Covenant Logistics Group, Inc. Q4 FY2025 Earnings Call

Welcome to the Covenant Logistics Group Q4 2025 Earnings Release and Investor Conference Call. Tripp Grant will be your host for today. I will now hand the call over to Mr. Grant to begin.

Yes. Thank you, Ross. Good morning, everyone, and welcome to the Covenant Logistics Group Fourth Quarter 2025 Conference Call. As a reminder, this call will contain forward-looking statements under the Private Securities Litigation Reform Act, which are subject to risks and uncertainties that could cause actual results to differ materially. Please review our SEC filings and most recent risk factors. We undertake no obligation to publicly update or revise any forward-looking statements. Our prepared comments and additional financial information are available on our website at www.covenantlogistics.com/investors. Joining me today are CEO, David Parker; President, Paul Bunn; and COO, Dustin Koehl. We're going to modify our opening comments from the usual format and address three key areas before covering the usual statistical and segment information. One, our view on the freight market; two, the equipment impairment charge and our capital plan; and three, a small acquisition we made in the fourth quarter. The freight market. We believe the freight market continues to evolve towards equilibrium between shippers and carriers. In fact, we might be at equilibrium now. During the fourth quarter, spot rates rose meaningfully. Revenue trends during the first three weeks of January have meaningfully improved compared to the prior year in all business units. We are also experiencing a sharp increase in bid activity with shippers who are interested in securing capacity contractually. Currently, we have also secured a few low to mid-single-digit rate increases that take effect during the first quarter within our expedited fleet and anticipate additional increases across both Expedited and Dedicated to take effect early in the second quarter. Based on regulatory changes, cost inflation, and the amount of insurance and claims risk inherent in the industry, we would not be surprised for industry-wide driver and truck capacity to continue to decline, perhaps materially. At the same time, most trucking cycles are led by demand. In our view, inventory restocking, tax stimulus and corporate earnings are biased in favor of improved demand. Equipment charge and capital plan. Operating a safe, fuel-efficient late-model fleet requires constant cycling of equipment to keep operating costs down and driver satisfaction up. With intentional fleet reductions and declining used equipment values in 2025, we deferred some trades, stacked up deliveries and have too much underutilized equipment. To improve our operations and balance sheet, we have moved a group of assets to held-for-sale status and lowered our expectation on disposition prices. Since our current size asset-based fleet is not generating the desired return on capital, we will not replace all the units disposed. We expect a modestly smaller fleet at the end of 2026 and only $40 million to $50 million of net CapEx for the year. Within our asset-based fleets, we expect the agricultural-related business within our Dedicated segment to grow and the other fleet serving more commoditized freight to shrink, will remain stable through our weed and feed approach. Overall, our goal is to reduce balance sheet leverage and improve return on capital. The acquisition. During the fourth quarter, we acquired the assets of a small truckload brokerage company. The business, which we will operate under the name, Star Logistics Solutions, has two niche customer bases: state and federal government emergency management departments, which represents an episodic and highly profitable disaster response capability that scales quickly to address hurricanes and other natural disasters; and two, high service consumer packaged goods companies, which affords leverage to general commodity freight market cycles that our asset-based truckload operations lack. With synergies, we expect Star to be accretive to earnings during the first half of 2026. With that background, I will move on to the quarter's statistical review. Year-over-year highlights for the quarter include: consolidated freight revenue increased by 7.8% or approximately $19.5 million to $270.6 million. Consolidated adjusted operating income shrank by 39.4% to $10.9 million, primarily as a result of margin compression in our Expedited Managed Freight and Warehousing segments, partially offset with improvement to Dedicated operating income within our Dedicated segment. Our net indebtedness as of December 