Covenant Logistics Group, Inc. Class A

Welcome to today's Covenant Logistics Group third 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.

Tripp you may begin. Thanks Ross. Good morning everyone and welcome to the Covenant Logistics Group third quarter 2023 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. A copy of the proposed 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 Porker and Paul Bunn. We are pleased with our third quarter's results, which benefited from the full quarter effect of the Lou Thompson & Son trucking acquisition in the second quarter reflected in our dedicated segments. In addition, our expedited segment benefited incrementally from the increase in demand for team driver freight as a result of the closure of Yellow. However, more broadly, the overall freight environment remained challenging with few signs of immediate macroeconomic improvement. Compared to a year ago, consolidated freight revenue was down 5%. The decline is primarily attributable to the combination of little to no overflow freight handled by our managed freight segment and a lower tractor count in our dedicated segment. The reduction of tractors assigned to dedicated resulted from exiting underperforming legacy contracts partially offset by acquiring Lou Thompson and Son. The result was higher earnings on fewer trucks. Adjusted operating income declined approximately 4.6 million or 20% compared to the prior year quarter. primarily as a result of our managed freight segment, which declined by approximately $4.7 million. Adjusted net income decreased 32% to $15.3 million, and adjusted earnings per share decreased 26% to $1.13 per share compared to the year-ago quarter. Weighted average diluted shares decreased as a result of our share repurchase program. Key highlights include freight revenue for the quarter was the highest for any quarter of the year, surpassing second quarter by 4%. The Lou Thompson and Sun Trucking operation continued to perform well with our first new poultry-related customer startup in late September and a strong pipeline of additional bids. The average age of our fleet at September 30th improved to 23 months compared to 29 months in the prior year and 26 months at June 30th, 2023. Within our combined truckload segments, compared to the prior year, operations and maintenance-related expenses declined by 6 cents, or 21%, and fixed equipment costs, including leased revenue equipment, expenses, depreciation, and gains on sale remained flat on a total cents per mile basis. Gain on sale of revenue equipment was 0.6 million in the quarter compared to 0.2 million in the prior year. Our tail leasing company investment produced $0.28 per diluted share compared to $0.38 per diluted share versus a year ago period. Our net indebtedness as of September 30th was $183.4 million, yielding a leverage ratio of approximately 1.7 times and debt-to-equity ratio of 31.8%. On an adjusted basis, return on invested capital was 10.6% for the current quarter versus 17.5%, in the prior year. And now Paul will provide a little more color on the items affecting the individual business segments.

Thanks, Tripp. The performance of Expedited during the third quarter provided for a 90.7 adjusted OR in the midst of a historically weak freight environment. We believe this says a lot about the work we have done to deploy assets with the right customers to lower our cost per mile, improve our utilization, and focus on what we can control. In the context of an 8% decline in revenue per mile, we believe a 12% improvement in utilization and a lower cost per mile are significant accomplishments. The improvement in utilization was principally attributable to newer equipment in the fleet and reduced downtime, which we will look to continue as year-over-year freight revenue per total mile compressions are expected to continue and be challenging for the remainder of 2023 and into 2024. Dedicated reflected another success story centered around our disciplined approach to capital allocation. Dedicated improved its adjusted operating ratio to approximately 93.6 by effectively weeding and feeding. We reduced the overall size of the fleet by 170 trucks, while nearly doubling adjusted operating income. Trading out approximately 400 legacy contract units for Lou Thompson & Son aligns with our strategy of exiting unprofitable or underperforming business and replacing it when opportunities arise that meet our profitability and return requirements. We are pleased with the year-to-year improvement to adjusted margin and expect this to continue to improve upon both the segment size and profitability over the long term. Managed freight experienced an 11% reduction in total freight revenue and a 57% reduction of consolidated adjusted operating profit. The significant reduction in revenue and operating profit was primarily the product of little to no high margin overflow freight from our asset-based truckload segments in the 2023 quarter. The brokerage environment remains highly competitive with numerous brokers aggressively competing for volumes at the expense of profit or margin. We anticipate continued margin pressure in this environment. Our warehouse segment saw a 15% increase in revenue and an 82% increase in adjusted operating profit compared to the prior year. The top line growth is a result of new customer startups over the last 12 months, and the operating profit improvement was a result of the combination of new customer business and improved rates for existing customers. Although we are pleased with the improved profitability within this segment, We will continue to focus on improving profitability more through improved labor utilization and rate increases with existing customers. Our minority investment in tail contributed pre-tax net income of $5.3 million for the quarter compared to $7.4 million in the prior year period. The decline was largely a result of reduced gains on sale of used equipment compared to a year ago. Tail's revenue in the quarter declined 8% and pre-tax net income decreased by 28% versus the third quarter of 2022. Tail increased its truck fleet in the quarter versus a year ago by 42 trucks to 2,195 and grew its trailer fleet by 153 to 7,013. Due to its business model, gains and losses on the sale of equipment are the normal part of business for tail and can cause earnings to fluctuate from quarter to quarter. Our investment in TAIL is included in other assets in our consolidated balance sheet and has grown to $61.6 million as of September 30, 2023, from our original investment of $4.9 million back in 2011. In 2022, we received $14.7 million in cash dividends from TAIL, and year-to-date, we have received $9.8 million in dividends in the third quarter of 2023. For the fourth quarter, we expect our revenue and earnings to experience a modest decline sequentially due to cyber attacks on a major customer and the ongoing United Auto Workers strike, which is temporary to press load volumes and revenue per truck and our expedited and dedicated divisions. More broadly, however, we are optimistic that the trough of the freight cycle is behind us, but remain cautious about the rate at which we'll see improvements. For 2024, we believe that the first half of the year may continue to be challenging and expect capacity to continue exiting the market. Although we're eager for the freight environment to improve, 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 by exiting underperforming capital tied to underperforming customers and investing capital in business units and customers that provide adequate returns improving our safety culture, and investing in our people. Thank you for your time, and we will now open up the call for questions.

