, I am happy to address that, and if we don't get to that right away, we will respond to it. Thank you, Ravi.

Ravi Shanker, Analyst

Understood. Thanks guys.

Scott Group, Analyst

Hey, thanks. Good afternoon, everyone. Can you provide some insight into the revenue and operating ratio for U.S. Xpress this quarter? What do you anticipate moving forward? Additionally, how crucial is it for the market to improve, and for pricing to rise, in order to enhance the U.S. Xpress operating ratio? Is it possible to achieve your desired profitability without an increase in market pricing?

Adam Miller, CFO

Scott, considering where that business started after the acquisition, we will need to improve both costs and revenues. On the cost side, we don't need to rely on market changes; we can make progress on various initiatives. For instance, in procurement, we're expanding the terminal network, which we believe will enhance safety, reduce turnover, and aid in recruitment, all of which can significantly affect costs. We've seen a mid-single-digit improvement in our cost per mile, which is promising, but we know there's more potential. On the revenue side, we've experienced low-single-digit growth, which is positive given that many in the market are facing declining revenue per mile. However, we haven't had a bidding season to reassess the current rates for U.S. Xpress. Achieving long-term profitability will require improvements in both revenue and costs. I believe it's only a matter of time before we can effectively address the revenue side to align U.S. Xpress rates more closely with our other brands.

David Jackson, President and CEO

The logistics business is performing well and contributing to earnings. The dedicated business is also contributing positively, and the subsidiary total is adding to earnings. The over-the-road component has made significant progress, and we have seen a reduction in driver turnover, improvements in revenue per truck, and increased accountability on the cost side, which has led to lower costs and improved margins. The recent earnings showed less of a drag than we anticipated at this stage, and achieving breakeven without market assistance seems within reach. While that isn't our primary goal, the progress made since the second quarter has been both dramatic and quicker than expected.

Scott Group, Analyst

Thank you.

Jack Atkins, Analyst

Thank you very much. Jack Atkins from Stephens here. Dave and Adam, I’d like to ask you about the LTL business for a moment. You mentioned it exceeded your expectations in the quarter. With the further market disruption in October, I’m curious about how the operating ratio in that business has trended in relation to normal seasonality. Did you face any additional expenses while trying to onboard some of the market share that may be shifting? Also, I'm interested in the opportunity to acquire some of the real estate up for auction from the Yellow estate in the coming weeks. I realize that’s quite a few questions, Adam, so I’d appreciate it if you could elaborate on that for a moment.

David Jackson, President and CEO

Yes. Adam, the enforcer might shut this down before we get started with all those questions. It is not typical for our two LTL franchises to see sequential improvement from the second to the third quarter, but we did observe a slight improvement this time. Whether this is related to an additional cost burden is unclear. In the LTL market, our customers had immediate needs, and our LTL team stepped in to handle those shipments. The focus was more on managing those shipments and maintaining service rather than discussing pricing. The truckload space operates differently, especially with irregular projects. Some of the volume we've taken on will be allocated long-term among LTL providers, and this will be addressed in the ongoing bidding process to ensure appropriate pricing as it fits into the network. Therefore, I wouldn't categorize this as a cost challenge. The sequential improvement is a positive indicator for us, and it's encouraging to see shipments become positive year-over-year, with revenue, excluding fuel, increasing in double digits, which are all very promising signs for us.

Jack Atkins, Analyst

Thank you.

Tom Wadewitz, Analyst

Yeah. Hey Dave, Adam, it's Tom Wadewitz here. I wanted to ask you a little bit about kind of cycle view. Dave, you offered some thoughts of kind of constructive and bid season. Do you need to see spot rates move up first in order to really see that improvement in contract? It continues to be a widespread between contract and spot and I think the brokers take advantage of that and compete against you guys. So I'm just wondering, is the kind of optimism on contract rates next year really contingent on seeing some momentum in spot rates ahead of that? And I don't know if you have a thought on just capacity exiting, and when you get enough of that to take place to tighten the market as well. So, thank you.