31 increased by $76.9 million to $296.6 million compared to December 31, 2024, yielding an adjusted leverage ratio of approximately 2.3x and debt-to-capital ratio of 42.3% as a result of executing our share repurchase program and acquisition-related payments. The average age of our tractors at December 31 increased to 24 months compared to 20 months a year ago as a result of year-over-year reductions to our high-mileage expedited fleet and growth in our less capital-intensive dedicated fleet. On an adjusted basis, return on average invested capital was 5.6% versus 8.1% in the prior year. Now providing a little more color on the performance of the individual business segments. The Expedited segment reported an adjusted operating ratio of 97.2% for the quarter, a performance that did not meet our expectations even in light of a softer freight environment. Results were partially impacted by the U.S. government shutdown, which persisted for nearly half the quarter. Despite these external challenges, the segment did not perform to our operational standards. Accordingly, we will continue our disciplined approach to fleet optimization by reducing fleet size and focusing on higher-yield freight. Looking ahead, we anticipate fleet capacity will adjust modestly in response to market conditions. As the market improves, our strategic priorities remain enhancing margins through targeted rate increases, exiting less profitable business and onboarding more profitable opportunities. Dedicated's 92.2% adjusted operating ratio was the best for any quarter during the year. We were pleased by how this segment improved its results each quarter throughout the year and are excited about the momentum we are taking with us into 2026. Dedicated grew the fleet by 90 average tractors or approximately 6.3% compared to the prior year as we have continued to win new business and specialize in high-service niches within that segment. Going forward, we plan to focus our efforts on continuing to grow these high service niches and reduce certain of our fleet that is exposed to more commoditized end markets where returns are not justified. Managed Freight experienced a significant improvement in freight revenue in the quarter as a result of the Star Logistics Solutions acquisition that occurred in October, but margins were compressed as a result of the growing cost to secure quality brokerage capacity. Over the longer term, our strategy is to grow and diversify this segment. Given the asset-light nature of this business, we note that an operating margin in the mid-single digits generates an acceptable return in capital given the asset-light nature of this segment. During the quarter, our Warehousing segment successfully launched operations with a key new customer, resulting in a 4.6% increase in freight revenue or $1.1 million compared to the same period last year. However, adjusted operating income declined by $1.6 million, primarily due to increased start-up costs and operational inefficiencies associated with onboarding the new customer as well as higher labor expenses, including overtime at other warehouse locations to manage peak volume demand. Looking ahead, we remain committed to driving organic growth within this segment and are focused on enhancing our operating income margin with a target of reaching high single digits. Our minority investment in TEL contributed pre-tax net income of $3.1 million for the quarter compared to $3 million in the prior year period. The impact of compressed leasing margins, a soft used equipment market and incremental bad debt expense in the quarter placed continued pressure on TEL's pre-tax net income. Although TEL's overall business and balance sheet remains strong, exiting capacity from the general freight environment is expected to continue to impact them over the short term. Regarding our outlook for the future, we remain optimistic about improving freight fundamentals, our ability to be more efficient with our equipment and capture operating leverage and improve financial results in 2026. The improvements are likely to come later in the year with the first quarter being impacted by seasonality, extreme weather, a still developing freight market situation and a potential margin squeeze in managed freight. The last few years have been characterized by acquisitions, dispositions and share buybacks as we have revamped the company. We have a stronger, more stable business and have recently added a piece that restores a measure of freight cycle upside. 2026 is all about execution, and we are hard at work to get that done. Thank you for your time, and we will now open the call for any questions.

