Covenant Logistics Group, Inc. (CVLG) Q2 2020 Earnings Report, Transcript and Summary

[Operator Instructions] I would now like to turn the conference over to Richard Cribbs. You may begin. Richard Cribbs;Covenant Transportation Group;Senior Vice President of Strategy & Investor Relations, Treasurer: Thank you, Shelby. Welcome to the Covenant Logistics Group second quarter conference call. As a reminder, this conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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, including, the documentation, the Risk Factors section in our most recent Form 10-K and our current year Form 10-Q. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances. As a reminder, a copy of the prepared comments and additional financial information is available on our website at covenanttransport.com under the Investors tab. I am joined this morning by Chairman and CEO, David Parker; Co-President, John Tweed; and Joey Hogan; and CFO, Paul Bunn. I will now turn the call over to Paul to summarize our financial results.

Thank you, Richard, and good morning, everyone. We will cover our prepared remarks first, followed by Q&A. Before I cover the normal detailed information, I would like to provide an overview of key drivers of our second quarter results because the numbers alone do not match where we think we are headed operationally or versus some of our peer results, and I'm sure that interests each of you. During the quarter, we shutdown our second largest facility in Texarkana and sold another facility in Dallas, Texas, and consolidated most of our non maintenance-related personnel in Chattanooga and Greeneville, Tennessee. This was a significant operational, HR, and IT lift, similar to an acquisition since the SRT business in Texarkana had been operated primarily as an autonomous solo refrigerated service offering. We downsized our fleet by 262 tractors and repositioned a portion of the remaining tractors between segments, which involved an intermediate -- immediate revenue loss with some ongoing expenses due to unpaid miles and a tail on fixed overhead, specifically depreciation. Our dedicated operations experienced volatility due to a concentration in automotive and automotive supplier business that were shutdown for a significant portion of the quarter as well as certain contracts that do not require a minimum load count or payment so that we had to put trucks to work elsewhere. The freight environment for the quarter was very weak in April and progressively improved. The sum of the above is that we pushed a lot of disruption and expense into a relatively weak freight quarter. The table in our operating press release -- the table in our press release, quantifies approximately $29.3 million of infrequent items, including net gains and losses on asset sales and impairments, certain shutdown and severance costs, but it does not capture all the related operational costs or revenue drop off and a tail on our fixed expenses. For the third and fourth quarters, we expect some ongoing operational and restructuring costs, but not at the level of the second quarter. While our fixed cost overhead continued to come down and the freight environment continues to improve materially versus the first two quarters. The sales pipeline is robust across our truckload and managed freight segments. Our team is focused on taking steps required over the remainder of the year to exit this year to be best prepared for 2021. Turning to more detailed results. Notable financial results for the quarter included: Our Highway Services Truckload segment's revenue, excluding fuel, decreased 7% to $73.3 million due primarily to an 8.8% average operating fleet reduction, partially offset by a 2% increase in average freight revenue per tractor in the 2020 period as compared to the 2019 period. Versus the year ago period, average freight revenue per total mile was down $0.126 or 6.7%, while average miles per tractor were up 9.3%. The main factors impacting the increased utilization were 1,180 basis point increase in the percentage of our highway services fleet comprised of team driven tractors at an improved average seated tractor percentage, as only 3.7% of our Highway services operational tractor fleet lacked drivers, compared with 6.9% during the prior year quarter. The longer average length of haul related to the higher percentage of team driven tractors contributed to the reduced average rate per total mile. Our dedicated truckload segment's revenue, excluding fuel, decreased 16.6% or $60.4 million, primarily due to the combination of the pandemic related second quarter automotive shutdowns at 2 large customers and an 8.6% average operating fleet reduction. Versus the year ago, dedicated average freight revenue per total mile increased 11.6% -- $0.116 or 6.4%, while average miles per tractor were down 14.3%. Excluding the impact of the truckload related restructurings on the second quarter and the second quarter 2020 adjustments, total operating expenses, net of fuel surcharge revenue increased $0.074 cents per mile compared with the year ago period for our combined truckload segment. This is very attributable to the higher per mile driver wages, non-driver wages and casualty insurance costs, basically offset by lower workers' compensation and maintenance and repair costs. Our managed freight segment's operating revenue increased 10.6% versus the quarter -- year ago quarter to $45.9 million. This increase was driven by a 40.3% increase in freight brokerage operating revenue and operating revenue to $28.4 million, partially offset by 17.9% decrease in the combined operating revenue of TMS and warehousing. Managed freight operating loss was $2.9 million for an operating ratio of 106.4. As a result of the second quarter decision to sell the assets of Transport Financial Solutions, the related results are presented as discontinued operations. This presentation has all activity net of tax into a single line item, income from discontinued operations net of tax. TFS' results net of tax provided $0.05 per share of earnings in the second quarter of 2020 and 2019, respectively. We recognized $0.5 million of pretax income from our 49% equity method investment in TEL compared with pretax income of $2.4 million in the second quarter of 2019, as TEL returned to profitability in the second quarter following reported losses in the previous 2 quarters. The average age of our tractor fleet continues to be young at 1.8 years as of the end of the quarter, down from 2.2 years a year ago. During the first half of 2020, we took delivery of 305 new tractors and 155 new trailers while disposing of 781 used tractors and 219 used trailers. We reduced our operational fleet size by 398 tractors or 13.2% to 2,623 tractors by the end of June from our reported operational fleet size of 3,021 tractors at the end of December. In the second half of 2020, we expect an average operational fleet size of approximately 2,550 tractors which we expect to allow us to maximize the utilization of our fleet, including an improved mix of more consistently profitable freight. Between March 31, 2020 and June 30, 2020, total indebtedness net of cash, decreased by $52.4 million to $284.4 million. This sequential decrease to net indebtedness included net cash proceeds from the sale of real estate and excess revenue equipment. At June 30, 2020, we had cash and cash equivalents totaling $67.1 million as well as available borrowing capacity of $58.3 million under our asset-based revolving credit facility for a total of $125.4 million of liquidity. The sole financial covenant under our ABL facility is a fixed charge coverage ratio that is tested only when available borrowing capacity is below a certain threshold. Based on our availability as of June 30, no testing was required, and we do not expect testing to be required for the foreseeable future. With this color, I will turn the call over to Joey for a recap of a few additional items.