If you would like to ask a question, please press star 1 on your telephone keypad now, and you'll be placed into the queue in the order received. Please be prepared to ask 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 Collins. Please go ahead, Jason.

Thank you, Robert. Good morning, gentlemen. Appreciate you guys taking my question. Can you talk a little bit about the experience with Luke Thompson? Seems to be going pretty well. I know initially when you guys bought them, sort of the theory was that you could really start helping them grow. Maybe sort of how should we expect that into 24 and beyond? And then maybe can you expand upon sort of uses of cash going forward? You've done a pretty good job of dispersing it between timely acquisitions and also the buyback.

Yeah. Yeah. Jason, this is trip. I'll be happy to talk about Lou Thompson first. You know, when we first got Lou Thompson in April of this year, they were about a 200 and just call it 225 truck fleet. Cause some of those trucks are shuttle trucks, but yeah, had a really, really good business, liked it, good culture, good fit, fit with exactly what we were looking for in our strategic plan. And one of the silver linings behind that, which is one of the silver linings that we look for with any acquisition is the opportunity to grow. And if you look back at Lou Thompson and how they've operated in the past, they've really been confined to one smaller region and kind of call it Northwest Arkansas. And One of the things that we've brought to them in terms of growth potential is something they've never had before. Certainly the family had the capital to grow, but getting outside of that wheelhouse of their region is something that they have not done before, and that's something that we've experienced starting to experiment with and see success with. Evidence being in September of this year, our first startup in Tennessee with a 20-truck fleet. I could see more substantial growth outside of the Northwest Arkansas or Tennessee wheelhouse step up in the next year. But because of the, you know, there's a couple of nuances with Lou Thompson that we've got to make sure that we're not, as we grow this business, that don't suffer. And one, it's service. And we have to maintain that gold level of service that Lou Thompson maintains. And so we're very careful about the growth and making sure that we're not sacrificing legacy business or new business by just trying to grow for the sake of growth. Two is, you know, capital, making sure that we can acquire the capital that we can grow with because they do. One of the reasons why we like them is because of their unique capital requirements, whether they're, you know, differently spec trucks or differently spec trailers, you know, it sets us apart a little bit. So, Capital is a big hurdle, but I do think that there is lots of opportunity. I'd be hesitant to kind of give numbers right now because we've got a lot of things in the pipeline, but that is a big kind of just call it feather in our cap next year with just the opportunities that I believe that we have with Lou Thompson over the next, you know, call it 15 months and beyond that.

Jason, to add on, this is Paul, to add on to what Tripp said, there is an intentional plan that to grow Lou Thompson each and every year for the foreseeable future. The exact pace of that growth, I agree with Tripp. It's getting the right equipment, and we're in process on some customer contracts right now, and there's a lot of stuff in the pipeline. So we'll stay balanced, but I think you'll see that business grow year over year for the foreseeable future.

