HEARTLAND EXPRESS INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read together with “Business” in Part I, Item 1 of this Annual Report, as well as the consolidated financial statements and accompanying footnotes included in this Annual Report. This discussion contains forward-looking statements as a result of many factors, including those set forth under Part I, Item 1A. “Risk Factors” and Part I “Cautionary Note Regarding Forward-looking Statements” of this Annual Report, and elsewhere in this report. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from those discussed. Overview We, together with our subsidiaries, historically have been a short-to-medium haul truckload carrier with approximately 99.9% of our operating revenue was derived from shipments within the United States with the remainder being Canada and no operations in Mexico. With the acquisition of CFI on August 31, 2022, we significantly expanded our scale and our transportation services. We continue to provide nationwide asset-based dry van truckload service for major shippers from across the U.S. and now including cross border freight to and from Mexico and our consolidated average length of haul has increased to approximately 500 miles. We continue to focus on providing high quality service to targeted customers with a high density of freight in our regional operating areas. We also offer truckload temperature-controlled transportation services and logistics services in Mexico, which are not significant to our consolidated operations. Through the acquisition of CFI, we now provide transportation logistics services across Mexico for our customers and provide cross-border freight services for customer loads moving from the United States into Mexico and loads originating from Mexico into the United States. We utilize third party service providers for all miles run in Mexico and to move freight across the US-Mexico border while leveraging terminal locations in the US and Mexico near the border to facilitate these moves. We generally earn revenue based on the number of miles per load delivered and the revenue per mile or per load paid. We operate our consolidated operations under the brand names of Heartland Express, Millis Transfer, Smith Transport, and CFI. We manage our business based on overall corporate operating goals and objectives that are the same for all of our brands. Our Chief Operating Decision Maker (“CODM”), our CEO, evaluates the operational efficiencies of our transportation services, operating performance and asset allocation on a combined basis based on consolidated operating goals and objectives. We believe the keys to success are maintaining high levels of customer service and safety, which are predicated on the availability of experienced drivers and late-model equipment. We believe that our service standards, safety record, and equipment accessibility have made us a core carrier to many of our major customers, as well as allowed us to build solid, long-term relationships with customers and brand ourselves as an industry leader for on-time service. Our headquarters is located in North Liberty, Iowa, in a lower-cost environment with ready access to a skilled, educated, and industrious workforce. Our other terminals are located near major shipping corridors nationwide, affording proximity to customer locations, driver domiciles, and distribution centers. Approximately 80% of our terminals are located within 200 miles of the 30 largest metropolitan areas in the U.S. We believe our geographic reach and terminal locations assist us with driver recruiting and retention, efficient fleet maintenance, and consistent customer engagement. Our long-term objectives, which have not changed since we were founded in 1978, are to achieve significant growth, to operate with a low-80s operating ratio (operating expenses as a percentage of operating revenue), and to maintain a debt-free balance sheet. We maintain a disciplined approach to cost controls. We do this by scrutinizing all expenditures, prioritizing expenses that improve our drivers' experience or our customer service, minimizing non-driving personnel through proven technology when the cost of doing so is justified, and operating late-model tractors and trailers with sound warranty coverage and enhanced fuel efficiency. With the two acquisitions of Smith Transport and CFI we now have debt. Also, our operating ratio has been pressured by the operations of the two entities acquired as their operating ratios were in the 90's at the date of acquisition. We anticipate getting back to debt free and low 80's operating ratio as we integrate the operations of these two entities. Our Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this document generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this document can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. Recent Developments On May 31, 2022 we completed our fourth acquisition within nine years. We acquired all the outstanding equity of Smith Transport. The Smith Transport acquisition added additional dry van truckload capacity to our core operations and this resulted 34 in increased revenues and increased operating costs after May 31, 2022. Therefore, our financial results for 2022 only include Smith Transport activity from June 1, 2022 to December 31, 2022. On August 31, 2022 we completed our fifth acquisition within nine years. We acquired all the outstanding equity of CFI. The CFI acquisition added additional dry van truckload capacity to our core operations and this resulted in increased revenues and increased operating costs after August 31, 2022. Therefore, our financial results for 2022 only include CFI activity from September 1, 2022 to December 31, 2022. In 2022, we generated operating revenues of $968.0 million, including fuel surcharges, net income of $133.6 million, and basic net income per share of $1.69 on basic weighted average outstanding shares of 78.9 million. This compared to operating revenues of $607.3 million, including fuel surcharges, net income of $79.3 million, and basic net income per share of $1.00 on basic weighted average outstanding shares of 79.6 million in 2021. We posted an 80.5% operating ratio (which represents operating expenses as a percentage of operating revenues) for the year ended December 31, 2022, compared to 82.6% for the same period of 2021, and an 13.8% net margin (which represents net income as a percentage of operating revenues) for 2022, compared to 13.1% in the same period of 2021. We posted an 84.8% non-GAAP adjusted operating ratio (1) (operating expenses as a percentage of operating revenues, net of fuel surcharge) for the year ended December 31, 2022 compared to 79.7% for the same period of 2021. We had total assets of $1.7 billion and total stockholders' equity of $855.5 million at December 31, 2022. We achieved a return on assets of 9.8% and a return on equity of 16.4% over the year ended December 31, 2022, compared to 8.4% and 10.9% respectively, for 2021. (1) GAAP to Non-GAAP Reconciliation Schedule: Operating revenue, operating revenue excluding fuel surcharge revenue, fuel surcharge revenue, operating income, operating ratio, and adjusted operating ratio reconciliation (a) Twelve Months Ended December 31, 2022 2021 (in thousands) Operating revenue $ 967,996 $ 607,284 Less: Fuel surcharge revenue 169,173 76,116 Operating revenue