Covenant Logistics Group, Inc. (CVLG) Q2 2013 Earnings Report, Transcript and Summary

Excuse me, everyone, and welcome to Covenant Transportation Second Quarter Conference Call. We now have our speaker in conference. [Operator Instructions] I would like to now turn the call over to Richard Cribbs. Mr. Cribbs, please begin.

All right. Thank you, Kurt. Good morning. Welcome to our second quarter conference call. Joining me on the call this morning are David Parker, Joey Hogan, along with various members of our management team. This conference call will contain forward-looking statements within the meaning of Section 27 of the Securities Act and Section 21 of the Securities Exchange Act. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. Please review our disclosures and filings with the SEC. As a reminder to everyone, a copy of our prepared comments and additional financial information is available on our website at www.ctgcompanies.com/investorrelations. Our prepared comments will be brief, and then we will open up the call for questions. In summary, the key highlights of the quarter were that our asset-based division's revenue, excluding fuel, decreased 0.3% due to a 4.7% decrease in average tractors, offset by positive 3.6% increase in average freight revenue per truck. Our revenue per truck increased versus year ago for the sixth consecutive quarter. Versus the year-ago period, our miles per truck were up 2.6%, while average freight revenue per total mile was up $0.015 per mile or 1%. Our largest subsidiary, Covenant Transport, experienced a year-over-year freight revenue per tractor increase of 3.5%. The execution of strategic initiatives since the second quarter of 2012 at our Star Transportation subsidiary resulted in an increase of 27.8%, while our refrigerated subsidiary, SRT, experienced a year-over-year decline of 4.6%. Compared to the year-ago period, the asset-based division's operating costs per mile, net of surcharge revenue, were up mainly due to higher driver wages and owner-operator settlement amounts, workers' compensation expense, revenue equipment rental expense, operations and maintenance expense, and casual insurance expense, as the prior-year quarter included a $3.5 million net gain on a refund of insurance premiums. These increases were partially offset by lower nondriver employee wages and reduced depreciation interest expense, primarily due to the shift to a greater percentage of owner operators in our fleet. The asset-based operating ratio contracted 140 basis points to 95.3%, when the benefit of the $3.5 million gain from the insurance policy refund is excluded from the 2012 quarter. Our Solutions logistics subsidiary increased revenue by 41.3%, due to the combination of reduced purchased transportation expense, improved fixed cost absorption with the added revenues and a reduction in personnel and overhead expenses associated with 2 locations that were producing subpar results. The operating ratio improved to 95.5 from 102 in the year-ago quarter. Additionally, our minority investment in Transport Enterprise Leasing produced a $550,000 contribution to pretax earnings or $0.02 per share. Since June 30, 2012, total indebtedness, net of cash and including the present value of off-balance sheet lease obligations, decreased by approximately $8 million to $255 million. We increased the net lease-adjusted indebtedness during the second quarter of 2013 by just under $3 million versus March 31, 2013. The average age of our tractor fleet continues to be very young at 2.1 years as of the end of the second quarter. With available borrowing capacity of $40.8 million under our revolving credit facility, we do not expect to be required to test our fixed charge covenant in the foreseeable future. Excluding the $3.5 million gain from the [indiscernible] insurance policy refund in the prior year quarter, our consolidated operating ratio contracted by 100 basis points to 95.4%, while net income was $1.9 million, compared to adjusted net income of $2.1 million last year. The main positives in the second quarter were: one, a 2.6% increase in utilization versus last year; two, a year-over-year reduction in average open trucks from 6.1% during the 2012 quarter to 4.3% during the 2013 quarter; three, significant improvement in the operating profitability at our Star Transportation and Solutions subsidiaries; and four, our safety efforts produced our lowest quarterly DOT accident rate per million miles over the last decade. The main negatives in the quarter were: one, slowed pricing growth; two, a deterioration of operating profitability from our asset SRT subsidiary; and three, cost increases across most of the business. Among asset-based service offerings since the end of the first quarter, we marginally reduced capacity allocated to our regional, dedicated and refrigerated service offerings, while maintaining capacity levels in our expedited offering. The expedited and regional service offerings experienced year-over-year positive revenue per truck growth percentages, while our refrigerated and dedicated service offerings had a decline in revenue per truck as compared to the prior year quarter. Freight results for the first 3 weeks of July 2013 have been decent. However, we continue to utilize improved systems and processes to challenge ourselves and operations employees to improve profitability through improved yields, better driver retention and appropriate allocation of valuable capital resources. We believe that our disciplined approach to continuous improvement will drive positive results. Thank you for your time, and we will now open up the call for any questions.

[Operator Instructions] Our first question comes from Brad Delco with Stephens.