David Jackson, President and CEO

Yes. I'll go ahead and start, and then Adam can add to this. Historically, during these cycles, there’s a pattern where spot rates begin to rise, and if you compare spot rates with contract rates, there's a point where they intersect. This intersection signals the beginning of a rise in spot rates, which typically indicates that the trend for contract rates is about to shift positively again. However, we haven't observed that lately; instead, spot rates have remained relatively stable. One challenge we face from cycle to cycle is that the dataset we analyze is always changing. It increasingly appears that our dataset focuses mainly on brokers and smaller carriers, which don't represent the majority of freight movement. It feels like we have a limited view of the market right now, making it tough to draw direct comparisons with previous years. It’s difficult to believe we won’t eventually see a situation where spot rates rise to meet contract rates, signaling a transition into a different market phase. The unpredictable nature of this transition is what makes it hard to forecast; it often occurs rapidly and unexpectedly. Various factors, whether it's weather conditions or fuel prices, typically act as catalysts. The aggressive strategies we've seen from non-asset-based companies seem unsustainable under current financing costs, which may lead to some smaller carriers facing difficulties. We're starting to notice signs of this, with reports of asset-based carriers shutting down operations just this month, and we've even heard of non-asset players halting operations. While these disruptions may not be enough to trigger a significant change, it’s impossible to predict with certainty. When a turnaround does happen, it usually takes a long time to develop. We feel like we're nearing that pivotal point. Adam, do you have any thoughts?

Adam Miller, CFO

Yes, I believe that as we observe some disruptions in operations, we notice immediate effects on our business. These effects can be short-term or longer-term, and we will see how it unfolds. This indicates that there isn’t much slack in the supply chain currently. Therefore, any increase in demand or significant decrease in capacity could cause the market to shift rapidly. We anticipate that this will occur in 2024; it’s just a question of timing. As we prepare for bids, we are focusing on rates that we consider sustainable as the market evolves. These are the discussions we are having with our customers, rather than merely waiting for the spot market to change, which would influence contract rates.

Chris Wetherbee, Analyst

Hey, thanks, good afternoon guys. I wanted to ask about the U.S. ex-fleet and how you think about that relative to some of the cost synergies that you're realizing. So I think you said about $100 million run-rate maybe moving up to $120 million by year-end. Is there a relationship between getting that cost synergy and then ultimately profit synergy? And the size of that fleet, I guess, in other words, do you need to shrink the fleet to be able to generate profitability? What do you think kind of you'll be able to net hold onto over the course of maybe one year, or maybe that 2026 target you have out there?

David Jackson, President and CEO

We believe we don't need to reduce our operations to achieve profitability. There are several challenges related to the Swift merger that we have yet to overcome. After the merger, we implemented hair follicle drug testing and made changes to the owner-operator program. In this instance, we didn't have those measures in place, so we are working hard to maintain the fleet and improve profitability on a per truck basis. Since we have only owned the fleet for a quarter, the size has remained nearly the same with only a slight decrease. Therefore, there are no plans to downsize the fleet.

Ken Hoexter, Analyst

Great. Good evening, and thanks for your thoughts on the pressures related to the rates. Hopefully, we've all been observing that and waiting for the capacity to exit in order to increase those rates. So, hopefully, that materializes. Dave, could you share your thoughts on intermodal? You mentioned its journey toward profitability. How confident are you in that perspective? Is it primarily about raising rates, or is it tied to navigating through a bidding season? What operational factors are contributing to the losses in intermodal, and what changes do you foresee that could lead to a turnaround?

David Jackson, President and CEO

I'm going to let Adam answer that.

