Covenant Logistics Group, Inc.

Welcome to today's Covenant Logistics Group Q1 2025 Earnings Release and Investor Conference Call. Our host for today's call is Chris Grant. At this time, our participants will be in a listen-only mode. Later, we will conduct a question-and-answer session. I would now like to turn the call over to your host, Mr. Grant. You may begin. Good morning, everyone. Welcome to the Covenant Logistics Group first quarter 2025 conference call.

As a reminder, this call will contain forward-looking statements under the Private Securities Litigation Reform Act, which are subject to risks and uncertainties that could cause actual results to differ materially. Please review our SEC filings and most recent risk factors.

We undertake no obligation to publicly update or revise any forward-looking statements.

Our prepared comments and additional financial information are available on our website at www.covenantlogistics.com slash investors. Joining me on the call today are CEO David Parker, President Paul Bunn, and COO Justin Kale. Before diving into the details, I'd like to give an overview of changes in our business mix that impact our revenue and expense comparisons year over year. We continue to increase assets and people invested in our dedicated protein business and reduce assets and people allocated to lower return business. In general, specialized dedicated customers have higher revenue per mile, higher cost per mile, and fewer miles per tractor per year than our other asset-based customers. As this specialized business grows, revenue per mile, driver and other employee cost per mile, and fixed costs per mile all increase. The year-over-year changes are more indicative of business necks than apples-to-apples rate and cost increases. Even with the change in business necks, miles remain an important part to our business. In the combination of weather and avian influenza took its toll on miles, we had lower fixed cost coverage, higher layover costs, and worse equipment damage than a normal first quarter. Lower miles enhanced the impact of business mix on our statistics. While our margins did not meet our standards, we navigated a difficult general freight market, absorbed inefficiencies from startups, overhead from lower-based business and dedicated, and weather better than most first quarters in our history and many companies in our industry. Overall, Our strategy is on track and Covenant is well positioned to grow revenue and earnings over time, recognizing that a variety of external factors are creating both uncertainty and opportunity in our business. Year-over-year highlights for the quarter include Consolidated freight revenue declined by 1.8% or approximately $4.5 million to $243.2 million. primarily as a result of our managed freight segment, which generated $6 million less freight revenue but exceeded our profit expectations by improving adjusted operating income by $0.8 million. Consolidated adjusted operating income shrank by 26.6% to $10.9 million, primarily as a result of adverse operating conditions in the quarter that reduced utilization of our revenue-producing equipment. salaries, wages, and related expenses increased with business mix, as well as poor workers' compensation experience. Combined cost of depreciation, interest, rent, and gain loss on sale increased due to lower fixed cost absorption from lower miles per unit. Our net embeddedness as of March 31st increased by 5.8 million dollars to 225.4 million dollars. yielding an adjusted leverage ratio of approximately 1.55 times and debt-to-capital ratio of 33.7%. The average age of our tractors at December 31st slightly decreased to 20 months compared to 21 months a year ago. On an adjusted basis, return on average invested capital was 7.6% versus 8.3% in the prior year. Now, providing a little more color on the performance of the individual business segments. Our expedited segment yielded a 94.2 adjusted operating ratio. While this result falls short of our expectations, we were pleased with the improvement we witnessed late in the period as operating conditions improved. Compared to the prior year, expedited's average fleet size shrunk by 48 units, or 5.3% to 852 average tractors in the period. and down modestly based on various market factors. Going forward, our focus will be on improving margins through rate increases, exiting less profitable business, and adding more profitable business. Dedicated experienced average fleet growth in the first quarter of 212 units, or approximately 16.7%, and grew freight revenue by $9.5 million, or 13.1% compared with the 2024 quarter. as a result of the impact of inclement weather and reduced volumes associated with avian influenza. The result was an operating ratio of 90.1, far short of our expectations for this segment. Going forward, we remain focused on our strategy of growing our dedicated fleet, specifically in areas that provide value-added services for customers. We believe that if we are successful in providing best-in-class service and controlling our costs, growth and improved profitability will result. Managed freight exceeded profitability expectations for the quarter by focused execution on profitable freight, assisting our expedited fleet with overflow capacity and reducing insurance-related claims, expenses as a result of improvements to our cargo control procedures. Going forward, we seek to grow managed freight with profitable revenue from new customers, work closely with our asset-based segments to capitalize on overflow opportunities when available, and optimize costs to yield longer-term margin goals in the mid-single digits, which will generate an acceptable return on capital given the asset-like nature of this business. Our warehouse segment saw a 6% decrease in freight revenue and a 42% decrease of adjusted operating profit compared to the prior year. The significant reduction in adjusted operating profit is largely due to facility-related cost increases, for which we have not yet been able to negotiate rate increases with our customers, and startup-related costs and inefficiencies related to the new business. For the remainder of the year, we anticipate improvement in revenue and adjusted margin for this segment. Our minority investment in TEL contributed prepax net income of $3.8 million for the quarter compared to $3.7 million in a prior year period. TEL's revenue in the quarter increased by 25% compared to the prior year by increasing its truck fleet by 431 trucks to 2,513. and increasing its trailer fleet by 1,000 to 7,824. Regarding our outlook for the future, although our first quarter's operational results fell short of our expectations, we were pleased with the improvement we witnessed late in the period. Momentum we have taken into the second quarter. Although April is shaping up to be a good operational month with better weather conditions and better poultry volumes, we recognize volumes can quickly shift negatively as port volumes are reduced with fewer imports. Although we were expecting 2025 to be a year of recovery for the freight economy, we recognize that economic uncertainties may create a delay to an improved freight environment. Regardless of what the remainder of 2025 has in store for us, we remain positive about our team and strategy, which is focused on disciplined capital allocations, executing with a high sense of urgency, improving operational leverage as conditions improve, growing our dedicated fleet, and improving our cost profile.