It's actually Ben on for Brad. Looking at the current rate environment we've seen from the other TR [ph] reports, it's been tough all around. In 1Q, you guys mentioned you're still kind of thinking about 3% for the year. Is that something that is still on as far as guidance? Or is it going to be lower than that?

Ben, we will continue to give rate increases. Without a doubt, there's been a couple of months of a pause. Some of that was -- some of that had to do with some of the highest rate increases that we got last year. To give you an example, one of our large customers, we did an 18-month contract. That was basically about a -- 8% last year with -- but they have to be held until January of next year, to give you an idea. So we had a couple of those. And then, there on the quarter, we had another large account that we ended up getting a 5% rate increase out of, but it took us about an extra month to get it. It should have happened April 1, and it happened about the middle of May, is when it came about. So they reduced the overall a little bit. I do believe that we can and we'll continue to get the rate increases. I think, though, there's liable to be a couple of more months before we're going to start seeing some of that. We got a lot that are in that October-November time frame. So I'm really thinking that fourth quarter is going to be much more of an attractive opportunity of a nice increase in the rates. I think I got a couple of months of modeling through some murky water here.

Yes, on top of that, Ben, you have the Star subsidiary as well. They're length of haul has increased from under 400 miles to almost 500. And during that time period, their rates are decreasing, but it's just relative to haul.

Right. And then when you look at hours of service, and I know it's very early, but are you seeing any impact yet? And how are those conversations going with shippers as far as getting rate due to whatever the impact is?

That's a great question, and it'll be interesting to see. Here's my take on it, is that for the industry, including us, it is going to be an effect that I think we all agree with, whether it's 1% or 4%. I think that it's going to take the industry a couple of months, July, August, before we get our hands around that number. Because July, even though I'm pretty happy with -- about what I'm seeing from a freight standpoint. And July is not -- it's not horrible. So July is kind of what I expected July value to be. But it's still July. It's not a time that you can really see how the hours of service is really affecting it because you're not running on all 8 cylinders. You're running on 6 cylinders. And we got to have a better business environment out there from a freight standpoint to really see the effect. We know that the 30 minutes of some of the expedited hot freight, whereas you go 2,000 miles and you're supposed to be there in 48 hours. And all of a sudden, you're taking a 30-minute break every 8 hours over a 2-day period of time. We're having to -- we're having to make some adjustments of an hour or so on delivery schedules. So you multiple that times x amount of hundreds and hundreds of teams, and it gives you an idea that it is going to have a negative effect. So I think that the industry will get their hands around it by the end of August. And then I think the industry will go back up to the shipping public to say we can handle 2% or 3%. Now to answer your question, what are the customers saying? Kind of quiet, but I got to tell you that we're not loaded with information yet. So don't think we're doing is saying, "We got a issue going on with hours of service, and we got to get our hands around it." So it's not like we're very verbose on being able to tell them what the issue is. And of course, every customer thinks that none of their freight has a problem. And because, as you know, it's accumulative. It's not necessarily -- we already know the customers that take you 2 hours to unload or 4 hours to unload. They've taken it before. We've already -- we already know that. We deal that -- we deal with that through detention. So that's not the problem. It is that you cannot run the same amount of hours in a week that you could run, and so it's a cumulative effect. So it is going to be a hard discussion that the industry is going to have to have. But one good thing about it, it's affecting from the small guys to the large guys, and nobody is going to be exempt from the difficulty.

And Ben, I'll add to that, too, that the customer, because freight isn't as heavy in the first 3 weeks of July, they're not feeling the impact because us and other carriers have had a little bit of flexibility to make sure that we still meet that customer's needs. And we're able to do that, but it's a lot of adjustments on our part and additional costs related to that and a little reduced utilization overall. But right now, the customer is not really feeling it because we've had the flexibility. But that won't be the case as we get busier.

Okay. And then on the freight environment, you said it's been just kind of okay in July. But can you kind of break out, give us some more color on which areas you may be seeing some strength, which areas are much -- which areas you may be seeing some weakness?

As I think among all of the asset sides, Start and SRT and Covenant, it's really a mixed bag. All regions of the country are not doing bad. But Brad [ph], it’s like this morning in Dallas. I mean, yesterday in Dallas, we were, say, plus 20, had 20 more loads than we had trucks. And then this morning, you're minus 10. You need 10 loads, you had more 10 trucks than you got loads. And that's really the way it is throughout the country. Where is it nice and strong at? The West Coast is good and strong. The Southeast is good and strong. Those 2 regions of the country, the Ohio Valley, which had been slow all this year for the last 2 months, has been very good. And the Ohio Valley has been strong for us. Chicago, though, has been up and down. The freight capital of the world, it's been up and down this entire year. And so the Northwest has been basically pretty slow all year long. We -- we've not really had any strength in the Northwest. Texas has been up and down. So to sum it up, I would say, strong. The Southeast, the West Coast, a bit strong. The East Coast has been solid. The mid -- Ohio Valley has been solid, and the rest of the regions of the country have been up and down, depending upon the day.