excluding fuel surcharge revenue 798,823 531,168 Operating expenses 779,638 501,877 Less: Fuel surcharge revenue 169,173 76,116 Less: Amortization of intangibles 3,653 2,390 Less: Acquisition-related costs 2,254 — Less: Gain on sale of a terminal property (73,175) — Adjusted operating expenses 677,733 423,371 Operating income 188,358 105,407 Adjusted operating income $ 121,090 $ 107,797 Operating ratio 80.5 % 82.6 % Adjusted operating ratio 84.8 % 79.7 % (a) Operating revenue excluding fuel surcharge revenue, as reported in this annual report is based upon operating revenue minus fuel surcharge revenue. Adjusted operating income as reported in this annual report is based upon operating revenue excluding fuel surcharge revenue, less operating expenses, net of fuel surcharge revenue, non-cash amortization expense related to intangible assets, acquisition-related legal and professional fees, and the gain on sale of a terminal property. Adjusted operating ratio as reported in this annual report is based upon operating expenses, net of fuel surcharge revenue, amortization of 35 intangibles, acquisition-related costs, and the gain on sale of terminal property, as a percentage of operating revenue excluding fuel surcharge revenue. We believe that operating revenue excluding fuel surcharge revenue, adjusted operating income, and adjusted operating ratio are more representative of our underlying operations by excluding the volatility of fuel prices, which we cannot control, and removes items resulting from acquisitions or one-time transactions that do not reflect our core operating performance. Operating revenue excluding fuel surcharge revenue, adjusted operating income, and adjusted operating ratio are not substitutes for operating revenue, operating income, or operating ratio measured in accordance with GAAP. There are limitations to using non-GAAP financial measures. Although we believe that operating revenue excluding fuel surcharge revenue, adjusted operating income, and adjusted operating ratio improve comparability in analyzing our period-to-period performance, they could limit comparability to other companies in our industry if those companies define such measures differently. Because of these limitations, operating revenue excluding fuel surcharge revenue, adjusted operating income, and adjusted operating ratio should not be considered measures of income generated by our business or discretionary cash available to us to invest in the growth of our business. Management compensates for these limitations by primarily relying on GAAP results and using non-GAAP financial measures on a supplemental basis. Our cash flow provided by operating activities for the twelve months ended December 31, 2022 was $194.7 million or 20.1% of operating revenues, compared to $123.4 million or 20.3% of operating revenues in 2021. During 2022, we used $663.3 million in net investing cash flows, which was primarily the result of $675.9 million net cash used for the acquisitions of Smith Transport and CFI, partially offset by $12.2 million of cash provided by net proceeds of property and equipment. We used $160.6 million to purchase property and equipment and received $172.8 million from the sales of property and equipment. We had net cash of $359.3 million provided by financing activities including $447.3 million provided by issuance of long-term debt partially offset by $81.5 million of repayments of finance leases and debt and $6.3 million used to pay dividends to our shareholders. As a result, our cash, cash equivalents, and restricted cash decreased by $109.3 million during the year ended December 31, 2022 to $64.5 million. Unrestricted cash and cash equivalents decreased $108.3 million to $49.5 million. We operate in a cyclical industry. In early 2022, freight demand was initially strong, following an extended period of freight demand at peak levels that began in mid 2020 and continued throughout 2021 and into 2022. Freight demand began to soften in the back half of 2022. While the current levels are down compared against those unprecedented levels experienced during 2021, overall we continue to have more opportunities to haul freight than we are able to cover with our existing fleet and available drivers. We expect freight demand to remain challenged at lower demand levels in at least the first half of 2023 based upon the freight demand experienced in January and February of 2023 and expected normal seasonal trends. However, continued supply chain issues for tractors, trailers and related parts, general consumer product output and inventory volatility, consumer demand, and disruption in oil and diesel markets all could create additional volatility regarding freight demand during 2023. The trucking industry has been faced with a qualified driver shortage. During 2021, increased freight demand, combined with the COVID-19 pandemic, intensified an already challenging qualified driver market. Competition for qualified drivers continued to be challenging in 2022 and is expected to be a challenge going forward due to the decreasing numbers of qualified drivers in our industry. However, driver availability began to change late in 2022 and to date in 2023, as a result of the changing freight and economic environments and we believe certain drivers have moved from smaller less financially stable carriers to more financially stable carriers and from independent contractors to company drivers. Although there has been some increased movement of drivers between companies in our industry, the issue of decreasing amount of qualified CDL drivers in our industry continues. We continually explore new strategies to attract and retain qualified drivers with changes in market conditions and demands. We hire the majority of our drivers with at least six months of over-the-road experience and safe driving records. As discussed below, the Company's driver training program provides an additional source of future potential professional drivers. In order to attract and retain experienced drivers who understand the importance of customer service, we have sought to solidify our position as an industry leader in driver compensation in our operating markets and for the services we provide. We have increased wages and enhanced the compensation for our drivers multiple times in the last three years. Further, we have continued to get more creative in providing better pay, benefits, equipment, and facilities for our drivers. Our comprehensive driver compensation and benefits program rewards drivers for years of service and safe operating mileage benchmarks, which are critical to our operational and financial performance. Certain driver pay packages include minimum pay protection provisions, future pay increases based on years of continued service with us, increased rates for accident-free miles of operation, detention pay, and other pay programs to assist drivers with unproductive time associated with circumstances outside of their control, such as inclement weather, equipment breakdowns, and customer issues. We believe that our driver compensation and benefits package is consistently among the best in the industry. We are committed to investing in our drivers and compensating them for safety as both are key to our operational and financial performance. Growth History and Capital Allocation In addition to past organic growth through the