Adam Miller, CFO

Yes, I think it's a combination of multiple things, just like any business that's operating at that level. It's not one thing that you have to get done. I think there's going to be some opportunity to pick up some additional volume in the bid season as we've got our rates with our rail partners adjusted based on the way our contract is structured with them. So I think that puts us in a better position to be aggressive there. I think we've got some operational efficiencies we need to work through in terms of how we manage chassis. And I think we've made some progress there. And we started the quarter out on a rough start, but we saw that sequential progress all the way through until we got to a level of profitability, just slightly in September, and we expect to continue that momentum. But it will be something that just takes time to work through and service is improving at both the West and the East. I think customers that had moved freight off of the rail to the truckload because of the issues with service are looking at that again as an option. And I think we've got some great relationships on the truckload side that we still don't do much with on the intermodal side that I think we'll be able to open up those doors. So it's going to be a combination of all those factors, Ken, that we think will get us to a good position where that's a business that can compete with the top providers there and generate a margin in there. Hopefully, high-single-digit, low-double-digit depending on where we're at in the cycle.

Ken Hoexter, Analyst

I’m not sure if I can clarify this. It seems like you're asking whether the work with customers is focused on the long term or if we're expecting profitability in the fourth quarter. Did I misunderstand, or is this part of the bid season that has already taken place or is about to occur quickly?

Adam Miller, CFO

We achieved slight profitability at the end of the third quarter, and we anticipate this trend will continue into the fourth quarter. While we expect to remain profitable, we are not yet at our target level. Reaching our goals will require a few more quarters as we improve our operational efficiencies and navigate the bid season to increase volume and address rates.

Allison Poliniak, Analyst

Hi, Allison.

Unidentified Analyst, Analyst

Hey everyone, it's James standing in for Allison. I wanted to revisit a question about truckload rates. It seems that while costs are still high and there is continued pressure, there is also a significant amount of capacity available. I'm curious about your perspective on what is keeping that capacity in the market and when you anticipate it might decrease. Is there a specific event you think would trigger that drop? I'm interested in your views on the pace of capacity and its potential exits.

David Jackson, President and CEO

I appreciate the question, James. We're seeing significant resourcefulness among small carriers trying to survive. It's difficult to determine if the stability in the used equipment market is playing a role in financing accommodations. There are definitely individuals, especially those operating one or two trucks, who may be temporarily living out of their vehicles just to get by during this tough period. Our exposure to small carriers shows that they are under significant pressure, managing costs while low on cash flow, and in some cases, deferring necessary maintenance like routine oil changes. Many appear to be just scraping by, relying on maxed-out credit cards, hoping to avoid major expenses like tires or mechanical issues. It's puzzling why we haven't seen more capacity leave the market because spot rates, in absolute terms, were sufficient to strengthen the market back in 2017 due to a decrease in supply. Given the current cost structure and inflation, it's hard to believe that we can sustain the same spot rates while facing higher costs; it feels more like a struggle for survival at this point. We're closely monitoring the situation and trying to gain a better understanding ourselves.

Unidentified Participant, Participant

Got it. Small follow-up, is there anything at the end-of-the year like maintenance events, insurance renewals, or anything else that might be sort of a catalyst over in the fourth quarter for exits? Thank you for the time.

David Jackson, President and CEO

I don't believe there is a specific event. Renewals and registrations happen regularly, but it seems they tend to cluster towards the end and beginning of the year. This is more of a general observation than something I can definitively point to, so I wouldn't say there is a single event that drives this.

Bruce Chan, Analyst

Hey, good evening, gents. Maybe just wanted to ask one here on core demand. I know you've got a pretty diverse base of customers, but is there anything that you've been seeing in terms of end-markets that may be worth calling out, especially anything around food and bev and what at least one big shipper talked about with regard to lower spending due to Ozempic, anything related to industrial, NTL, or LTL related to the UAW, anything there just maybe be material enough to affect your outlook for the rest of the year.

David Jackson, President and CEO

Adam and I are looking to each other and both kind of shaking our heads like no. So, I think what's been a little different this year is we have seen a little more seasonality through the beverage season and a little bit of produce in the second quarter that we saw none of last year and seen a little bit around the holidays, which is more of a food and beverage play but haven't seen any.