Thanks, Paul. The main positives in the second quarter were: number one, significant progress in our efforts to restructure our business units, terminal network, management team to focus on our talent, time and capital on areas where we believe we have the ability to grow and produce a consistent, acceptable margin. Number two, we executed a number of decisions and transactions consistent with our strategic plan, including the sale or exit of certain real estate, downsizing unprofitable operations, and reallocating fleet assets. Number three, we recognized the largest portion of our strategic implementation costs, including certain costs that were not separately identifiable. Number four, cost control execution that we expect to provide significant cost savings as we move through the remainder of this fiscal year. Number five, year-over-year freight revenue per tractor increase in the Highway Services segment. Number six, TEL's return to a profitable quarter. Number seven, a sizable increase to our liquidity position. And number eight, decreasing net indebtedness by $52 million during the quarter, while also lowering our weighted average interest rate through refinancings and new financing efforts from our financing partners. The main negatives in the quarter were, number one, the revenue and related profitability loss with two of our large dedicated automotive customers experienced pandemic-related plant shutdowns for a large portion of the quarter before stepping up production late in the quarter. Along with the temporary deferral, the start-up of a dedicated service provided to a new large automotive account. Number two, the revenue and related profitability loss from managed freight service to an airline industry, as pandemic significantly reduced domestic air travel. And three, the impairment charges on tangible and intangible assets. In relation to our strategic plan of lowering fixed costs, we've been analyzing our senior management personnel on the needs of a business our size for several months. We felt positive about our team members, but also felt that a flatter and less costly corporate organization was needed. We identified 6 senior VP's at higher positions that we do not expect to need going forward. Two of those positions that were eliminated have been filled by Ron Rogers and Richard Cribbs, who will transition out of the company over the next coming weeks. We have valued and appreciate both of their contributions, and this was one of the difficult decisions that Paul talked about earlier. Severance costs are expected to be included in the third quarter as one of the ongoing costs we mentioned above that will move into the second half of the year. Also, after the quarter, we sold the assets of our factoring business, TFS, on July 8. The transaction was valued at approximately $131 million, including $8 million of an estimated earn-out. We received $108 million of cash and $14 million in stock to date. We are now involved in a dispute concerning the transaction. The purchaser asserts that subsequent to the closing, it identified that approximately $66 million of the $103 million in assets acquired were advances against future payments to be made pursuant to long-term contractual arrangements between the obligor on such contracts and TFS clients for services that had not yet been performed. As opposed to advances against future payments for services that had been performed that this fact was not disclosed to the purchaser and the purchase of such advances were not contemplated by the purchase agreement. The purchaser and we have met to determine whether this dispute can be amicably resolved, and we have continued to exchange with them various structures to resolve the situation. We're also evaluating other options should the discussion not produce an amicable resolution. It's too early for us to determine the likely outcome of this dispute, any liability or expenses that we may incur, any cash we may need to pay or invest, the impact on our total leverage or the gain or loss we may ultimately record on the transaction compared with a $26.5 million gain we previously estimated. The facts are still being gathered, and we may or may not find a solution that is acceptable to both the companies. And as you might going to expect, we will not be taking any questions regarding this topic in our Q&A period. For the balance of 2020, our main goals will be to, one, to reduce our fleet size as described above and monetize a large percentage of assets held-for-sale, which were about $66 million at the end of June. Number two, to allocate our fleet assets across our contract logistics expedited and higher-margin irregular route operations. Number three, to significantly lower our fixed costs. And four, to return managed freight back to its pre-COVID margin percentage. We believe that achieving these goals will position us to enter 2021 with an improved business mix, fleet profile and cost of operation. Pursuing our plan will continue to involve difficult decisions and may result in additional strategic restructuring expenses. However, we believe the investment will strengthen our position in the U.S. logistics industry and provide for a less cyclical business model based on a more sustainable, higher-margin sectors where we can add value to our partner customers and for our stakeholders. Thank you for your time. And Shelby, we'll now open the call up for any questions.

[Operator Instructions] We'll take our first question. Caller, please go ahead.

It's Jack Atkins from Stephens. So I have several questions here. Maybe if we can start for a moment and just kind of talk about what you guys are seeing in the freight markets right now? Everything we're seeing and hearing out there would indicate there's been a much better than normal seasonal progression in July and August, particularly for expanded capacity and team drivers. Can you talk about what you're seeing in the business and sort of what your customers are telling you about their expectations for the second half of the year, especially headed into peak season?