development of our regional operating areas, we have completed ten acquisitions since 1986 with the most recent and our fifth acquisition within the last nine years, CFI, occurring on August 31, 2022 36 following the acquisition of Smith Transport on May 31, 2022. These ten acquisitions have enabled us to solidify our position within existing regions, expand into new operating regions, expand service offerings to address longer length of haul needs from customers, pursue new customer relationships in new markets, as well as expand business relationships with current customers in new markets. We are highly selective about acquisitions, with our main criteria being (i) safe operations, (ii) high quality professional truck drivers, (iii) fleet profile that is compatible with our philosophy or can be replaced economically, and (iv) freight profile that will allow a path to a low-80s operating ratio upon full integration, application of our cost structure, and freight optimization, including exiting certain loads that fail to meet our operating profile. We expect to continue to evaluate acquisition candidates presented to us, however, we do not expect to make any significant acquisitions while we are paying down debt. We believe future growth depends upon several factors including the level of economic growth and the related customer demand, the available capacity in the trucking industry, our ability to identify and consummate future acquisitions, our ability to integrate operations of acquired companies to realize efficiencies, and our ability to attract and retain experienced drivers that meet our hiring standards. We manage our business primarily based on long-term cash flow generation prospects and return on equity, and we place less emphasis on quarterly earnings per share or short-term revenue volatility. When we are experiencing or expect favorable freight markets, we invest in fleet expansion internally, dependent on our ability to hire drivers that meet our qualifications, and through acquisitions. When freight markets are less favorable, we concentrate our assets on customers offering the most acceptable returns and are willing to shrink our fleet to maintain margins and limit net capital expenditures. We have also deployed available cash opportunistically toward dividends and stock repurchases. However, we expect to focus on paying down the debt resulting from our 2022 acquisitions in 2023. For the periods ended December 31, 2022, our operating cash flows as a percentage of operating revenues five-year average was 23.0%, our three-year average was 22.4%, and most recently for 2022 was 20.1%. Tractor Strategy and Depreciation Our CODM makes all revenue equipment purchasing and selling decisions on a combined basis based primarily on age, condition, and current market conditions for the equipment regardless of which legacy fleet the equipment was associated with. Our tractor strategy is important to our goals and differs from the practices of many of our peers. We strive to operate a relatively new fleet to keep operating costs low, better driver comfort, and enhance dependability. We seek the flexibility to buy and sell tractors (and trailers) opportunistically to capitalize on new and used equipment markets, size our fleet to the volume of attractive freight, and manage cash tax expense. One method we use to accomplish these goals is to depreciate our new tractors (excludes assets acquired through an acquisition) for financial reporting purposes using the 125% declining balance method, in which depreciation is higher in early periods and tapers off in later periods. We believe this method more accurately reflects actual asset values and affords us the flexibility to sell tractors at most points during their life cycle without experiencing losses. In addition, the decline in depreciation during later periods is typically offset by increased repairs and maintenance expense as the tractors age, which keeps our total operating costs more uniform over the operating life of the equipment. Trailers are depreciated using the straight-line method. Revenue equipment acquired through acquisitions is generally revalued to current market values as of the acquisition date. Assets obtained more than a year prior to the acquisition by the acquired company are depreciated on a straight-line basis aligned with the remaining period of expected use, whereas those obtained less than a year prior are depreciated consistent with newly purchased assets. As acquired equipment is replaced, our fleet returns to our base methods of declining balance depreciation for tractors and straight-line depreciation for trailers. We believe our revenue equipment strategy is sound over the long term. However, it can contribute to volatility in gain on sale of equipment and quarterly earnings per share. At December 31, 2022, our tractor fleet had an average age of 2.0 years and our trailer fleet had an average age of 6.3 years. During 2023, we expect the age of both our tractor and trailer fleets to remain consistent with the average age at December 31, 2022, based on estimated net capital expenditures in 2023 due to our expectation of a shortage of reasonably priced new revenue equipment available. Fuel Costs After salaries, wages, and benefits, fuel expense was our next highest operating cost in 2022. Containment of fuel cost continues to be one of management's top priorities. Average DOE diesel fuel prices per gallon for 2022 and 2021 were $4.99 and $3.29, respectively. The average price per gallon in 2023, through February 20, 2023, was $4.55. During March 2022 the DOE average fuel prices increased to over $5.00 per gallon. The DOE average fuel cost remained above this elevated threshold for the period from March through December 31, 2022, although the DOE weekly average for the last four weeks of December fell below $5.00 per gallon. The trend of fuel prices below the $5.00 per gallon threshold has continued in 2023 as the DOE average through February 20, 2023 was $4.55. We are not able to pass through all fuel price increases through fuel surcharge agreements with customers due to tractor idling time, along with empty and out-of-route miles. Therefore, our operating income 37 is negatively impacted with increased net fuel costs (fuel expense less fuel surcharge revenue) in a rising fuel environment and is positively impacted in a declining fuel environment. We expect to continue to manage and implement fuel initiative strategies that we believe will effectively manage fuel costs. These initiatives include strategic fueling of our trucks, whether it be terminal fuel or over-the-road fuel, reducing tractor idle time, controlling out-of-route miles, controlling empty miles, utilizing on-board power units to minimize idling, educating drivers to save energy, trailer skirting, and increasing fuel economy through the purchase of newer, more fuel-efficient tractors. Results of Operations The following table sets forth the percentage relationships of expense items to total operating revenue for the periods indicated: Year Ended December 31, 2022 2021 Operating revenue 100.0 % 100.0 % Operating expenses: Salaries, wages, and benefits 35.8 % 41.2 % Rent and purchased transportation 5.6 0.6 Fuel 20.1 16.4 Operations and maintenance 4.0 3.6 Operating taxes and licenses 1.7 2.3 Insurance and claims 3.6 3.4 Communications and