And going back to your original questions on use of cash and Here's what I can say, that if we can grow Lou Thompson, there will be some opportunities for some growth CapEx involved next year. And I can't really comment on future capital allocation plans or decisions that have been made, but what I can do is kind of talk about just in strategy, but giving you a glimpse of what we've done since January 1st of 2022. We repurchased $110 million of stock, paid $10 million of dividends, had three very accretive acquisitions for $156 million, so paid out a total of $275 million that are moving the business forward and moving the valuation forward. In turn, we've had to sell capital. We've had to sell underperforming capital, two terminals for $56 million that repurchased weren't producing a return on investment. And certainly, you guys have seen the truck counts come down over the previous quarters. We're selling off underperforming capital to help finance these things that are producing above market returns on invested capital. And so the secret sauce is doing more of what we've done in the past, but without getting into the into any more specifics about our specific plans about the next 12 months.

Listen, that makes sense. And one more question, I'll turn it over to some other people here. So we hear a lot on the drive-in side about sort of where we are with sort of the destocking. It seems like that's largely over. When do you think the sort of restocking will take place? What are your customers telling you about sort of what to expect in the coming quarters?

You know, Jason, I agree with you. I think the destocking is behind us, and I think we're probably, hopefully in the next six months, we would believe we have to get in some sort of more normalized restocking pattern. You know, if fuel prices stay high, hopefully capacity continues to exit the market. But maybe in the next six to nine months, we can get this thing back in balance a little bit.

I'll keep my fingers crossed for you guys. Appreciate the time as always, gentlemen.

Thank you, Jay. And our next question comes from Scott Group from Wolf Research. Please go ahead, Scott. Looks like Scott actually went out of the queue. So our next question comes from Jack Adkins from Stevens. Please go ahead, Jack. Hello, Jack. Are you on mute?

I'm here. Sorry about that. Can you hear me now, guys? Yes, sir. Okay. Sorry about that. And thanks for taking my questions. And good morning. So I guess maybe just a couple of follow-up questions here. I'd love to maybe go back, Paul, to your comments and prepared remarks about, you know, the trough of the cycle is behind us. And I know you maybe touched on it a bit in that last answer earlier. to Jason's question, but I mean, what's kind of driving that confidence? Is it maybe you're just seeing capacity exit? Is it a function of maybe, you know, the comments around inventory destocking being behind us? Well, what's giving you confidence that we're beyond the trough of the cycle, or maybe we've seen the trough?

Yeah, I think we're probably in it to have seen it, Jack, and I think some of us, the inventory destocking, I mean, you're seeing a lot of these brokers bid stuff at these crazy low rates, and then two weeks later, a month later, you turn around and the same freight's back on the market because they can't get carriers to service it. You're starting to see, in addition to small fleets be challenged and the capacity exiting there, you're starting to see some capacity exit in the broker space where this whole notion of buying business and just trying to grow revenue for the sake of growing and taking losses on it. That I think people are saying that model doesn't work. Um, and so, you know, I do believe that over time and again, over the next six to nine months, all that'll continue to shake out. I mean, you're coming up on people having to buy tags and pay for their annual insurance. And with all the geopolitical things, if fuel goes up, we're, We're going to get to a breaking point here for long where, you know, folks can't run stuff and lose cash in perpetuity. Yeah.

No, that makes sense. I just wanted to kind of get you to push that out a bit. So just a couple other questions for me, and I'll hand it over. But, you know, when we think about the fourth quarter and some of the, you know, Is there any way to maybe frame up the impact that that's having to your fourth quarter results? Absent those, would you have expected maybe results to be flat or maybe improve sequentially from an earnings perspective?

Jack, I would tell you absent those, we probably would have been around flattish quarter over quarter. There's less work days in Q4 with all the holidays and And there's really, you know, we don't play much in the peak anymore. There's not much peak out there. And so, you know, I would have told you we would have probably been flattish. And, you know, kind of like we said, I think we'll be down sequentially, but I still think it'll be a nice fourth quarter. Okay. The bottom's not going to fall out from under it or anything. Right.