David, why don't you answer that, and I'm going to ask John to jump in behind you.

Okay. Yes. Jack, yes, I agree 100% with what you just said. As June came to a close and we got into July, just got over the July the Fourth right there, freight has been very strong. As I look at all the regions of the country, speaking about the expedited side of the business right now, as I look at all the regions of the country, we were talking this morning that the only city in the country that has probably been -- the word is not slow, but less dynamic is probably Chicago and which I find interesting. But that said, the rest of the country is going strong. And the West Coast for the last 2 solid months has been extremely strong. And so from a freight environment, on the expedited side, we just got off the phone call just a little while ago on a dedicated piece of business that we've already got, 25 trucks. We've been building it here lately up to 25 trucks, and they want another 10 trucks starting ASAP. And so there is no complaints. And I don't see that reducing any on the expedited side for a little while. I mean, I think we're seeing the evidence of projections of 20% GDP growth in the third quarter and whatever it's going to be in the fourth quarter, which is going to be positive. I think it's heading right into a very strong fourth quarter. I think it's headed into a strong peak season. So I couldn't be any more happier on the expedited side.

John, do you have anything you want to add to that?

Yes, Jack, it's John Tweed. The only thing I would add to that is just to expand what David said, maybe even as an example, last week, if we had to had every 1 of our seats filled, whether that means a team in a truck versus a solo or all of our non-team trucks seated, our revenue would have been 5% higher than it actually was. So we're definitely in an environment where demand is very strong, and we're back to looking for how do we find another quality driver to seat our trucks. During the second quarter, as we rationalized our fleet size, we got very aggressive with safety. And we became a little more heavily unseated than we normally would. So we're kind of in a pipeline process now of building back our driver base and demand got ahead of us. So we're hoping that by the time we get through August, we'll be rightsized on our driver fleet and enjoy the revenue from that. But we're definitely seeing strong demand, not just across the expedited, but also in our solo and dedicated fleets as well.

Okay. That's helpful, John, and David, thank you for that. I guess just let me kind of think about this a little bit further. If we go back to 2017, and things are feeling an awful lot like 2017 in terms of how they're progressing here. You guys were marginally profitable in the second quarter of 2017. And then you had just a really strong third and fourth quarter. When I think about how your business is trending in 2020, again, it feels very similar. And then you have these cost reduction items and strategic initiatives on top of that. So I know you guys didn't provide any guidance with the results last night or on the call. But is there any way you can kind of help us think about how we should we think about the profitability of the business trending into the second half of the year, especially relative to what you guys were able to earn back in 2017?

Paul, why don't you grab that one. I'll come in behind you.

Yes. Jack, here's what I'll tell you, July -- but we didn't give guidance. We don't have July closed, as we've been busy with several things as of late. July is going to progress very nicely compared to the second quarter. And then we've got incremental improvement built in for peak season in Q4 coming off where we will be in Q3. And so I think it's going to continue to build July all the way through peak season in December. And so I think it's going to be very nicely.

Yes. I think, Jack, a picture I'd put around it is from a -- I think I heard a word from somebody sloppy or messy or somebody that's described it last night, and it was. And -- but I think that we tried to lay out all the reasons for that, which the response to all of that has been to keep us focused on the long term and to keep us focused on what's doing the right thing for the business. And yes, we made some very quick, big, very difficult decisions that we felt at the time were the right things to do to help let's call it, propel or push us through as the economy recovers. And so that was the strategy. The result of this is messy. And at a time when we didn't know how long the COVID-type freight period will last. And so it was a little of a gamble. But nevertheless, we felt it was the right thing to do long-term for the business. So as we pushed through into the second half, I think the immediate period, it's going to be nicely or we were trying to figure out the right words this morning. We're encouraged at where freight is. Dave and John did a good job answering that, I think the cost side, you're all going to see that very dramatically as we move into the second half of the year. And so I'm excited. We're not running the business for peak. I think peak has shown over the last couple of years anyway that the impact for peak is getting less and less inside of our model. I do believe -- I agree with David. I think peak is going to be crazy this year, just for a lot of reasons. And -- but we're not running a business for peak. We're running the business for long-term, sustainable, more consistent results. And we feel the decisions that we've made are going to help us along that path.

Jack, one thing that I'll point out to you is that just the depreciation alone change from kind of a run rate in Q2 to a run rate in Q3 is probably $1 million a month. When we talk -- Joey talked about just on fixed costs, not including any of the kind of strategic initiatives. But we depreciated all the trucks and trailers. I think there's $65 million, $66 million of those in assets held-for-sale at the end of the Q2. We depreciated those all the way up through June 30, just based on kind of how the accounting rules work as we were -- made some decisions really fast in May and June and had to -- we're pulling equipment. We needed to keep depreciating them through the impairment date at 6/30. So all of those items that are in assets held-for-sale will have depreciation stopped. We feel really good about what we wrote them down to. And so just that one item alone will pick up $1 million a month on the fixed costs and not inclusive of any revenue changes or other kind of strategic cost initiatives. Richard Cribbs;Covenant Transportation Group;Senior Vice President of Strategy & Investor Relations, Treasurer: Jack, just one other thing here -- this is Richard. One other thing to think about the noise of the second quarter was really what we did is we accelerated the strategic plan, the execution that we had planned to do over a course of a longer period of time. And given the management changes and other things that we took care of, we were able to do a lot of that all in a very short time period. And it's very close to being done. And so what that leaves us with is where we wanted to be, probably a year from now, we're already there. And that's pretty exciting. So there was a lot of push to get the cost down, there's a lot of push to restructure the business to who we wanted to be when we grew up. And it's very close to being there now. So I hope everyone sees that there was a change in the tone, change in the attitude to do whatever we needed to do and go ahead and get it done. And yes, it looks messy for a short time period, but from a long-term standpoint, it really cleans it up and puts us in a great position in the logistics industry.