utilities 0.7 0.7 Depreciation and amortization 13.7 17.1 Other operating expenses 5.3 3.5 Gain on disposal of property and equipment (10.0) (6.2) 80.5 % 82.6 % Operating income 19.5 % 17.4 % Interest income 0.1 % 0.1 % Interest expense (0.9) % 0.0 % Income before income taxes 18.7 % 17.5 % Income tax expense 4.9 4.4 Net income 13.8 % 13.1 % Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021 The Company acquired CFI on August 31, 2022 and Smith Transport on May 31, 2022, therefore the operating results of the Company for the year ended December 31, 2022 includes the operating results of CFI and Smith Transport for four month and seven months after acquisition, respectively. The acquisitions impacted the change in operating revenues, salaries, wages and benefits, rent and purchased transportation, fuel expense, operations and maintenance, insurance and claims, depreciation and amortization, other operating expenses, and interest expense in 2022 compared to 2021 as further explained below. Operating revenue increased $360.7 million (59.4%), to $968.0 million for the year ended December 31, 2022 from $607.3 million for the year ended December 31, 2021. The increase in revenue was driven by an increase in trucking and other revenues of $267.7 million and an increase in fuel surcharge revenue of $93.1 million. The increase in trucking and other revenues was primarily from the acquisitions of Smith Transport and CFI. The increased fuel surcharge revenue was the result of increased miles driven as a result of the acquisitions in addition to a 51.8% increase in average DOE fuel cost in 2022. Smith Transport and CFI contributed 34.9% of the operating revenues, for the year ended December 31, 2021, including Smith Transport which contributed 13.3% and CFI which contributed 21.6% of the operating revenues. Operating revenues (the total of trucking and fuel surcharge revenue) are primarily earned based on loaded miles driven in providing truckload services. The number of loaded miles is affected by general freight supply and demand trends and the number of tractors. The number of tractors is directly affected by the number of available drivers providing capacity to us. The increase in total miles was a result of the additional capacity acquired. The increase in freight rates, earned on miles driven, was generally due to strong market conditions and demand for our freight services. In early 2022, freight demand was initially strong, following an extended period of freight demand at peak levels in 2021. However, demand softened each quarter sequentially in 2022 as compared to 2021. While the current levels are down compared against those unprecedented levels experienced during 2021, we continued to have more opportunities to haul freight than we were able to cover with our existing fleet and available drivers. For 2023, we expect 38 freight demand to remain challenged at lower demand levels during the first half of 2023 or longer based-upon the freight demand experienced in January and February of 2023 with expected normal seasonal trends. We expect our operating revenue to grow, primarily from our Smith and CFI acquisitions, partially offset by a weaker freight market. Our operating revenues are reviewed regularly by our CODM on a combined basis across the U.S. due to the similar nature of our services offerings and related similar base pricing structure. The operating revenues increase was the net result of an increase in loaded miles as a result of more drivers following our 2022 acquisitions along with an increase in the average rate per loaded mile. Fuel surcharge revenues represent fuel costs passed on to customers based on customer specific fuel surcharge recovery rates and billed loaded miles. Fuel surcharge revenues increased $93.1 million primarily as a result of an increase in average DOE diesel fuel prices of 51.8% during 2022 compared to 2021, as reported by the DOE, along with an increase of miles driven following our 2022 acquisitions. Rent and purchased transportation increased $50.5 million, to $54.3 million for the year ended December 31, 2022 from $3.8 million for the same period of 2021. The significant increase resulted from the acquisition of CFI which included more purchased transportation utilized throughout their operations, including independent contractors and other third party brokerage relationships. Further contributing to the rent and purchased transportation increase is lease expense from the acquisition of Smith Transport and their leases along with a terminal lease entered into in May 2022, following the sale of that property. Salaries, wages, and benefits increased $96.3 million (38.5%), to $346.3 million for the year ended December 31, 2022 from $250.0 million in the 2021 period. Salaries, wages, and benefits increased primarily due to the increase in the number of drivers and support staff following our 2022 acquisitions. In response to current hiring and retention challenges in our industry, we continue to get more creative in providing better pay, driving opportunities, benefits, equipment, and facilities for our drivers. We expect the qualified driver shortage within the trucking industry to continue to be a challenge in the foreseeable future. However, driver availability began to change late in 2022 and to date in 2023, as a result of the changing freight and economic environments and we believe certain drivers have moved from smaller less financially stable carriers to more financially stable carriers. Fuel increased $95.0 million (95.4%), to $194.6 million for the year ended December 31, 2022 from $99.6 million for the same period of 2021. The increase in fuel was primarily due to more miles driven following our 2022 acquisitions and higher average diesel price per gallon (51.8%) as reported by the DOE. The average DOE diesel fuel prices per gallon for 2022 and 2021 were $4.99 and $3.29, respectively. During March 2022 DOE average fuel prices increased to over $5.00 per gallon. The DOE average fuel cost remained above this elevated threshold for the period from March through December 31, 2022, although the DOE weekly average for the last four weeks of December fell below $5.00 per gallon. The trend of fuel prices below the $5.00 per gallon threshold has continued through the first seven weeks of DOE average fuel prices in 2023. While this is an improvement compared to the majority of 2022, the latest DOE diesel fuel price in February 2023 is up 10.6% compared to the same week of 2022. We cannot currently predict how long and how much the average diesel prices will remain elevated. Depreciation and amortization increased $28.9 million (27.8%), to $133.0 million during the year ended December 31, 2022 from $104.1 million in the same period of 2021. The increase in depreciation and amortization is a result of ongoing fleet replacement strategies and increase in depreciated units from the Smith Transport and CFI acquisitions. We expect depreciation expense in 2023 to be approximately $200 million to $210 million. Operating and maintenance expense increased $17.6 million (81.6%), to $39.1 million during the year ended December 31, 2022, from $21.5 million in the same period of 2021. Operating and maintenance costs increase is mainly attributable to an increase in miles driven and increased costs of our expanded fleet of revenue equipment following our 