I mean, you said it'll be a modest decline, right? Yeah. Yeah. Okay. That makes sense, Paul. And I just, I guess maybe kind of shifting gears to one other topic, and that's the underlying dedicated operations. You know, margins have improved a good bit there with the addition of Lou Thompson, but could you maybe, you know, I know it's been sort of a longer term strategic focus to improve the profitability of the core dedicated business. You've got the auto strikes going on there. So I know that kind of clouds it a bit, but could you maybe talk about the progress you're making there in terms of the organic dedicated operations?

Yeah, we talked a little bit in Indigo about Lou Thompson, and so I think you'll see that truck grow next year. I think we're probably 90% through the weed and feed plan. And so, you know, dedicated has been hard to grow in this environment with the one-way truckload market being as low as it is. I would say our pipeline is really robust, but, you know, folks are reluctant to pull the trigger because they can save a little bit of money by running, you know, three months more or six months more or whatever in the one-way world. But I think you'll see a lot of that capacity come back into dedicated. When rates start heading north, I think you'll see a lot of dedicated contracts start getting signed. And so, again, to summarize that, I think we're through the majority of the weight and feed. There's only, I would say, 10% of the business we're probably still not happy with. I think you're going to see Luke Thompson grow. and we've got a strong pipeline on call it the non-poultry dedicated, it's just going to be a function of, you know, when one-way truckload rates start moving the other direction, you're going to see some folks, I think, start locking in on some of this, you know, pipeline work we've been working on for the last year.

Okay. All right, guys. I'm going to hand it over to somebody else. Really appreciate the time. Thank you.

And our next question comes from Michael Vermitt from Newland Capital. Please go ahead, Michael.

Hey, guys. How are you doing?

Hey, Mike. Hey, Mike.

I've got to say, it's been an amazing turn at the company to be putting up these kind of numbers at a trough environment. Two quick things. When you're looking on the acquisition front, if there are, what your pipeline looks like now? Are there more... potential sellers coming to the market and the verticals that you're focusing on?

Yeah, a couple things. We continue to look in the market, Mike, for niche, you know, above average return acquisitions that we think we can grow. That's the answer to the first question. As far as there are some of those in the market right now. And so we just continue to look and see what might be a fit. And that kind of answers the second part of your question. You know, we, we really look for something we can integrate within one of the, one of the verticals of the company, you know, be it expedited or dedicated or, or managed trends or warehousing. And so we're just going to, Tripp said it early on, we're going to continue down that path of capital deployment that if, if investing in growth CapEx is the best return, that's what we're going to do. If it's, buy shares back, that's what we'll do. If the right acquisition with the right profile comes along, that's what we'll do. And so I think Tripp laid it out really good earlier. We're just going to kind of keep working down that path because that has, it has really turned around the way we operate the business and the results. And you can see those evident from where we were to where we're at. So we're probably just keep doing more of the same.

Yeah. And I think Mike, the key to that is being really disciplined with our approach. I mean, we get a lot of, you know, SIM decks come our way and open them and then turn them down within, you know, five minutes of opening them. And then of those, maybe 2% of them, we look at them for a day and talk about them and then turn them down and, You know, we've been real fortunate lately, I guess, with the last three that have just come up. And I think that, you know, we've talked about it internally, when folks publicly know what we're after and what we're looking for and what we're interested in, we're getting to see more volumes of those. And so we're going to continue to be disciplined in our allocation approach, capital allocation approach as it comes to M&A. But it seems like the uptick has been really helpful or has really picked up a lot of which is because we've been public about, you know, what we're trying to do.

Got it. Um, next question, I guess maybe this is for David or I don't know. Yeah. We've done such a phenomenal job changing the company and reducing the volatility and our valuation, our valuation is pretty much where it was. five years ago, right? We're trading under 10 times, nine times. The group trades closer to 20. So, you know, there's nothing really comparable to us. No one's performed like we have through this cycle. Is there a point where you think about taking the company private or doing something, you know, internally if the market's not going to reward us?

Hey, Mac. This is David. Hey, number one, I got your same sentiments. You know, I don't disagree with anything you just said there. Of course, we can't talk about going private or anything like that, but that's why we got a board. We got a board to talk about all the issues that are there, and we're busting our butts. And as I said, you know, two or three years ago when we started down this road of of where we should be at in the market, somebody's going to love us. Wall Street can love us. We're going to love ourselves. We bought back 25% of the company and we're doing a great job. This team is doing unbelievable. I could not be any more excited about what the group is doing. They're doing great. I think that Wall Street will reward us. I think one day that it will wake up and say they are doing well and we will get rewarded. But again, we brought back 25% of the company. Somebody's going to love us. So we're going to have to determine who's going to love us.