This is John. I would add, this is John. We did 3 start-ups of new contract operations in the second quarter, which because of the pandemic we were penalized. We had the expense, but we didn't get the revenue. And now we have 2 starting up in the third quarter. So the maturity of the first 3 and finalizing the last 2 are going to show positively for the second half of the year as well.

And we'll take our next question. Caller, please go ahead.

It's Jason Seidl from Cowen. I want to focus a little bit on your average revenue per tractor and your mix of business that you expect going forward. So how should we look at that? Not only are -- is the industry obviously seeing spot truckload rates go up, but you might be seeing, I think, a spike in team business in the back half of the year, if I'm not mistaken. So talk to us a little bit about what should we look out for 2H '20?

Yes. Let me start. I'm going to give like a quick little overview. I'm going to let John kind of follow-up. We said in the release, we're going to average in the second half of the year about 2,550 trucks. Kind of the breakout of that, kind of as you think about it, expedited, we will settle in around 950 trucks; our dedicated true, what we call long-term contracts, fixed minimum guarantee, dedicated, it's going to end up around 800 trucks; and our solo fleet, around 750-ish trucks. So as we move those -- as we move -- continue to get the fleet settled into each of those buckets, it is going to be, I think, potentially a little bit more messy as people kind of see the movements of those throughout the second half of the year. I think the opportunity for us, as we see there today, where is the utilization or let's call it the revenue opportunity today. We still see it quite a bit in that irregular route, continuous smooth solo fleet and then some in our expedited fleet. And so that's kind of how the pieces are going to sort out as we move to the second half. I'll let John kind of talk about the kind of freight market and pricing, kind of, what we see today. John, you still on?

Yes, I'm here, Joey. So the freight market in general is strong everywhere across all 3 of our segments. As Joey pointed out, we're going to be submitting a strategic plan to the Board in August. It really is built around a goal of growing to over $1 billion in revenue enterprise, with about 2/3 of that being built around the assets. Those assets will be broken into three segments: expedited; our true dedicated, which is dedicated business that has contracts 3 to 5 years for a specific customer; and then our solo operation, which is really built from scheduled continuous move type work. It's not what everyone used to call the gypsy solo. It's more of -- we've got a select group of customers that were doing round-trips, scheduled runs for. If you look across all 3 of those segments today, in addition to our freight management group, freight is strong, and we're evaluating right now of what our pricing strategy is going to be going into the rest of the third quarter and the fourth quarter of this year. So we're very optimistic about that.

Okay. That's great color, guys. On the -- on your fleet, you mentioned an average age of 1.8 years old. I would imagine that's sort of where the "goal" is and maybe even a little bit on the young side. What should we look at in the back half of the year on your CapEx spend?

Yes. I mean, actually, Jason, it's a little bit younger than we need to be. I think kind of the way to think about it is a lot of that dedicated fleet that we mentioned, John and I talked about can run 4.5 years -- 4.5 to 5 years. The solo side, depending on its utilization is around 4 years. On the expedited side, we kind of run 2.5 years. So as you sort through all that at 1.8 years overall, that on. That's really -- that's just a combination of the shrinking of the fleet, taking basically 450 trucks out from the end of December to kind of into the second half, it's moving that average age down because obviously, we're pulling out the highest cost to equipment to dispose of. So it's leaving younger equipment. So I think it's, on average, it's a little bit lower than it's going to be in long term. I think you'll see it move back into that 2 to 2.2 range. And CapEx, Paul?

Yes. CapEx, Jason, it's really going to depend -- we spoke about that $60 million plus in assets held-for-sale. It just really depends on how fast we can churn that out of here. The trucks are churning pretty fast. Some of the reefer trailers, not so fast. And so I think we're going to be anywhere from net proceeds of, call it, negative 10 CapEx to positive $10 million in CapEx for the remainder of the year with, kind of, a target being about a net neutral, really just depending on the effect of the used equipment that moves out of here. And then that will -- there'll be a waterfall effect to that into 2021 as well as how much we carry over into the next year.

The used equipment market right now, Jason, is -- and don't think this is a proxy for the entire market, what we have on the truck side is relatively speaking, younger truck. And so it's getting a lot of attention. So we're excited about that. It gives us some confidence. I just -- we sold 136 trucks in the month of July, for example. And so that's a big month. And so we feel that, that momentum is going to continue through the end of the year. We do have a lot of reefers for sale. If anybody want any reefer they want to buy, give us a call. But I think the reefers could take us a little bit longer because the season is not over. And so we know we've been in that business a long time. We do have some drives. We're going to be pulling out of the fleet that we're a little heavy on that those are smoking hot. We don't have -- we won't have any problem getting rid of those. But truck fleet, I'm just really excited about. We have a younger product. It's not where the majority of the used market is. And so we're -- our product that we're showing in the market is pretty -- it's good right now.