2022 acquisitions along with higher costs of parts and materials as a result of production shortages. Due to increased costs and limited availability of new revenue equipment, which we expect to continue into early 2023, our revenue equipment trade activity in 2022 was significantly below levels experienced in recent years. There was a 60.9% decrease in volume of trailers sold during 2022 as compared to 2021, and a 49.1% decrease in the quantity of tractors sold. At December 31, 2022, the Company’s tractor fleet had an average age of 2.0 years and the Company's trailer fleet had an average age of 6.3 years. The average age of our tractor and trailer fleets was increased by the inclusion of the Smith Transport and CFI equipment obtained through our 2022 acquisitions. Operating taxes and licenses expense increased $2.8 million (20.5%), to $16.4 million during the year ended December 31, 2022 from $13.6 million in 2021, due to an increase in number of revenue equipment units (tractors and trailers) licensed in 2022 as compared to 2021. The increase in number of revenue units licensed is the result of our 2022 acquisitions. 39 Insurance and claims expense increased $13.6 million (65.4%), to $34.4 million during the year ended December 31, 2022 from $20.8 million in 2021. There was an increase in severity and frequency of claims as well as an increase in risk exposure resulting from more miles driven, along with an increase in insurance premiums in 2022 compared to 2021. In addition, the overall cost to insure our revenue equipment, on a per unit basis, has increased year-over-year due to a lack of insurance capacity across the transportation industry mainly as a result of the current legal environment. We expect that insurance premiums will continue trending upward. In recent years we have modified our coverage to better match the benefit of insurance coverage received to the insurance premiums charged. We will continue this evaluation with our 2023 insurance renewal, which could result in a change to our coverage limits and insurance premium costs. Other operating expenses increased $30.0 million (140.3%), to $51.4 million, during the year ended December 31, 2022 from $21.4 million in 2021, due mainly to increased variable costs associated with the increase of revenue equipment units in our fleet and miles driven as a result of our 2022 acquisitions. Gains on the disposal of property and equipment increased $59.5 million (158.8%), to $96.9 million during the year ended December 31, 2022, from $37.4 million in the same period of 2021. The increase was primarily due to a $73.2 million gain from the sale of a terminal facility, partially offset by a $5.6 million decrease in gains on sales of trailer equipment and a $3.7 million decrease in gains on sales of tractor equipment, with the remaining $4.4 million decrease primarily due to the 2021 sale of a terminal facility. The decrease in gains on trailer sales was primarily due to a 60.9% decrease in volume of trailers sold, partially offset by a 79.6% increase in the gains per unit sold in 2022 as compared to 2021. Gains on tractor equipment sales decreased as a result of a 49.1% decrease in the quantity of tractors sold partially offset by a 44.8% increase in gains per tractor sold. We expect the used equipment market to remain relatively strong in 2023, although our participation may be limited by production shortages and increased costs for new revenue equipment to replace sold units. Interest expense increased by $8.6 million as we had no interest expense in 2021. The interest expense is made up of $7.5 million from the Credit Facilities coinciding with the acquisition of CFI while the remaining $1.1 million is the result of debt and financing leases assumed through the Smith Transport acquisition. Our effective tax rate was 26.2% and 25.2% for the twelve months ended December 31, 2022 and 2021, respectively. The increase in the effective tax rate is primarily the result of an increase in the accrual of tax for uncertain tax positions specific to transactions occurring in 12 months ended December 31, 2022. Inflation and Fuel Cost Most of our operating expenses are inflation-sensitive, with inflation generally producing increased costs of operations. During the past year there has been an inflation uptick. Significant price increases in original equipment manufacturer revenue equipment has impacted the cost for us to acquire new equipment, while there has been a corresponding inflationary impact to prices offered on the sale of our used equipment. The cost increases have also impacted the cost of parts for equipment repairs and maintenance, inclusive of tires. The continued qualified driver shortage experienced by the trucking industry has had the effect of increasing compensation paid to drivers. Significant inflation has been experienced in insurance and claims cost related to health insurance and claims as well as auto liability insurance and claims. Further, innovations in equipment technology, EPA mandated new engine emission requirements and driver comfort have also resulted in higher tractor prices. We have the ability to limit new equipment purchases given our average age of revenue equipment, particularly our tractor fleet, is in the top tier of our industry. We do not believe that extending our trade cycle in 2023 will significantly increase operations and maintenance expense compared to the rest of the industry. We historically have limited the effects of inflation through increases in freight rates and certain cost control efforts. Over the long term, general economic growth and industry supply and demand conditions have allowed rate increases, although the rate increases received have significantly lagged the increases in tractor prices and related depreciation expense. In addition to inflation, significant fluctuations in fuel prices can adversely affect our operating results and profitability. We have attempted to limit the effects of increases in fuel prices through certain cost control efforts and our fuel surcharge program. We impose fuel surcharges on substantially all accounts. Although we historically have been able to pass through most long-term increases in fuel prices and operating taxes to customers in the form of surcharges and higher rates, these arrangements generally do not fully protect us from short-term fuel price increases or continued rising price environments like we experienced throughout 2021 and 2022. These arrangements also may prevent us from receiving the full benefit of any fuel price decreases. Additionally, we are not able to recover fuel surcharge on empty miles, out of route miles, or fuel used in idling. 