Covenant Logistics Group, Inc. Class A

Welcome to today's Covenant Logistics Group second quarter earnings release conference call. Our host for today's call is Tripp Grant. At this time, all 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.

Thank you, Jen. Good morning, everyone, and welcome to the Covenant Logistics Group second quarter 2023 conference call. As a reminder, this call will contain forward-looking statements under the Private Securities Litigation Reform Act, which were 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. A copy of the prepared comments and additional financial information is available on our website at www.covenantlogistics.com slash investors. I'm joined on the call today by David Parker and Paul Bunn. We are pleased with our results for the quarter, which showed comparative resilience in the midst of a very soft freight environment. Consolidated freight revenue was down 9% compared to a very tough prior year comparable when the freight environment peaked. The decline related primarily to operating approximately 11% fewer weighted average tractors in our truckload operations and less overflow freight handled by our managed freight segment due to lower overall demand. Adjusted operating income fell approximately $12 million or 43% compared to the prior year quarter. primarily as a result of our expedited and managed freight segments, which declined by approximately $7.5 million and $6.5 million respectively, offset by an increase of approximately $2 million in our dedicated segment. Adjusted net income decreased 44% to $14.4 million, and adjusted earnings per share decreased 34% to $1.07 per share compared to the year-ago quarter. Weighted average diluted shares decreased as a result of our share repurchase program. Key highlights for the quarter include all four of our business segments, including expedited, dedicated, managed freight and warehousing, achieved sequential improvement and profitability in the second quarter. The acquisition of Lou Thompson & Son Trucking, Inc., a dedicated contract carrier comprised of approximately 200 tractors specialized specializing in poultry and live haul transportation. We've been pleased with the operational results today and are excited about the growth opportunities that lie ahead. Within our combined truckload segments, operation and maintenance related expenses declined on a cents per total mile basis by six cents or 21% and fixed equipment costs including least revenue equipment depreciation and gains on sale remain flat compared to the prior year. The average age of our fleet at June 30th remained flat sequentially at 26 months compared to March 31st, 2023, largely due to the equipment acquired from Lou Thompson and Sun Trucking. For the remainder of 2023, based on our current equipment order, we anticipate sequential improvement to the average age of our equipment. Gain on sale of revenue equipment was $2 million in the quarter compared to $0.4 million in the prior year. Our tail leasing company investment produced $0.29 per diluted share compared to $0.33 per share versus a year ago period. Our net indebtedness at June 30th climbed to $187.2 million in the quarter primarily as a result of the acquisition, yielding a leverage ratio of approximately 1.7 times and debt-to-equity ratio of 33.1%. On an adjusted basis, return on invested capital was 13% for the current quarter versus 17.6% in the prior year. Now Paul will provide a little more color on the items affecting the individual business segments.