And Jason, let me clarify one thing. When Joey said that we are reducing or getting out of the higher cost trucks, what he meant by that was operational costs. So fuel -- worst fuel economy and more maintenance and repairs that won't fit and so that's another piece of the improvement you're going to see on the cost side going forward.

Yes. And just to be clear, guys, I don't have room in my garage for a reefer trailer, so you won't be hearing from me. Since you sold so many in July, should we expect -- what kind of gains on sales should we expect in 3Q?

I would say, given how we impaired those, I'd say probably breakeven-ish kind of numbers. Breakeven...

Hopefully, we've gotten price, we're winning, losing no money. So at the end of the day, to go through all that work, which Paul and the team did a fantastic job, get a price to move them. But we don't want to be egregious either way, especially on the gain side. So we're trying to get them priced correctly. Everybody did a good job on that, and let's move them. And I think you'll see us move them.

And we'll take our next question. Caller, please go ahead.

Dave Ross here from Stifel. You mentioned in the second quarter, you got caught off guard by a couple of the dedicated contracts that had no guaranteed minimums. Were you able to go back and fix or change the issues in those contracts, meaning if something like this happens again in 6 months, will it be a different story?

John, why don't you take that one? I'll fill on it from you.

At this point in time, I don't -- we haven't been able to make any impact on that. I think we're waiting for the pandemic to allow us more to get in front of our customer again. And our prayer is the demand is going to get strong enough so that we'll be in a position with some of these customers that we can require a little more stickiness to the contract. But as we speak to this point, we have not. Now, on the other hand, if you look at in the second quarter, we lost 200 trucks worth of legacy Covenant dedicated business over the lack of contract stickiness. And we were able to replace a lot of that with new business where the contracts are more of a commitment from the customer standpoint. So trust me, if we can get a market and if we can get a customer that allows us to come sit down in front of them, again, we're going to increase the amount of commitment that our customers are making to our trucks like we are at their service.

And specifically, as it relates to the auto recovery, a lot of the OEMs had a fairly quick bounce back, whether that was just restocking or other, how would you describe the bounce off the bottom? And do you think it's done? Or do you think that there's more strength there to go for the auto guys to get back to where they need to be?

Yes. So 2 of our automotive clients are really strong. One is kind of got a scratching our heads a little bit. So I think if you were to look at it today, it continues to get stronger by the week. As a matter of fact, in some areas because of what we did with cleansing our driver base, we're struggling a little bit to catch up. The customer is allowing us a little grace in that area. But it continues to get stronger every week. So at this point, I can't really tell you we can see a ceiling on demand from the automotive folks, but we're just watching it every day to see what it yields.

And I want to add a little bit to that also is that when you look at the way in which we've been going for the last 3 years, and that is in a nutshell contract logistics being 75% eventually, I think we're kind of 50-50 right now, but 75% in the future, which is not just dedicated, but warehousing and TMS, et cetera, in that bucket. And then the expedited side being about 25%, 30% of the total. That's what the Covenant Logistics team will be. And as we look at the -- what we're calling the -- you heard 2 comments. One is the solo side. And you also heard continuous movements. There is no doubt as we build the dedicated side of the business that John is talking about there with the long-lasting contracts that are there, that's the way that the dedicated side is going to go. That say, in 2 points, one is, I could tell you, during the second quarter, I would say, if not 100%, 99% of it has been flushed out. I mean the ones that did not have the contracts that you or me would low ended and allowed out clauses and allowed 30-day notice or allowed them to take down 50% a month and those kind of things, they've all done it. I mean, those are, I want to say, 99% of those customers exercised that in the second quarter. So then when you look at the solo side, that we call it solo 750 trucks, a lot of that, probably 400 of those trucks are in what you heard continuous movements. Some of that business we've had for 25 years. We call it continuous movement because it doesn't have a 3, 4, 5-year contracts like we are going to be building the dedicated side of our business. But it does have continuous movements evident by the fact that we've been doing it for so many years. But that then, when you had a pandemic, and they shut plants, there is no recourse. There was no fixed cost that was covered. It was just down to nothing waiting on the plant to open of where we got hit out on that. That said, that business, that continuous movement business, operates at, Joey, 8%, 10%, 12% margins. I mean very, very good margins that we've had for 20, 25 years. It just does not have a pristine contract that we want. But let me tell you, it's a lot better than having OTR and say, I hope that they give me a load today when there's not a pandemic. So I hope that it at least clarifies what we're saying on that continuous movement fleet.

Yes. And I don't think pandemics are going to become an annual occurrence. So you're probably well positioned going forward. Last question I've got is on the driver retention. You mentioned getting more aggressive on safety and probably culling some drivers that might have been more of an insurance risk, which should help you going forward. But near term, given the demand surge, puts you in a place where you couldn't accept as many loads maybe as you wanted. Do you see any pay pressure in the second half for drivers as you look to refleet or reseat the tractors?

Go ahead John.