40 Liquidity and Capital Resources The growth of our business requires significant investments in new revenue equipment. Historically, except for acquisitions, we have been debt-free, funding revenue equipment purchases with our primary sources of liquidity, cash flow provided by operating activities and proceeds from sales of used equipment. In conjunction with the acquisition of CFI on August 31, 2022, (the “CFI Closing Date”), Heartland entered into a $550.0 million unsecured credit facility which included a $100.0 million revolving line of credit (“Revolving Facility”) and $450.0 million in term loans (“Term Facility” and, together with the Revolving Facility, the “Credit Facilities”). The Credit Facilities includes a consortium of lenders, including joint bookrunners JPMorgan Chase Bank, N.A. and Wells Fargo Bank, National Association (“Wells Fargo”). The Credit Facilities replaced the previous credit arrangements in place for the Company which consisted of a November 2013 Credit Agreement with Wells Fargo, along with an asset-based credit facility with Citizens Bank of Pennsylvania that was assumed as part of the acquisition of Smith Transport on May 31, 2022. The full amount of the Term Facility was made in a single draw on August 31, 2022 and amounts borrowed under the Term Facility that are repaid or prepaid may not be reborrowed. The Term Facility will amortize in quarterly installments beginning in September 2023, at 5% per annum through June 2025 and 10% per annum from September 2025 through June 2027, with the balance due on the date that is five years from the CFI Closing Date. Based on debt repayments made through February 28, 2023, required minimum payments have been covered through March 31, 2025. The Revolving Facility consists of a five-year revolving credit facility with aggregate commitments in an amount equal to $100.0 million, of which up to $50.0 million is available for the issuance of letters of credit, and including a swingline facility in an amount equal to $20.0 million. The Revolver will mature and the commitments thereunder will terminate on the date that is five years after the CFI Closing Date. Amounts repaid under the Revolving Facility may be reborrowed. The Credit Facilities include an uncommitted accordion feature pursuant to which the Company may request up to $275.0 million in incremental revolving or term loans, subject to lender approvals. The indebtedness, obligations, and liabilities under the Credit Facilities are unconditionally guaranteed, jointly and severally, on an unsecured basis by the Company, Borrower, and certain other subsidiaries of the Company. The Borrower may voluntarily prepay outstanding loans under the Credit Facilities in whole or in part at any time without premium or penalty, subject to payment of customary breakage costs in the case of SOFR rate loans. The Credit Facilities contain usual and customary events of default and negative covenants for a facility of this nature including, among other things, restrictions on the Company’s ability to incur certain additional indebtedness or issue guarantees, to create liens on the Company’s assets, to make distributions on or redeem equity interests (subject to certain exceptions, including that (a) the Company may pay regularly scheduled dividends on the Company’s common stock not to exceed $10.0 million during any fiscal year and (b) the Company may make any other distributions so long as it maintains a net leverage ratio not greater than 2.50 to 1.00), to make investments and to engage in mergers, consolidations, or acquisitions. The Credit Facilities contain customary financial covenants, including (i) a maximum net leverage ratio of 2.75 to 1.00, measured quarterly on a trailing twelve-month basis, and (ii) a minimum interest coverage ratio of 3.00 to 1.00, measured quarterly on a trailing twelve-month basis. Outstanding borrowings under the Credit Facilities will accrue interest, at the option of the Borrower, at a per annum rate of (i) for an “ABR Loan”, the alternate base rate (defined as the interest rate per annum equal to the highest of (a) the variable rate of interest announced by the administrative agent as its “prime rate”, (b) 0.50% above the Federal Funds Rate, (c) the Term SOFR for an interest period of one-month plus 1.1%, or (d) 1.00%) plus the applicable margin or (ii) for a “SOFR Loan”, the Term SOFR Rate for an interest period of one, three or six-months as selected by Company plus the applicable margin. The applicable margin for ABR Loans ranges from 0.250% to 0.875% and the applicable margin for SOFR Loans ranges from 1.250% to 1.875%, depending on the Company’s net leverage ratio. One of the nine consortium lenders is West Bank. Our CEO has served on the Board of Directors of West Bancorporation and West Bank, a wholly owned subsidiary of West Bancorporation, Inc., the financial institution that holds a portion of our deposits, since 2013. We have had a banking relationship with West Bank since 2003. West Bank's share of the Revolving Facility is $8.2 million while the West Bank share of the initial Term Facility was $36.8 million. We had $375.0 million outstanding on the Term Facility and no outstanding under the Revolving Facility at December 31, 2022. As of February 28, 2023 the outstanding balance on the Term Facility was $360.0 million. Outstanding letters of credit associated with the Revolving Facility at December 31, 2022 were $13.9 million. As of December 31, 2022, the Revolving Facility available for future borrowing was $86.1 million. As of December 31, 2022 the weighted average interest rate on 41 outstanding borrowings under the Credit Facilities was 5.6%. The May 31, 2022 acquisition of Smith Transport included the assumption of $46.8 million of debt and financing lease obligations associated with the fleet of revenue equipment of which $40.3 million was outstanding at December 31, 2022, (the "Smith Debt"). The Smith Debt has $9.7 million of outstanding principal and is made up of installment notes with a weighted average interest rate of 4.4% at December 31, 2022, due in monthly installments with final maturities at various dates ranging from November 2023 to January 2029, secured by related revenue equipment. The remaining Smith Debt of $30.6 million are finance lease obligations with a weighted average interest rate of 3.9% at December 31, 2022, due in monthly installments with final maturities at various dates ranging from July 2023 to April 2026 with the weighted average remaining lease term of 2.3 years. At December 31, 2022, we had $49.5 million in cash and cash equivalents, $382.4 million in outstanding debt, $30.6 million in finance lease liabilities, $21.0 million in operating lease obligations, and $86.1 million available borrowing capacity on the Revolving Facility. We intend to diligently pay down the debt we incurred and assumed to complete our most recent acquisitions, while maintaining our regular quarterly dividends and funding our ongoing capital expenditure needs. While we are paying down the debt, we do not currently expect to declare special dividends, repurchase shares of our common stock, or make significant acquisitions, however we will remain flexible to ensure the best deployment of our capital. Operating cash flow for 2022 was $194.7 million compared to $123.4 million for 2021. This increase was primarily due to a $32.5 million increase in net income net of non-working capital adjustment items, along with $38.8 million more cash provided by working capital items. Cash flow from operating activities was 20.1% of operating revenues for the year ended December 31, 2022, compared to 20.3% for the same period of 2021. Cash flows used in investing activities were $663.3 million during 2022, representing an increase in cash used of $660.6 million compared to cash flows used in investing activities of $2.6 million during 2021. The increase in cash used in investing activities was mainly the result of net cash used of $675.9 million for the acquisition of Smith Transport and CFI partially offset by $14.6 million