[Operator Instructions] Our next question comes from Scott Group with Wolfe Research.

It's actually Reena Krishnan in for Scott Group. So I guess, maybe just following up on some of the questions earlier in terms of the outlook for the second half, when you do talk with your customers, maybe it's hard to get visibility on the impact of hours of service and how [indiscernible] that's going to play out. And it is going to take a little while to kind of feel the impact and understand it. But what are you hearing from them in terms of just expectations for peak season in the second half? I mean, just kind of looking at what happened last year, with the late start around October and then we had some other incidents like Hurricane Sandy and things like that, I mean, how -- what are you hearing from them in terms of, I guess, just the volumes perspective? I mean, it sounded like -- it sounds like things have just really kind of slowed from maybe what the expectations were maybe around February or some sort of maybe relatively better.

Yes, those are great questions. The customer is concerned. Now I would say only 20% of them are doing anything about it from a standpoint of saying, "Let's talk now to be able to tie up capacity." I think, for the last 4 to 5 years, the last 4 years, in particular, since '08, '09, '10 is okay, '11, the last 4 years, I think the customer had seen a snowball that everybody believes that's definitely going to happen. I mean, 2 plus 2 equals 4. And there's not enough capacity in the United States for -- unless we're going be at 1% GDP growth for the rest of our lives. That's the only way that we will continue. But the other side of that is that there is definitely a lot of times, as I gave the regions and the strengths and the weaknesses of the regions, with 1% GDP growth and there's times I'm telling you the South is strong and the West Coast is strong, and it's really strictly the take on the economy. But the customers are concerned because they do know that capacity is going to run out. They just don't know which day. And so therefore, you got most of them that are flipping a coin and only 20% of them are saying, "Let's make sure that we are truly partners, and we do something about it now." And the other 80%, in my opinion, are saying, "We know we got a problem. Hey, we're talking through it." But they don't want to do anything to say, "Let's put it to bed right now, and make sure that they are protected."

Okay, great. That's helpful. And I think the other thing I just wanted to get a sense from you guys is, it just seems like in 2Q, we see that and we're hearing from some of the other carriers that it seems like there's an interesting, maybe not expanding the fleet, but definitely continues to replenish it in taking advantage of the used truck market. What sort of happened there that -- I thought that pricing had sort of slowed and maybe demand in the used truck market had slowed, but it seems like it's picking back up again. Any insight you guys have to offer there? And how should we be thinking about gains on sale going forward?

Reena, this is Joey. I think on the equipment side, overall capacity side, we're really not planning on adding any capacity in total throughout this year. And I think the main reason for that is, one, even though we're making progress, we're still not where we want to be yet return on invested capital. Two, even though our utilization was up, our capacity was down 5% versus year ago. And so that's -- that largely has been driven by the driver situation. And so being able to add capacity is extremely difficult right now. Where we are focused on is refreshing the fleet as quickly as we can. I think some of the technology that's out there and some of the equipment we're seeing is pretty encouraging. And so we are going to be aggressively in the second half of this year. I want to say upgrading, but refreshing the fleet more than we probably would have, well, I know with more than we had planned on in the second half. And so we -- our average age at the end of June was 2.1 years. We should be down at the end of December, about 1.8 or 1.9. So we're going to drop that. So we're going to have a pretty, pretty meaningful tractor equipment plan at the back half of the year. Do we expect big gains from that? We're not planning big gains. But we do feel pretty good that we'll be on the game side of the equation. But some of the equipment we have that we're trading or selling, actually selling, is probably the less desirable trucks in the fleet. And so I don't expect big gains out of those. So we're going to be -- but I do believe we'll be on the plus side, though.

Okay, that's helpful. And then just looking at that and your -- I understand your CapEx expectations are probably higher. How should we be thinking about what you can do in term -- about the debt pay-down and free cash flow levels this year?

I would expect, now that we've increased the CapEx a little bit, that third quarter would probably won't see any debt paydown or very little. But the fourth quarter, we should be back into a area where we can pay down a little debt and maybe even get basically even for the year, would be my hope, just depends on how those -- how the proceeds look from the sale of the used equipment and how we do, continuing in our operating cash flows.

[Operator Instructions] Mr. Cribbs, there are no further questions at this time.

All right, excellent. Thank you, everybody, for calling in. And we'll look forward to talking to you next quarter. Bye.