Yes. Absolutely. Absolutely. I mean, especially, I guess the wildcard here is what happens with the government support and unemployment and those type of things. But I do think the quality of driver that we want in our trucks is going to continue to cost us more money, especially to inspire the high-quality teams to get in our team trucks, so we can grow the capacity in that part of our business. So I don't think that we're in an environment where we're going to have the privilege to be like some driver pay it all. I think we're going to just continue to have to be wise to make sure that we identify what are the attributes needed for each of the individual driver jobs that we have across our asset business, and make sure that we stay on top week-over-week by watching what's going on with the front door in recruiting, what's going on with turnover. We spend a lot of time looking at when drivers leave us, where do they go? The verification process gives us visibility to that. So we're using that as an indicator of, are we losing a driver over just another job? Or is it pay? Or what's really inspiring our driver to want to move? So -- but I don't think the pay thing is over.

No. I agree, with John, 100%.

I will take our next question. Caller, please go ahead.

It's Wesley on for Scott Group. I appreciate you guys saying you're optimistic about pricing in 3Q and 4Q. And we were kind of close to flattish in 2Q. So wondering if we can see that inflect positive by 3Q or if that's a 4Q event? And to what magnitude you might be thinking.

I think what -- our pricing is moving. It's kind of interesting. There's no question that before your pricing moves, you got to have volume movement. We can price all freight, we won't, but if somebody is not willing to give it to you, it doesn't matter. You won't get any miles on your trucks. And so you've got to have some increase in quantity volume before you can aggressively or even reasonably move the pricing. So what I think you've heard David say, John, say, volume has been moving significantly. And our -- we saw it in our revenue per truck in June. We were up double digit, about 10% in the month of June in revenue per truck on the truck side of the business. And July was up even more than that.

On a year-over-year basis.

On a year-over-year basis. And so that's -- that is a proxy of volume, mix and pricing. And so I think it's a little early to say yet. We're confident because remember, a year ago comparisons have gotten much easier as we move into the third quarter based on what was going on a year ago also. I think it's a little early to say what the range could be versus year ago yet. I think we're extremely confident that revenue per truck versus year ago is going to be up very, very nicely. Now the combination of that, whether it's utilization or pricing, I think you probably ought to hold on that for right now, so we get a little bit more clarity on the full quarter.

Joey, you mind if I make a comment?

Go ahead.

A couple of things. Remember, going forward, only about 40% to 45% of Covenants assets will be as much at the pressure of the commodity market as have been in the past. If you look at our continuous move, regional solo, and our dedicated business, those -- the pricing on those is really driven more from pricing, P&L, cost-plus modeling type approach. So what we're looking at in those two areas is really trying to get our arms around, what is the industry really seeing from standpoint of inflation in two primary areas: One is insurance and other is drivers. And using that as the foundation of going back to our customers, ask for additional pricing or revenue support. So that's kind of maybe a little different in how you've looked at Covenant in the past, and that's what we're going to be looking at as we go forward in the second half of the year and approaching our customers.

Yes. And as you -- to kind of add to this great point is, as you steer the business kind of mix moving into that continuous move to dedicated from the more volatile expedited side as the mix moves, not that mix is going anywhere as it becomes settles into a kind of a, let's say, call it, 1,000 trucks, that impact to our overall volatility in pricing is going to drop dramatically. And peak is always going to be important on the expedited side, but it's going to become less of an issue or an impact going forward.

Okay. And I know you were kind of already asked about profitability in 3Q and 4Q, but I just want to ask again more specifically on OR if you have any kind of directional idea of where July might end up? And what could be reasonable for 3Q and 4Q?

Wes, this is Paul. I think mid-90s. So we're kind of high 90s in Q2 and on an adjusted basis. And it looks like mid- 90s is definitely in the hunt.

Okay. And one more. Can you quantify the overhead you're taking out of the business? And how much you've seen in 2Q and how much you might see in 3Q?

Let me see if I can answer it this way. We have a very specific target that we've committed to our Board that we would achieve by the fourth quarter on fixed cost reductions. It was disclosed back in our proxy related to our 2020 incentive plan. And so you'll see in there a fixed cost target reduction that I want to say was about 22% -- 22%, 23% reduction in overall fixed cost. I may be off on that Wes. I'm a little late, Paul, help me, get me out of the ditch, I'm turning off of Richard, so keep me out of the ditch, but I think it was around that number.

I think the proxy might have been more general term and not giving an exact amount but you can check that.

So a big reduction. And included in that fixed cost target was interest expense because that's just cost of capital. So we are -- I'm really encouraged by all the teams divide and conquer and assigned, and we're going to hit that. We're going to exceed that target. And so as far as numbers of teammates, which is very difficult, I know that we had about 1,500-ish non-driving teammates, including 500 of that 1,500, let's say, were warehouse team members. So the 1,000 non-warehouse, non-driver team members were probably down 250, 25% of those since, let's call it, April, and a lot of those were assigned in our Texarkana operation, a lot out of our corporate overhead. So it's been aggressive.

I think, Joey people -- you just said, I think, about 250 people will get us back to the $1 million a month in depreciation, that's the biggest number. And then interest, net debt is down $111 million at the end of July from where it was at June 30. And so you can take a 3.5%, 4% interest rate on that. And that's going to be -- your interest will be $0.5 million a month as well.