more of net cash provided by property and equipment in 2022, compared to net purchases of property and equipment in 2021. The increase in net cash provided by property and equipment was primarily due to cash received from the sale of a terminal property. We currently anticipate higher net capital expenditures for revenue equipment in 2023 compared to 2022 as a result of the larger fleet size following the acquisitions and efforts to refresh these fleets. Cash flows provided by financing activities increased $437.4 million in 2022 compared to 2021. The $359.3 million provided by financing activities during 2022 included $447.3 million from the issuance of long-term debt partially offset by $81.5 million of repayments of finance leases and debt and $6.3 million used to pay dividends to our shareholders. In 2021, $78.1 million was used in financing activities including $45.9 million to pay dividends, including a special dividend, and $32.0 million for repurchases of our common stock. We have a stock repurchase program with 6.6 million shares remaining authorized for repurchase as of December 31, 2022 and the program has no expiration date. There were no shares repurchased in the open market during the year ended December 31, 2022 and 1.8 million shares were repurchased in 2021. While we are paying down the debt, we do not currently expect to repurchase shares of our common stock, however we will remain flexible to ensure the best deployment of our capital. Any future repurchases will depend on market conditions, cash flow requirements, securities law limitations, and other factors. The share repurchase authorization is discretionary and has no expiration date. We had net payments of $44.0 million and $38.5 million for income taxes, net of refunds, in the twelve months ended December 31, 2022 and 2021, respectively. The increase in net tax payments is the result of increased taxable income, partially offset by taxes paid with returns filed in 2021 that was not applicable to returns filed in 2022 and tax treatment of fixed asset transactions. Management believes we have adequate liquidity to meet our current and projected needs in the foreseeable future. Management believes we will continue to have significant capital requirements over the long-term, which we expect to fund with current available cash, cash flows provided by operating activities, proceeds from the sale of used equipment and to a lesser extent, available capacity on the Credit Facilities. 42 Contractual Obligations and Commercial Commitments The Company's material cash requirements include the following contractual obligations and commercial commitments at December 31, 2022. Payments due by period (in millions) Contractual Obligations Total Less than 1 year 1–3 years 3–5 years More than 5 years Purchase obligation (1) $ 108.0 $ 108.0 $ — $ — $ — Obligations for unrecognized tax benefits (2) 6.5 — — — 6.5 $ 114.5 $ 108.0 $ — $ — $ 6.5 (1) Relates mainly to our commitment on revenue equipment purchases, net of estimated sale values of tractor equipment where we have contracted values for used equipment. (2) Obligations for unrecognized tax benefits represent potential liabilities and includes interest and penalties. We are unable to reasonably determine when these amounts will be settled. See below for a detailed discussion of our unrecognized tax benefits. At December 31, 2022, we had a total of $5.7 million in gross unrecognized tax benefits included in long-term income taxes payable in the consolidated balance sheets. Of this amount, $4.5 million represents the amount of unrecognized tax benefits that, if recognized, would impact our effective tax rate as of December 31, 2022. The total net amount of accrued interest and penalties for such unrecognized tax benefits was $0.7 million at December 31, 2022, and is included in long-term income taxes payable within the consolidated balance sheet. Income tax expense is increased each period for the accrual of interest on outstanding positions and penalties when the uncertain tax position is initially recorded. Income tax expense is reduced in periods by the amount of accrued interest and penalties associated with reversed uncertain tax positions due to lapse of applicable statute of limitations, when applicable, or when a position is settled. These unrecognized tax benefits relate to risks associated with state income tax filing positions for our corporate subsidiaries. A reconciliation of the obligations for unrecognized tax benefits is as follows: December 31, 2022 (in thousands) Gross unrecognized tax benefits $ 5,744 Accrued penalties and interest associated with the unrecognized tax benefits (net of benefit of interest deduction) 722 Obligations for unrecognized tax benefits $ 6,466 A number of years may elapse before an uncertain tax position is audited and ultimately settled. It is difficult to predict the ultimate outcome or the timing of resolution for uncertain tax positions. It is reasonably possible that the amount of unrecognized tax benefits could significantly increase or decrease within the next twelve months. These changes could result from the expiration of the statute of limitations, examinations or other unforeseen circumstances. We do not have any outstanding litigation related to income tax matters. At this time, management’s best estimate of the reasonably possible change in the amount of gross unrecognized tax benefits is approximately no change to an increase of $1.0 million during the next twelve months, due to the net combination of estimated additions and expiration of certain statute of limitations. The federal statute of limitations remains open for the years 2019 and forward. Tax years 2012 and forward are subject to audit by state tax authorities depending on the tax code and administrative practice of each state. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management routinely makes judgments and estimates about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. We have identified certain accounting policies and estimates, described below, that are the most important to the portrayal of our current financial condition and results of operations. 43 The most significant accounting policies and estimates that affect the financial statements include the following: Revenue equipment estimated useful lives and salvage values Over 97% of our total miles comes from company drivers operating the Company's revenue equipment. Management estimates the useful lives of revenue equipment based on estimated period of use for the asset. It has been our historical practice to buy new tractor and trailer equipment directly from manufacturers. Tractors and trailers are depreciated using the 125% declining balance method for new tractors (excludes assets acquired in an acquisition) and straight-line method, respectively, over the estimated useful life down to an estimated salvage value. Management believes this is the best matching of depreciation expense with the decline in estimated tractor and trailer values based on the use of the tractor and trailers. Revenue equipment acquired through acquisitions is generally revalued to current market values as of the acquisition date. Assets obtained more than a year prior to the acquisition by the acquired company are depreciated on a straight-line basis aligned with the remaining period of expected use, whereas