Excellent. And then one other thing, when we look at, you know, let's say we're near the trough here and we're doing, you know, four to 450 of trough earnings. When we look at what we've added in here, layered in the acquisitions, what's on the table here, is there any reason to think we won't be getting back up to the 550 to 650 as we, uh, approach another peak, you know, is the earning power stronger at the company now than it was?

Without a doubt, without a doubt. But, you know, we're working on five-year strategy and of course, you know, five-year strategies, as we all know, I love our strategic planning and looking out the next five years because we've been doing this for about a solid three years during this time that you've seen us do what we've, you know, what we've achieved, uh, It's been a great strategic plan. And we got five-year plans. And, again, those can change in a year depending upon, you know, the conditions out there. But, hey, I couldn't be any more happier. The numbers, we are going to get back to when things turn around, we're going to shoot off very nicely. There's no doubt in my mind that we've got the company positioned to have outstanding, an outstanding future. Again, I couldn't be more proud of where we're at. This is probably the most difficult environment. I mean, we can compare it to 08, 09, and we all could say that it may even be worse than 08 or 09 because, to be honest with you, I'll never forget, October of 08, ISM was a 38th. And by June, July, the following year, about eight months later, we were showing extremely nice, positive internal numbers on utilization and revenue and those kind of things. And none of us in the industry is seeing that in this environment today. And we're all sitting there saying, is it going to happen now? Is it going to happen in March? Is it going to happen next June? And nobody knows that. And performing the way we're performing – I say hallelujah.

For sure. Look, there's no company that I can find right now in this environment that's performing as well as we are. So, you know, you said it five years ago, and the company is a completely different company now. So, you know, great job, guys. All right.

Thank you, Mike. Thanks, Mike. And our next question comes from Scott Group from Wolverine Research. Please go ahead, Scott.

Hey, thanks. Good morning. Sorry about that earlier. I was just wondering, as we get to 2024 bid season, how are you thinking about expedited rates, dedicated rates? Do you think rates can start moving up next year? Do you think there's some further downside risk to rates? What's your approach early on to bid season?

Hey, Scott. This is Paul. You know, here's what I think. As you know, a lot of the bids come out early in the year. And so I'll tell you what we're thinking. Expedited is probably flattish to maybe down a percent or two. And dedicated, we think, is probably flattish because a lot of that gets done early in the year. I think on the managed trans side, you know, a lot of that's more in the spot market. Yeah. I think they'll get the benefit of things as the year goes along next year. And so I think there will be some rate opportunity by this time next year, but I think there won't be in the early part of the year. So you could kind of say we're kind of in the flattish world because, you know, a lot of the folks we talk to, I mean, it's costs keep going up, small guys keep going out of business. I mean, this thing will – It's getting to a point where folks aren't going to do this for practice, whether it's small carriers that are, you know, keeping rates depressed through brokerages or large carriers. Most people are kind of at the place where they are where they are.

Makes sense. And so in an environment where rates are flat to maybe down slightly, you said, we felt some cost inflation. Are we... Confident about the ability to sort of grow earnings from this low $4 level next year?

Yeah, we think we can incrementally grow earnings next year. I mean, I think there's a few key things. What does our maintenance cost do? What does our insurance cost do? How does some of this pipeline that we were talking about a minute ago – you know, when does that come on board and, and how quick does it get to the, you know, kind of model profitability level. But, but yeah, we, we think that we can have some incremental, uh, earnings growth in 24 off 23, nothing significant next year. Uh, but as soon as, as we're talking about with Mike, I'm going to go as soon as things pop, I think it's going to, you know, you'll see a more material amount of earnings growth. And so, um, That's kind of the way we're modeling it out right now.

Okay. Makes sense. Thank you guys for the time. Appreciate it.

Thank you. And at this time, there are no further questions. I'd like to turn the call back over to Tripp for closing remarks.

Yeah. We'd just like to thank everybody for your participation today and wish everybody a good rest of the week and a good weekend, and we'll talk to you next quarter. Thank you very much.

This concludes today's conference call. Thank you for attending. The host has ended this call. Goodbye.