Thanks, Tripp. Taking a moment to dive deeper into what drove our results for the quarter, starting with our expedited segment, freight revenue declined 7% compared to the prior year, largely due to a 6% reduction in the average fleet. Rates declined by just over 10%, but were offset by almost a 10% improvement in average total miles per truck compared to a year ago. The improvement in utilization was principally attributable to newer equipment in the fleet and reduced downtime. While we are pleased with the segment's utilization improvement, we recognize that year-over-year freight revenue per total mile comparisons will continue to be challenging for the remainder of 2023. While cost headwinds from salaries and wages and fixed equipment costs compressed margins, they were somewhat offset with improvements to variable-based equipment costs for the quarter. Our dedicated segment experienced an 8% reduction in freight revenue compared to the 2022 quarter as a result of a 217 or 15% reduction in the average number of total trucks, offset by an 8% increase in revenue per truck. Despite the addition of Lou Thompson & Son Trucking Fleet, the overall fleet reduction in our dedicated segment aligns with our strategy of exiting unprofitable or underperforming business and replacing it when opportunities arise that meet our profitability and return requirements. We were pleased with both the year-over-year and sequential improvement to the adjusted margin and expect to continue to improve upon this segment's profitability over the long term. Managed Freight experienced a 21% reduction of total freight revenue and a 76% reduction in adjusted operating profit. The significant reduction in revenue and operating profit was primarily attributable to little to no overflow freight from our asset-based truckload segments. The brokerage environment remains highly competitive with numerous brokers aggressively competing for volumes at the expense of margin. We anticipate continued margin pressure in this environment. Our warehouse segment saw a 37% increase in freight revenue compared to the prior year, resulting from the startup of new customers during the previous 12 months. We're pleased with the top-line growth we've achieved in this segment, and the team has done a phenomenal job in executing these startups, which are both intense and time-consuming. However, despite the significant top-line growth in the segment, we've only seen about a 10% improvement in adjusted operating profit compared to the prior year. Although we're pleased with the sequential profitability improvement within this segment, we will continue to focus on improving profitability of the mid-single digits through improved labor utilization and rate increases with existing customers. Our minority investment in tail contributed pre-tax income of $5.4 million for the quarter compared to $7.1 million in the prior year period. The decline was largely due to reduced gains on the sale of used equipment compared to the year ago. Till's revenue in the quarter grew 11% and pre-tax net income decreased by 26% versus the second quarter of 22. Till increased its truck fleet in the quarter versus a year ago by 210 trucks to 2,283 and grew its trailer fleet by 84 to 7,031. As a reminder, Till focuses on managing lease purchase programs for clients, leasing trucks and trailers to small fleets and shippers, aiding clients in the procurement and disposition of their equipment through a robust equipment buy-sell program. Due to the business model, gains and losses on the sale of equipment are a normal part of TEL's business model and can cause earnings to fluctuate from quarter to quarter. Our investment in TEL is included in other assets in our consolidated balance sheet and has grown to $66 million as of June 30, 2023, from our original investment of $4.9 million in 2011. In 2022, we received $14.7 million in cash dividends from tail, and we are anticipating approximately $19.8 million to be received during the second half of 2023. As we enter the third quarter, we are optimistic that the trough of the freight cycle is behind us, but are cautious about the rate at which we will see improvements. Regardless of how the freight economy responds, our primary focus remains on the long-term. by continuing to invest in areas that provide opportunities for us to make forward progress on our strategic plan, the acquisition of Lou Thompson and Son, and our investments in new revenue-generating equipment, people, technology are examples of this. Thank you for your time. We will now open up the call for questions.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad now. You'll be placed into the queue in the order received. please be prepared to ask your question when prompted. Once again, if you have a question, please press star 1 on your phone now. And our first question today will come from Jason Seidel with TD Cohen.

Thank you, operator. Gentlemen, good morning. I wanted to cue in on that last comment that you talked about in terms of the broader trucking industry. I'm with you guys that we're sort of off the bottom here, but how should we think about pricing on a sequential basis? Because I'm still getting some feedback from some private truckers, from some just really low-ball pricing out there, like P8 in North Carolina at less than a buck a mile being offered. So how should we think about that, at least in the near term?

You know, Jason, here's what I would say is we're still seeing that too. But as a reminder... most of our stuff's tied up under contract rates. So when we talked about continuing to see margin pressure in the brokerage, that's really where we've got exposure to that. On the dedicated and expedited side, I don't think we're going to see any pricing pressure in the near term. I think we'll see what contract rates do next year. I think that's probably what will have the larger effect on us. And I think it's probably too early to tell exactly what those are going to do next year. But yeah, a lot of the stuff that's out there in the spot market, I mean, it will negatively affect the brokerage a little bit, but it shouldn't affect expedited and dedicated for the balance of the year.

No, that makes a lot of sense. Also, you called out a little bit of gains on sale. How should we look at gain on sale going forward, and what does the equipment market look like?

Let me talk about the market and I'll let Tripp talk about gains on sale. Used equipment market has just continued to precipitously drop. It dropped a little bit from January to March, but since March it's been kind of in a free fall. Seems like July maybe has kind of hit a little bit of a floor in the used equipment market, but March to July was a pretty big drop.