Thank you for your time, and we will now open the call for any questions. If you would like to ask a question, please press star 1 on your telephone keypad now. You will be placed into the queue when you order a seat. Please be prepared to answer your question when prompted. Once again, if you would like to ask a question, please press star 1 on your phone now. And our first question comes from Jason Seidel from TD College. Please go ahead, Jason.

Hey, thanks, Robert. Good morning, gentlemen. We're going to talk a little bit about the dedicated side. You know, obviously, you know, you have some issues with the bird flu epidemic here, but... I wanted to talk about the competitive nature of sort of the non-poultry business that you're seeing out there. You know, what we should expect going forward and how do you think that's going to play with margins as we move throughout 25 and maybe even into 26 given the longer term nature of those contracts?

Yeah. Hey, Jason. Paul, how you doing? Good, Paul. Here's what I would say splitting out the non-poultry. It's really competitive out there. I would say I'll break dedicated into two worlds, specialized and non-specialized. Because some of what we have is specialized that is not poultry. In that business where we've got a specialized truck, a specialized trailer, or a specialized driver, I would say it's still, there's not as much pressure there. The business that is more 53-foot dry land dedicated, it's tough right now. And there's a lot of competition. And so I think the longer this one-way market has stayed down, the more competition and more folks are moving freight to the one-way market and more one-way people are running the dedicated. And so it has hurt. That said, I think, you know, like you've seen in cycles past, whenever the one-way market goes the other way and The premium for dedicated is not as high as it is today. You'll probably see that loosen up from a customer perspective a little bit. But it's definitely a pretty competitive environment out there. As it relates to margins in total, I think we'll see dedicated margins improve for a couple things. I think the weather, just like expedited, the weather... significantly affected dedicated in the first quarter. So just with better weather and whatnot, it'll help dedicated. And then as we continue to last, the bird flu, you know, the worst of the bird flu was probably over in January, early February, but little chickens don't eat as much as big chickens. And it takes a little while to kind of get the train back on track and, you know, get the pump primed again. And so the combination of those foods margins in dedicated and total should improve. But in the non-commoditized space, in the commoditized type dedicated stuff, it's a tough market right now.

And how should we view your presence in this space? Are you going to look to continue to move away from the commoditized market and trying to get more into specialty?

Yeah, I would say every time we can find a specialty deal, That's what we're looking for. And I think most of our, you know, we've purged through most of the commoditized stuff that's true commodity. I think a lot of that stuff has left and gone to the one-way market or kind of reset over the last, you know, 12 to 18 months.

Yeah, I would say, Jason, that's been our strategy probably for the last couple of years. And Lee Thompson, the acquisition of Lee Thompson was probably – the biggest indicator of, you know, that being our strategy and our biggest investment in that. But, one, I would say it's difficult to move the needle right now. And, two, I think that over time you will see us continue to move our percentage of more specialized dedicated to a larger percentage of our fleet. Because there's no doubt about it, we're going to have to constantly, you know, redefine what we consider as specialized or what we consider as defensible or niche-y because it is becoming increasingly competitive. And I think it's going to even become more so after this cycle ends.

Interesting. You know, given all the macro uncertainty that's out there, you know, what's that doing to the deal market? Because I know you guys are constantly in the market to do probably on the smaller type deals. But talk to me a little bit about how that's been impacted as well.