Adam Miller, CFO

Yes. I think there are maybe some specific customers who may have made more progress on inventory than others that might see a different demand pattern than others, but I think that's more specific to their strategy versus something that's broader to a certain sector.

Jon Chappell, Analyst

Thank you. Good afternoon. Adam, maybe better-for-you. I know it's not a core business, but it does tend to move the needle pretty significantly, the insurance business. Just looking for a little bit of clarity there and if we take the midpoint, what you've kind of guided to for the fourth quarter, and that looks like $40 million EBIT drag. I know you're evaluating strategic alternatives. But as we think about how that plays into 2024, it seems like it's pretty cycle-independent first and foremost, is that a business that goes back to kind of breakeven in 2024? Is it a first-half drag that maybe you get a bit of a second-half recovery or is it just kind of a lesser loss line item for 2024?

Adam Miller, CFO

Yes, the business has faced challenges over the past four quarters, and we are exploring ways to mitigate the losses. We are currently focusing on tightening our underwriting standards in the short term and looking into reinsurance opportunities that could help reduce volatility and outstanding liabilities on our balance sheet. We are committed to examining all potential strategies to address these losses. For 2024, we anticipate a reduction in losses compared to our current position, though we recognize the need for quicker action. It’s frustrating to deal with a challenging situation, and we have a dedicated team exploring every possible alternative. We expect to see some progress in the fourth quarter and into 2024, and if we identify effective strategies, particularly with the reinsurance options, we will act promptly.

Amit Mehrotra, Analyst

Thanks, operator. Hi David. Hi Adam, excuse me. I guess, there is an expectation that earnings can be up meaningfully next year, and I know you guys do an exceptional job kind of pivoting to where maybe the opportunities present themselves. So there is obviously that opportunity or potential next year. But I guess the question, David, I want to understand how you're thinking about how expectations are calibrated for next year? How you think the slope of the recovery from here? Can it be more muted? Is there an opportunity to see gaps higher if you think those opportunities are likely to show up? We're just kind of late in this year now and demand doesn't seem to be there, and I'm just trying to understand kind of getting your head a little bit and how you're thinking about the recovery path from where we are today.

Adam Miller, CFO

Thank you, Amit. As we have mentioned in previous calls, recoveries in the truckload sector typically start with an increase in volume, which then leads to some improvement in rates, and ultimately, both volume and rate improvements contribute to earnings. This process will be gradual. The comparisons at the beginning of the year won't be easy, but we anticipate they'll become somewhat easier as we move into next year. Regarding our business, our LTL operations are expected to continue performing well and should be quite predictable and positive. We also have a significant opportunity in the truckload space with U.S. Xpress, which is nearing breakeven. If we secure additional bids and experience some strength, this could lead to a substantial increase in sales, which has not been the case before. As we noted a couple of quarters ago, we aim to ensure that our peaks in earnings performance surpass those of the previous cycle. However, predicting the timing of this is challenging and somewhat out of our control in the truckload sector. Our focus remains on preparing ourselves for the future by strengthening our business and relationships in that space. We'll be providing our guidance for 2024 next quarter, and I'm thankful that we can do this in three months, as many factors could change in that time. Our approach to running the business is to work hard as if nothing will change, controlling what we can. We will be ready to act when market conditions improve. That's my best answer for you right now, Amit.

Amit Mehrotra, Analyst

Yes, that's very fair. Thank you, wish you guys the best. Thank you.

David Jackson, President and CEO

Thank you.

Adam Miller, CFO

Thanks, Amit.

Operator, Operator

And this ends our Q&A session. I would like to turn it back to our speakers for closing remarks.

David Jackson, President and CEO

Okay, well, thank you. Thank you, Ludie. We are grateful for your interest today. I think we hit a record number of questions today. So if we did not get to your question, please feel free to call us at 602-606-6349. Thanks for joining the call today; take care.

Operator, Operator

And ladies and gentlemen, this concludes today's conference call. Thank you for participating; you may now disconnect.