Yeah, I agree and I'd Quite honestly, and this is just me speaking, I don't see the used equipment market getting any better in the next six to eight months, especially when you look at the rate it has dropped over the last few months. We've talked about this in previous calls, but this is a very heavy CapEx year for us where really over the last year and a half I would say we've been really investing in upgrading the fleet and we're going to continue to do that because we think it's for the best you know it it provides an optimized way of operating the fleet for us both I would say on kind of the the ongoing you know variable cost and I think that there's some fixed cost benefits with uptime but here's what I would say I you know, going forward, yes, we do have more newer equipment. We're not, you're not going to see a lot of, you know, fleet count growth in the back half of the year, which means that we're going to be selling a lot of equipment too. So it's just a matter of, you know, how much it continues to drop. I don't think you're going to see huge gains on sale in Q3 and Q4 may see a little bit, but I don't think anything, you know, I don't also don't think you're going to see significant losses either. So it's, It's marginal, I would say, but we watch our depreciation on our equipment, make sure that we're depreciating it adequately, and I think we'll be okay there.

Okay. That's a great color. Last one, and I'll turn it over to somebody else here. Lou Thompson, you got about two-thirds of a quarter. Looks like a good acquisition for you guys, getting you in a niche end market that you really weren't in. When I was hosting some calls with industry people before earlier this quarter, a lot of them were talking about how there's a lot fewer financial buyers in the marketplace for smaller niche acquisitions. Do you foresee other opportunities for yourself down the road because multiples have come in a little bit?

Jason, here's what I would say. A, I agree there's less financial buyers in the market. B, we're always looking for those really niche value add, you know, contractual type businesses. And so, you know, we got to digest, remember we did AAT in February of 22, and then we, you know, we just did Thompson in April. So, you know, we got to digest, but any of that niche, good margin, contractual type businesses out there, yes, we continue to field calls and and are going to keep looking at stuff like that as it comes about.

Yeah, and I just want to, just adding to that a little bit, is making sure that our balance sheet could absolutely support an additional acquisition, and it's something we may look at in the future, but our main focus, whether it's AAT or Lou Thompson, most recently Lou Thompson, is really focusing on learning that business and starting off, getting out of the gate on the right foot, which we have the first two months of, you know, since we acquired them. But there's a lot of executional risk at play with, you know, anytime you do something a bit different, I would say, or niche-y, kind of as Paul had mentioned. But, you know, we're really focused on execution and want to make sure we do those the right way. And, you know, and I think we'll reap benefits from those that we've already done in the future if we can kind of continue to refine that and make sure we're executing at a high level.

Well, thank you, gentlemen. I appreciate the time as always.

Thanks, Jason. Thanks, Jason.

And our next question will come from Scott Group with Wolf Research.

Hey, thanks. Good morning, guys. Hey, Scott. Can you just talk us through how you're thinking about back half of the year from an earnings standpoint? Do you think we see further sequential earnings growth from Q2 into the back half of the year? What are the puts and takes?

Yeah, I mean, I don't want to get into giving any sort of, like, defined guidance, but we feel like we've got, and you've probably read it in the release, I mean, we're optimistic about the back half of the year. We said that there's, we feel like we're at the trough of the freight recession, and, you know, part of that may be, you know, due to our model. You know, we've got a lot of LTL, you know, customers expedited. We've got, if you look at 2Q, we've got just two months of Lou Thompson. We've talked earlier about, you know, the optimism about how well Lou Thompson is, you know, running out of the gate as well as, you know, some potential growth opportunities that may come to fruition later in the year and early next year. So I think I'm optimistic about being able to, you know – increased earnings sequentially in Q3. I think there's a big question mark. Q4, there's some downtime with the holidays, and there's a big question mark about peak. Not that peak is a big part of our business, but last year it was virtually nothing, and I'm just not sure how much that's going to contribute this year in 2023. But yeah, I think we're bullish on the next half of the year for us.