You know, I guess what I'd say, there are a lot of what I call little bitty deals out there right now. I mean, and I think that's a signal of capacity exits and folks that are struggling for capital. You know, I would say we continue to kind of sort through the intermediate size deals as they come through. But I would say... The volume of those is about the same as it's been the last couple years. I mean, you know, there's one or two things a quarter that are interesting and that we evaluate.

I think there's one or two a quarter that's interesting that we evaluate, and then there's 15 a quarter, nope, nope, nope, nope. You can just see people wanting out.

And a lot of those are on the smaller scale or the OTR market. Yep, I agree.

Gentlemen, appreciate the time as always. Thank you, guys. And our next question comes from Daniel Imbrow from Steve and Dink. Please go ahead, Daniel.

Good morning, guys. Thanks for taking the questions.

Hey, Daniel.

We want to start on the day to get on the expedited business a little bit. It's obviously a LTL line haul within that. I'm curious any commentary from your standpoint on how that end market is shaping up. We're seeing any signs of improvements. kind of with your LTL customers there, and how has the AAP or the government business trending as we move here through the first part of the year?

I would say this, David. I would say on the LTL side, it's really a smorgasbord. I mean, I see some of our LTLs that are doing better than others, and I see that our national LTLs are probably being hurt more so than the regional LTL guys. But we had a discussion on that just in the last few days. You know, I see a lot of the industrial side that the LTL guys are involved in that is hurting some of those guys. And what I mean by that is down 2% to 3% kind of numbers. But, yeah, I'm seeing some stress on the LTL side on probably half of our business. Okay. So that is something that we're just having to work through and see what happens. As well, when I say LT, I'm also included in their freight forwarders and air freight industry that we haul for and all that segment of substitute service.

And how about AAC, David?

Yeah, AAC, Daniel, they've had a good first quarter and are looking good going into the second quarter. So that business is continuing to perform nicely We've done some things strategically to continue to expand equipment types that we offer in that space, and so we get more at-bats. And that's been a really good strategic move, and we're going to continue to do that, have some more things in the hopper so we can continue to get more. The more at-bats, the more times you're going to hit, and continue to be really happy with that business and its performance.

That's helpful. And then maybe, Tripp, David just talked about how many deals are out there in the M&A market, but how is your appetite for M&A in this environment given the uncertainties? I think you did introduce a new $15 million repurchase program, so should we take that as an indication that you view the buyback as a higher risk-adjusted return than M&A, or how should we think about your appetite for deploying capital?

I think it's the same. Our playbook has basically remained unchanged. We think we've got a good deal now with the share repurchases. We continue to look at M&A deals as they come up, but I think the key that we always talk about is being disciplined on what we need and what fits our strategy, what fits our culture, what fits our segments, and what we can execute on well. We're going to continue to look at M&A deals, and I think you'll see us deploy capital in that manner. But if the right one doesn't come along, we may not do one. So that's the biggest trap I think we could fall into is trying to do one just to do one and not being right for the long term.

Daniel, I'll add to what Chris said. Having the share repurchase is not going to preclude us from doing the right deal if the right deal comes across. That said, we're not. We're not in love. We're just doing a deal just to do a deal. So I would say we're going to keep looking and keep doing the share repurchase. And over time, I think it will work out.

And I would just input, and we noted this in the release, that our capex this year is going to be much less than what it was last year. And I think we'll probably have more EBITDA this year just with the growth, year-over-year growth, and some of the truckload business, the poultry business. And so I anticipate... You know, we don't have a stated goal on leverage, but I'm not concerned about getting over two times. I think, you know, somewhere between one and two times is where we want to operate EBITDA leverage. And with the reduced capex this year, it kind of affords us the opportunity to do these things without getting too extended in a situation like this.

Maybe let's clarify there on the CapEx outlook. What part of the CapEx budget are you reducing? Is it just fewer new trucks?

No, it's not.

What I would say is last year from a CapEx perspective, we had a ton of growth in poultry. A very CapEx intensive business and essentially doubled the size of that business. So we had a lot of growth CapEx in our 2024 number and 2025 is While there is some growth, and we do anticipate some growth in our asset-based businesses, it won't be nearly as much as we saw last year. And so I'm thinking that this year is a more normalized, like a maintenance CapEx year. So just think about it in the $75 million to $80 million total, of which we did almost 20 of net CapEx in the first quarter. So we're on pace, and, you know, if... I think we'll generate a good sufficient, a lot more free cash this year than we did last year.

Great. Appreciate it.

And, Dan, one other thing about LTL. One of the statements that our LTL guys were making in the last week is that they just haven't seen the seasonal trend that's normal. They haven't seen it pick up.