Yes. And keep in mind, you asked kind of how that was flowing. The 250 people, quite a bit of that cost was still in the second quarter, as people kind of work through the end of their tenure here. And so more of that will come in the third quarter. And then there's still a handful counting the six executives included in that, that will, at some point during this quarter, roll off so that entering the fourth quarter, they should be pretty much done, or we should be pretty much done for that.

[Operator Instructions] We'll take our next question. Caller, please go ahead.

This is Nick Farwell, I have just a quick follow-up question. I was a little confused by your Joey or David, I'm not sure someone mentioned it, your average second half truck would be roughly 2,550, as I remember. You end June at 2,820. I think David commented or someone commented that you're trying to reseat trucks because of, obviously, all the demand. So I'm surprised you'd be cutting trucks further 270, when you're also commenting, you're trying to add butts to seats, or drivers to seats, however you want to describe it. Did I miss something? Did I miss something in the arithmetic or the directional indication about trying to add a little to capacity?

Yes. I think to open, Nick, this is Paul. Trucks at the end of July, we're down to 2,543 in the month of July and they're averaging about that 2,550. So between June 30 and July 31, most of those trucks came out already. And then some of those are open, to John's point, because of the market, the blatant work and whatnot. So we're basically -- the July numbers that we were alluding to a minute ago, we're basically already at that target and expect to hold the truck count flat. It's just trying to get all of them seated end of June number -- at June end, and I think, well 2,623.

The end number was at 2,800. That was the average number probably. So it was 2,623 already at the end of June, as we reported, will go down to 2,543 by the end of July.

So Nick, think about 3 things. One is making sure we consolidate our quality drivers to get as many things as we can get operating, not only on the expedited side, but remember, we got some teams on the dedicated side as well. The second thing is to make sure that we only have high-quality drivers driving our trucks. From an insurance and risk standpoint, we're getting really serious about our exposure. And making sure that we're doing a good job putting the right people in our trucks. And then the third thing is we're making sure the freight that we put on the trucks that we have is profitable. So the combination of focusing on those 3 items has created a little disruption as we've gotten to rightsizing our fleet. And our -- if you look at this plan that we're going to be presenting to the Board, what it's really going to say is, we're going to get to buy 2,750 trucks over the next 3 years, and we're going to make sure that they're investing where they bring us the best ROIC. So that's kind of what we're setting ourselves up for going forward.

And still growing the 3P on the transportation management side, in the warehousing time, in the warehousing side, especially to have really strong margins.

One other quick question. You said the optimal mix at this particular point of time was 950, 800 and 750 solo. Are you approximately at that mix now and then you're just sort of fine-tuning it? Or do you still have some readjustments to make on the...

We're pretty much there and fine tuning...

No, let me give you a picture just to kind of show the impact of the fleet reduction and its impact to revenue per truck. In March, our revenue per truck for the month was up about 5%. This is consolidated. All the fleets saw where we were. April was down 2%. May was down 1%. June was up 10%. July was up significantly more than that. So the impact of the fleet rationalization into the revenue we're producing on the trucks, total trucks that we're running, it's been significant. And so I think that's given us great encouragement that the movement that we're trying to accomplish is actually showing itself in the actual production on the assets. And so I think, as John said, now, we're in the tweaking mode, 50 here, 20 here, good-looking new piece of business, where we're going to find that capital because we're not going to grow the fleet. I mean, it's -- we're going to move assets as we need to move those assets for new business. Next year, I think, again, we're not into '21 yet, but as John kind of laid out a 3-year vision. But next year, we are planning a little growth next year, but let's not talk about next year now. Let's get the fleet stabilized, which I think we're close. Are we achieving the cost reductions that we've targeted, yes or no? And is it translating into what we expect on the bottom line, which, hopefully, yes.

Just a conceptual question. If you were up 10% in June, how much of that was price versus, I'll call it, productivity? Just roughly, is it 50-50? Is it ...

The large majority is productivity [Technical Difficulty] go ahead John.

So the other thing Nick, I was going to say is, keep in mind through this transition, we're going to be putting some business rules in place and some disciplines. And it's going to cause a little noise around this truck count. For example, we're looking very seriously at what percentage of our driver base are we going to allow to have been with the company for less than 120 days? And as we've kind of cleaned up this churn of drivers and seeing the impact it has on our costs and our productivity and safety, some of those disciplines are going to cause a little bit of disruption while we're integrating them over the next couple of months. So that's the other thing we're dealing with a little bit in rationalizing these trucks and routes.

Also one more thing, Nick. One of the things that we talked about was there were several unidentifiable costs related to the exit of those trucks and trailers. And so what you see included in total miles is going to be some non-revenue miles that were moved to move the fleet in position to be sold or to be prepared for sale and those type of things. And so that shows up on the cost side, but it also kind of reduces the rate a little bit, too, in those circumstances.

And we're not done with that. There's going to be a little bit of that in the third quarter as well with trailers.

So really, just to sort of finalize this thought process. Really the rationalization, the restructuring, all of which has been really occurring over a relatively short period of time is going to likely begin to really manifest itself, again, subject to the economic environment, in this upcoming retail season. I mean that's where we really see if you guys are improving the internal profitability of the business, because you had such a seasonal period in Q first, what, 2 to 3 months of early '21, presumably?

That's right. Yes.

And we intentionally took advantage of the lax period through the second quarter in the pandemic to really hit at all and we did.