Scott, let me add one thing to that. I agree with everything Tripp said. I think the one thing to watch is with our reduced share count, a few things going in the right direction could really be accretive in the back half of the year. One bad accident could pull it the other direction. I think that's one of the things everybody's got to remember with this reduced share count is The earnings have a lot of leverage up, but, you know, you also have a bad accident or something. There's a lot of leverage on the downside. So, you know, on the balance, I agree with what Tripp said. I think we're optimistic about the back half of the year and, you know, think we can continue to improve earnings quarter over quarter.

Okay, helpful. And then, so you just mentioned you got a lot of LTL customers. What are you seeing now? in the market right now in the last week or so as, as shippers are scrambling to leave yellow, um, how is this a benefit?

Yeah. Yeah. Um, we're, we're, we're filled in a number of calls on the, in the expedited division. Um, as, as you know, we do business with practically every major LTL and freight forwarder in that division. And, um, And so we continue to field a lot of calls as people need some incremental capacity. And, you know, it's probably, you know, maybe 5% growth on expedited revenue during the quarter. I mean, it's definitely going to be a positive on expedited in the third quarter. There was really none of that in the second quarter, so it should be a positive for expedited in the third quarter and likely into the fourth. Yep.

And then just lastly, you mentioned the increased sort of leverage earnings because of the buyback. What is the plan with the buyback going forward? Are you going to continue to be aggressive with it? Do you pause it? How do you think about that?

I mean, I can't really give specifics. All I can say, I guess, with that is we do have an open buyback plan right now that has some parameters around it that the banks will repurchase based on those parameters. But here's what I would say. I really like how we've deployed capital over the last couple of years, and buybacks have been a big portion of that. So I think that they're always going to be on the playbook, you know, not saying that we're going to buy back X amount of shares in Q3 or Q4, but I think as circumstances warrant, I think that they're always going to be the go-to, a go-to, potential go-to in our playbook to activate as part of our capital deployment plan. We like them. We've seen benefits from them. The question is, as circumstances change, how do you reprioritize those types of things and decisions? I think they're always going to be there, and I think that you guys will probably see us think about it or talk about it and move forward with another one in the future when circumstances warrant

Makes sense. Thank you, guys.

Thanks. Thanks, Scott.

And our next question will come from Jack Atkins with Stevens.

Okay, great. Good morning, and thanks for taking my questions, guys. Congrats on a great quarter. So I guess just kind of going back to the LTL and sort of the expedited comments there for a moment. How are you guys thinking about approaching, you know, deploying additional capacity into that market? I mean, is it, you know, you have some longer-term partnerships there. Is it really a function of looking to, you know, secure longer-term commitments for additional trucks that you'd be willing to deploy into that, you know, that LTL line haul part of the market?

Yeah, Jack, you hit it. I mean, you know, we're... I would say there's a few trucks here, a few trucks there to a lot of folks, but for us to add a significant volume of trucks, it's going to be with the folks that we have longer-term partnerships with. As we move those trucks around, they're going to be more heavily weighted towards folks that are willing to sign up for those on a longer-term basis and that we were partners with through the the 21-22 cycle, and they've been partners with us through this 23 cycle, and so that's how we're going to allocate our resources on trying to grow these teams for them.

But as you think about this from an investor perspective, I guess the point I'm trying to make there, or the question I'm asking is, as you bring on new business there, this isn't just a short-term thing. sort of, you know, stopgap for some of these guys. This is potentially a longer-term sort of step up in business activity with this particular part of your customer base.

Yeah, I think, you know, we'll keep a high percentage of whatever we add with these customers on a longer-term basis. Because it's your point, they're digesting this growth and their model's changing, and so, yeah, we're strategically... trying to make sure where we grow the most is for people that it's going to be sticky.

Yeah. No, absolutely.

Jack, keep in mind, about 55%, 60% of that expedited revenue is on guaranteed contracts.

Right. Absolutely.

Yeah. As Paul was saying, when we add these trucks, what we do is going on to those customers that have been partners to us, and we're partners. A part of that partnership that we got are long-term partners.

agreements between us oh absolutely and that's paid paid dividends over the last you know last couple years for sure so i guess you know david um you know good to good to hear your voice i guess maybe would love to get your perspective you know as well in terms of just just how you're thinking about the cycle i know you you bring a lot of a lot of perspective to this you know i guess could you maybe kind of help us think about you know where where we are you know in terms of you know, coming off the bottom here. And as you sort of think about capacity and, you know, all the puts and takes, are you more or less optimistic about sort of where we're headed from a cycle perspective over the next six months?