those obtained less than a year prior are depreciated consistent with newly purchased assets. As acquired equipment is replaced, our fleet returns to our base methods of declining balance depreciation for tractors and straight-line depreciation for trailers. Depreciable lives of tractors and trailers are 5 and 7 years, respectively, when purchased new. Management estimates the useful lives on tractors based on average miles per truck per year as well as manufacturer warranty periods. We have not historically run tractors outside of manufacturer warranty periods. Management estimates the useful lives of trailers based on manufacturer warranty periods as well as our internal maintenance programs. Estimates of salvage value are based upon the expected market values of equipment at the end of the expected useful life. A key component to expected market values of equipment is our historical maintenance programs which in management's opinion are critical to the resale value of equipment. Management selects depreciation methods that it believes most accurately reflects the timing of benefit received from the applicable assets. It is reasonably likely that changing revenue equipment markets could result in a change in depreciable life or salvage value estimate. Management believes that a change in estimate will not significantly affect the long-term financial condition of the Company or its ability to fund its continuing operations. A change in estimate would impact depreciation and amortization in the consolidated statements of comprehensive income and revenue equipment in the consolidated balance sheets. We have not had any material changes to our estimate methodology in the past three years. Auto Liability and Workers’ Compensation Claims Reserve The Company is self-insured for a portion of the risk related to auto liability and workers' compensation. Management estimates accruals for the self-insured portion of pending accident liability and workers’ compensation claims by evaluating the nature and severity of individual claims and by estimating future claims development based upon historical development trends, utilizing the facts and circumstances known on the applicable balance sheet date. The accruals are made up of individual case estimates, including reserve development, and estimates of incurred-but-not-reported losses based upon past experience. Auto liability and workers' compensation unpaid liabilities are determined by projecting the estimated ultimate loss related to a claim, less actual costs paid to date. Industry development as well as our historical case results are used to determine development of individual case claims. The estimates rely on the assumption that historical claim patterns are an accurate representation for future claims that have been incurred but not completely paid. The ultimate resolution of these claims may be for an amount significantly different than the amount estimated by management and case reserves are continually adjusted as new or revised information becomes available on the status of each claim. There is a high level of estimation uncertainty related to determining the severity of these types of claims, as well as the inherent subjectivity in estimating the total costs to settle or for defense against these claims. These liabilities are undiscounted and represent management's best estimate of our ultimate obligations. The actual cost to settle self-insured claims liabilities may differ from the Company's reserve estimates due to legal costs, claims and information on known claims that have been incurred but not reported as well as various other uncertainties. It is reasonably likely that the ultimate outcome of settling all outstanding claims will be more or less than the estimated claims liability at December 31, 2022. Management believes that the ultimate resolution of these claims will not significantly affect the long-term financial condition of the Company or its ability to fund its continuing operations. A change in estimate could impact salaries, wages and benefits (workers compensation) or insurance and claims (auto liability) in the consolidated statements of comprehensive income and insurance accruals in the consolidated balance sheets. We have not had any material changes to our estimate methodology in the past three years. Business Combination Estimates The purchase price of an acquired businesses is allocated to the estimated fair values of the assets acquired and liabilities assumed as of the date of the acquisition. The calculations used to determine the fair value of the long-lived assets acquired, including intangible assets, revenue equipment and properties can be complex and require significant judgment. For the valuation of long-lived assets we weigh many factors when completing these estimates. We may also engage independent valuation specialists to assist in the fair value calculations. During 2022 we engaged valuation specialists to assist us in determining the fair value of intangible assets, revenue equipment and properties acquired through our acquisitions of Smith 44 Transport and CFI. Goodwill is not amortized, but is subject to impairment testing on at least an annual basis and its valuation is directly impacted by the valuation estimates of the other acquired long-lived assets. We are also required to determine if an intangible asset has a finite or indefinite life. For intangible assets determined to have a finite life, we estimate the useful lives of the acquired intangible assets, which determines the amount of acquisition-related amortization expense we will record in future periods. While we use our best estimates and assumptions, our fair value estimates are inherently uncertain. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Any adjustments required after the one year measurement period would be recorded in the consolidated statements of income. The judgments required in determining the estimated fair values and expected useful lives assigned to each class of assets can significantly affect net income. Income taxes Significant management judgment is required to determine the provision for income taxes and to determine whether deferred income taxes will be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. A valuation allowance is required to be established for the amount of deferred income tax assets that are determined not to be realizable. We have not recorded a valuation allowance against deferred tax assets as it is management's opinion that it is more likely than not we will be able to utilize the remaining deferred tax assets based on our history of profitability and taxable income. Management judgment is required in the accounting for uncertainty in income taxes recognized in the financial statements based on recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The unrecognized tax benefits relate to risks associated with state income filing positions and not federal income tax filing positions. Measurement of uncertain income tax positions is based on statutes of limitations, penalty rates, and interest rates on a state by state and year by year basis. New Accounting Pronouncements See Note 1 of the consolidated financial statements for a full description of recent accounting pronouncements and the respective dates of adoption and effects on results of operations and financial position.