And so just finally -- by the way, I applaud this, not that it makes any difference whether I applaud anything or not, expediting the process of rightsizing the company, it's always difficult. Obviously, like to do at the optimal time when perhaps the end of last year or the first quarter of this year when business is tough anyway. But these are very -- my impression is, these are extremely difficult decisions to make, and they aren't made necessarily overnight. So you probably made the decision sometime. I don't know the answer to this, but February or March and then accelerated it throughout a period in which your business was actually improving, improving broadly notably. And instead of dissipating that effort, you accelerated. I just find that -- I applaud you for it for whatever the hell that's worth.

Nick, a lot of reason that it was improving was the changes that are being made. So it wasn't just the market, in my opinion, given this was included, the choices that were being made are being made.

Well, you basically said that with productivity enhancement close to the 10% in June. I mean, that's -- to me, that's a hugely impressive operating number. I mean that -- what better confirmation do you have about the improvements you're trying to achieve over a relatively short period of time...

Keep talking Nick.

We got some awesome people, and they got it done in the second quarter.

And we'll take our next question. Caller, please go ahead.

This is Jack Atkins again. Just a couple of clarification points, if we could. Back to the question on operating ratio in the second half of the year. Paul, I think you said you expected mid-90s. Is that a comment on the third quarter, comment on the second half overall? Could you just maybe clarify that for folks so we can have our models sort of calibrated correctly?

Third quarter.

Okay. That was kind of in the third quarter. And then I guess you would expect sequential improvement from there into the fourth just with seasonality?

We hope so.

Just -- yes, give us a little time.

Understood. Understood. You got to -- I'm a sell-side analyst, you got to excuse me, I'm getting excited. Okay. Last question, and I'll be through. But the 22% to 23% reduction in fixed costs, Joey, that you referenced, could you maybe give us a sense for what dollar amount that's based on? Just so we can kind of maybe think about the way to quantify that in terms of dollars?

Jack, one thing before he answers that, to keep in mind is that some of that capital cost with truck plus trailers that was earning revenue against it. And so it's not all just hitting the bottom line. So there's some margin changes in that from taking those costs out, not just dollar-for-dollar cost out.

The same thing, a big interest reduction, but you're going to lose the top line revenue on TFS.

Well then maybe to ask a question in a different way. Is there a way to think about the cost, when we kind of finish this, these sort of transformation initiatives, and you guys seem to be in the seventh, eighth inning of it. How should we be thinking about the cost or the improved profitability of the underlying business, apart from what's happening to the freight market, just trying to think about how all this nets out in terms of improvements in the underlying profitability of the business. Is there any way to kind of help us frame that up?

Well, I think as you move forward, hopefully, we do a good job of giving you that visibility into those pieces. So in essence -- so here's a couple of points. If the fleet is down 25%, our fixed cost needs to be down at least 25%, or we're not -- we're getting less efficient. So if you look at what the fleet is going to be down 16%, 17%. So assuming you keep every bit of that revenue and you won't, your fixed cost needs to come down with that. Not only depreciations should come, your interest expense should come, your indirect cost should come. All that should come down. And that's part of a lot of the terminal changes that we made starting last year into this year was, as the fleet was -- we thought was going to be -- would need to be rationalized, our fixed cost investment in our terminal network was, we just felt was too high. And we had some properties that were very valuable. And so we made some hard decisions on that, too. So the fixed cost reduction, if you just focus on the fleet side for a second, it's got to move big to keep us -- to allow us to gain momentum to get more efficient, which then should turn into better OR on whatever those divisions are that use those assets, all things else equal. So yes, I'm saying our fixed cost should be down. It has to be down significantly as we brought the fleet down just where we can move forward in efficiencies for better OR to your question.

I think you can also add to that, that quite a few of those trucks were operating at above 100 OR that we're taking out. So just by reducing the fleet, in those cases, you actually improve your profitability because they were showing a loss at an operating level. So I wouldn't tell you how many trucks that was, but it was a pretty good-sized number, especially on that solo refrigerated side.

I think that on the managed freight side, which is where we have our brokerage business, combined with our warehousing and TMS business, that's what we call managed fleet. The return on invested capital on that side, the OR needs to be, let's call it, 97-ish or better to want to justify or to receive, let's call it, mid-teens return on invested capital or better. So that's the target in our minds. 97% is kind of the -- all right, we need to make it sure it's at least a 97% or better there on the truck side or the asset side, if you will. Dedicated -- in my mind, we need to have at least a 92% or better to justify the return of the investment on capital, most of that solo. And then on the expedited side, I mean, it needs to be mid-80s just because the capital needed in that business, you have a much higher invested capital base on the expedited side because you're turning that equipment quicker. So therefore, you have a higher investment. So your turn needs to be better, plus it's more volatile. So that's kind of the numbers that we're kind of looking at in the 3 pieces. I think we're not there. I think dedicated, let's call it, knocking on that door. I think managed freight is knocking on that door, expedited has some opportunity, and we think a lot of things we're doing there, next target is not broke. But it's just -- I think there's some opportunity to really dial that in more. Those are kind of the targets around those 3 that I would point you to.

And we have no more questions in the queue at this time.

Well, we appreciate everybody and your time today. Great questions, and appreciate your patience, and we look forward to talking to you next quarter. Thanks a lot.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.