Yeah. You know, I was on a panel last week at a conference with Tom Albrecht on insurance, but had a big carrier conference, carrier panel. And Because I think there's two things happening. We went around the room. The last question on the panel for that day was, when do you think, because the whole group was a bunch of smaller carriers, and it's when do you think that things are going to get better? And when's that day going to come? And the times, Jack, were anywhere from I heard spring, I heard 12 months from now, I heard spring, I heard December. And I was the last one to answer a question on there. Cause this is the way I do believe. And I believe that we're going to fill it in September. I believe in the next couple of months, the trucking industry truckload guys are going to feel capacity constraints. I'm not saying it's going to be 2022 over again, but it's going to feel better than the last 12 months that we've gone through. And it's all because of, because I'm not sure about the economy, uh, But capacity is left, is leaving our industry, evident by the fact of what Paul said that's happened on the used truck prices just in the last 50 days. It hurts. It hurts right now. It hurts this month. But overall, it's good because as capacity leaves, the pricing power will return and the pricing will make up for whatever shortfall we're disappointed in that we didn't sell a used truck for. And, uh, And that's all happened in the last 60 days. So I really believe trucking will start sensing it in the next couple of months, a tiny capacity, as long as the economy at least kind of stays and hangs where it's at today. Those are my thoughts.

Okay. All right. No, I appreciate that. Maybe last question, long-term strategically. I mean, as you guys think about the way you'd like to have your mix of assets deployed today, you know, within the truckload market, you know, you've been investing more, you know, outside of, you know, the kind of traditional long haul over the road, you know, highly cyclical parts of the truckload market into things like AAT, Lou Thompson and Son, you know, longer term commitments within your, you know, within your expedited team business for LTL. How do you think about the long term mix of assets between traditional OTR truckload and more niche parts of the market that really remove the cyclicality and where you can really see compounding growth?

I would say this. I would say that we've been on this journey now really in 2015 when we brought on Delta Airlines. I actually went to the board and said, we're going to change our company around. We're not going to be this feast or famine and and hope things get better tomorrow. We are going down another road. And so we started that in 2015. It really came into fruition in 2018 with the acquisition of Landair. It really came into fruition in 2020 when we shut down SRT and the over the road solo side of the covenant business. And we got out of the solo business and we were really in the markets of, you know, expedited, dedicated warehousing and managed freight. And managed freight is brokerage and TMS. And we are really looking at those four avenues. And as I look at the whole, and it's this, is that two things got to happen. We got to bring value to the customer. But that customer's got to bring value to us. That's got to be a two-way street that we're both bringing value because at the end of the day, if we're not bringing value, if our customer is not bringing value, the relationship will eventually end. Something will happen. And we were just so tired over all these years, 35 years or 33 years or whatever it's been, uh, okay, the market's up. Let's go increase rates 5%. The market's down. Let's give it all back. And our model today is not doing that. And, uh, And it's because we're bringing value. Our expedited side of our business is teams. Everybody doesn't have teams. We're one of the largest team providers out there. If you truly need teams, then pay me for what it costs me to operate these teams. And we'll be there during the great times of 2022. The expedited side. It's not that they came in and slaughtered us on rate. They came in this last year and said, instead of 20 trucks, I need seven teams. And we work with our customers on that. And we've got to make sure that you've got a pipeline to be able to take care of the ones that give you back. And then the broker side is really filling the OTR side of our business. And as you know, brokerage is up and down and barges are up and down. But as long as we can, it's a high ROI on that business. And so I'm very pleased with that. And then Paul talked about the warehousing. But those are the four areas areas that we're concentrating in and those are the areas that we're going to continue to build either through internal growth or through acquisitions as you call it niches and those kind of things because that's what we love we love something that's hard and something that everybody doesn't do and it brings value to the customer so that's our model thank you david it looks like it's clearly working i'll hand it over

As a reminder, if you'd like to ask a question, please signal by pressing star 1 on your touchtone phone. And our next question comes from Barry Hames with Sage Asset Management.