So that's another side note. And our next question comes from Jeff Kaufman from Vertical Research Partners. Please go ahead, Jeff. Thank you very much. Hi, everybody. Hi, Jim.

I was just kind of curious. Could you dive a little deeper into this protein business and how avian flu impacted? I know it happens every year, but you've only had this for about, what, two years, so it's still kind of new to us. This happens, I guess, fleets get slaughtered, and then they get repopulated, and then we eventually grow back. Where are we in that process, and when should we see this? I know you mentioned little chickens eat less than big chickens, but when should we see this start to normalize?

Here's what I'd tell you, Jeff. Let's go back to the beginning. You're right. There's some amount of bird flu every year. I would say just in talking to some industry folks, this year is probably as bad as any year it has been. You know, I'd say in the top two in the last 15 years. The timing of it is generally the same kind of flu season that, you know, us as humans have, kind of early to mid-fall to mid-winters to kind of an October to February kind of thing. And it has to do with the migratory birds. That's what carries the bird flu. And actually, that's how the poultry fleets or flocks get it. It's from migratory birds that are migrating from up in Canada to either the southern U.S. or Central America. And so they get it. They're not migratory patterns. And so you said it. Exactly right. I mean, when these flocks get infested with this, the regulations, the Department of Ag regulations in those states, they go in and they'll terminate those flocks. So what that does, it kind of hurts you on two sides. It hurts you from on the lob hall side where there's no birds to take to the processing plant. And then the other part is, as you quoted me, They repopulate it with the little birds, and the little birds eat less than the big birds, so your feed volumes are down. And so it just takes some time to get the pump kind of primed back up when all that happens. And I would say we felt it, you know, in the fourth quarter. I'd say we felt it January, February, March. We're feeling it a little bit in April. I would say by June, we should be back at 100%. We're probably at 85% today. We'll be at 90-something percent in May and back at 100% in June. As far as capacity, and so there should be some, again, improvements in the results once we get that back on plane.

When you came into this business, you ever thought you'd be talking about migratory bird patterns? No.

All right.

So I think I kind of understand what's happening in dedicated and expedited. Can you give me – oh, you did with the tuck-in acquisition. You did in dedicated. Could you talk a little bit about that, and then could you – Also, give me an idea of what's hitting revenue in warehouse and managed transportation and how we should think of that moving forward.

Yeah, let me, a little touch in acquisition. It was, you know, a caller earlier asked about M&A, and so we had the opportunity to do a tuck in on kind of a specialty dedicated for you. And, you know, when we talk about specialty trucks, specialty drivers, specialty trailers. That business met one of those criteria. It's a business that David and I had a little bit of history with the owner. It was a good business, and it was on the smaller side, but the owner was in a place he wanted to exit, and it was a business we thought we could fold in and then actually grow. And so, I mean, it's a, you know, 60, 70 truck kind of deal and we think long term we can turn it into 125, 130 truck kind of deal at solid revenue per truck per week, solid margins and it's in a pretty defensible space that not everybody's in because of some of the specialty nature. So again, just another example of how some deals are big, some deals are little. It was a little deal. We've seen basically none of the earnings from it. We'll start seeing a little bit of that in the second quarter. As it relates to warehousing and managed freight, the warehousing business, I would say, revenue is relatively consistent. The margins were down a little bit in Q1, but I think, you know, some of that was, I mean, again, the weather affected them with storms and ice and warehouses shut down. You can't bill for the services if none of the employees can show up and so forth. I think you'll see warehouse do a little better in Q2 and continue to get better throughout the year. We had a startup, a good startup in Q1 on the warehousing side that we hadn't seen the full benefit of and have got another pretty large startup coming later in the year. And so, you know, a small startup in Q2. So, again, I would say that business is kind of steady as she goes. The pipeline looks good. The team looks good. The margins look good. The return on investment capital is great. And so we'll just keep going down the path on that business. Managed freight, I would say we're doing some things differently. You know, we hired about a year ago, you guys know we hired Dustin Hales, our new chief operating officer. And so he's brought some new wrinkles to the game plan. And I think we're starting to see better overflow freight between some of our asset businesses and our non-asset businesses. And then we've had some customer growth in managed freight as well. And I think you'll see revenue in that business up in Q2 and Q3 and margins compared to what you saw last year. So really happy with managed freight and warehousing. Not only where they're at, but where they're going.

All right. Thank you very much. And as a reminder, if you would like to ask a question... Please press star 1 on your phone now. Gentlemen, at this time, there appears to be no further questions. All right, everyone.

Thank you for joining our first quarter earnings call. I appreciate everybody attending, and we look forward to speaking with you next quarter. Thank you.