Hi, guys. Thanks very much. Good quarter. I have two questions. One is, David, I wanted to circle back on your comment about capacity leaving the industry. When you look at your brokerage segment, you might be able to get a read on that in terms of all the carriers that you work with. Is there anything either numerical or anecdotal you could talk about to flesh that out a little bit more? I have one other question, but go ahead. Thanks.

I was just going to say on the brokerage side, yes, you can. I would say the main thing that's happened on the broker side is that the small carriers have reached a point that they're not going no lower. And that's what we have seen is that we can't get the capacity for any lower rates than what's out there. So it's showing you that capacity is starting to tighten a little bit because the rates are not falling like they were.

Got it. Okay. Thank you. And then the, The other question is, on the asset-based businesses that, as you pointed out, are more contract, are most of those role in the spring? And any feel for where contract rates are in the market now versus where they might have been six months or a year ago? Thanks.

Yeah, most of our... Most of our stuff is in the spring. I would say January to April is when most of the asset-based contracts reset. Pricing is probably down mid-single digits if you combine dedicated and expedited. I would say our pricing is probably down mid-single digits if you weight those. I would say people that have more of a uh, OTR, you know, you caused able to say, you call, we haul top exposure. Uh, those are probably down a lot more than mid single digits. Um, David, any more color you want to add on that?

No, I, I agree. It is a spring event next year. We had right start. We start looking at rates again. And I agree with Paul. Great.

And just one, one last quick follow up on that. Um, So looking at the cost side for next year, you know, as we start thinking about next year, are there any big puts or takes we should think about as we're thinking about cost structure in 24 versus 23? Thanks.

So on the cost side, I mean, we've been pleased with what we've seen and, you you know, with a lot of the cost, you know, we've been really laser focused, I would say, as an enterprise starting in the fourth quarter of last year, kind of seeing, I think it's safe to say we kind of first felt it pretty significantly in November of 2022. And as a response to that, you know, we've been laser focused on cost and the enterprise as a whole has done a great job and just you know, really focused on cost savings throughout the enterprise, whether in a business unit or a back office. And, you know, that being said, that, you know, that can only go so far. But I think a big part of the success story of, you know, where we have seen success, I would say, is on the investment in our new tractors. And we've done a lot there. It was painful last year. We had to pull some trucks early and created some fleet disruptions and created some drag on the P&L and impairment charge. If you go back and read the Q4 release, it was a little bit muddy, but we are seeing improved fuel economy. We're seeing improved maintenance costs. We're seeing improved retention because we're in, you know, it's a different market, but, you know, we'd like to think of it that they're in newer equipment and better equipment and the more efficient. And so our utilization has improved as well. So, I do think that we'll continue to see cost improvements as we continue to upgrade and reduce the average age of our fleet. Fuel is kind of a wild card. It goes up one month and goes down another month. I think directionally it's going to be going down. Quite honestly, I don't see a lot of reduction in wages. It's a little bit of a mixed bag. I feel good about our cost journey to date, but You know, 2024, will we have that type of leverage? We squeezed a turn up pretty hard this year. And, you know, how can do we have the leverage to kind of offset some of those costs? But, you know, it's kind of a hard question to answer because I think there's some ups and downs in there. But but we feel good about the things that we can control and we're real happy with what we've done today.

Great. Thanks very much. Good luck.

Thank you.

Once again, if you'd like to ask a question, please press star 1 on your phone. And we'll pause for just a moment to allow everyone an opportunity to signal. And it appears there are no further questions at this time. Mr. Grant, I'll turn the call back to you for any additional closing remarks.

Yeah, Jen, thanks so much. Just wanted to thank everyone for your time and participation today. We're excited about the quarter, pleased with our results, and are optimistic about the future. And we look forward to speaking with everyone next quarter. Thanks very much, and have a good afternoon.

This concludes today's conference call. Thank you for attending.