And our first question comes from Jason Seidl from TD Cowen.

I guess my first question is, you mentioned in your Expedited segment, you're getting low to mid-single-digit price increases that are pushing through. Is that the average now? Or is that just you're starting to see a few of those roll through? And I guess, what are your expectations as we move through the bid cycle?

Yes, it's both. The average is around 3.5% for the first three weeks of January, and it is gaining some momentum. So far, I am pleased with how the discussions are progressing. While I'm not ready to commit to the number being 3.5% for the long term, customers seem very receptive. They recognize that the industry has struggled with rates over the past four years, which may have fostered some empathy. I feel optimistic about the rate opportunities. The outcomes will largely depend on economic conditions. If we achieve 3.5% now, we're being very transparent with our customers and maintaining constructive conversations. We hope to revisit this in June, among other things. This reflects our position after the first three weeks, and while it’s too early to declare a trend, I am encouraged by our initial performance.

And I would add to that. I mean, I would add a little bit to that on the rates from existing customers is one thing, but we're also starting to win business at higher rates. And one of our themes for this quarter has been capital allocations. And I think we're going to have some opportunities to redistribute capital to some of those newer, higher-performing businesses with customers that perhaps we can't get the appropriate rate with. So it's not just pure rate on existing customers. I think that one of the bright sides of what we're seeing, and we said in the release or the opening comments was that we are starting to win business at a pretty decent price. You go back 12 months ago to win business, you were having to price it at a breakeven or a slight loss just to win anything.

Yes, I agree. A year ago, new business was coming in at an even lower level. Now, all new business can replace less profitable business.

Now it feels like there's a lot more bids now than there was, let's say, a year ago in the marketplace. Are people just trying to pull forward the bid because they're worried about maybe how the supply-demand market is going to look for truckload, call it, six months from now?

Yes, Jason, our bids in January increased by 33% compared to the fourth quarter, which can be attributed to two main factors. Firstly, companies are trying to get ahead of the situation, and I completely understand that since I would do the same in their position. Secondly, many of the bids we're receiving are from new customers who appear to be concerned about capacity and are reacting to what they observe in the market. These are the two key points that I notice regarding the current situation.

Here's what I'd say they're concerned about capacity. And I would tell you, cargo theft has ticked up a little bit in the last four, five months. It was really bad in 2023, early 2024. A lot of people did a lot of things. And I would say it was beaten down pretty good for two years. And what I'm seeing people say, especially is I need a high-value program, I need assets. More in the past six to eight weeks than in the last six to eight months or 16 months.

That's great color. I got two more quick ones, and I'll turn it over to the next person here. On the Warehousing side, it seems like your revenue is up, obviously, profit is not, but there were some start-up costs. Should we expect that sort of...

It will get better.

It will get better. And my question in terms of the Warehouse space bookings, it looks like Prologis had some positive commentary on that. I'm just wondering what you're seeing out there in terms of the bookings? And then I got a balance sheet question after that.

Yes. On the Warehousing side, everyone remembers how tight it was in 2021 and 2022, with a lot of overbuilding in the warehouse space. It became quite loose in 2023, 2024, and the early part of 2025. I agree that things are tighter now than they have been in the last 24 months, but they're not as tight as they were in 2021 and 2022. To answer your first question, yes, we took on two big accounts in 2025, with one of them starting in November, which created a significant drag on the fourth quarter. I can say that Q1 will perform better than Q4, and Q2 of this year will improve further compared to Q1. Consequently, we expect incremental improvement each quarter.

That makes sense. And then, Tripp, obviously, you guys just made an acquisition of a company that looks like it diversifies the business mix a bit in terms of getting more governmental relief contracts and everything else. But how should we think about you guys going to market for the remainder of '25 given the balance sheet that you have now? And what's your level of comfort in taking that leverage ratio up?

Yes. I think you meant for '26, but...

Yes, sorry.

I often make that mistake too. Our leverage following this acquisition is slightly higher than our long-term preference. While we haven’t publicly stated a specific target, we aim to maintain moderate leverage. Considering the excess equipment we have yet to sell, which we expect will move in the first quarter, along with the new acquisition from October, we anticipate improvements in our leverage. I believe the leverage ratio will enhance starting in the first quarter and should continue to improve with our capital plan. We are quite optimistic about 2026, and any future acquisitions will require significant work. Our primary focus for 2026 will be to integrate our current assets with the Star acquisition and position ourselves to seize emerging opportunities, which we are already beginning to notice. There will likely be further developments due to market changes, leading to disruptions among other peers regarding capital costs. We are prepared to capitalize on new opportunities and need to allocate our capital efficiently. While acquiring another company in 2026 could be beneficial in the long run, it also poses a potential distraction. Therefore, our main priorities include reducing our debt, ensuring flexibility, and leveraging market changes as they arise.

Appreciate all that color, Tripp, and you guys try to stay warm out there.

And our next question comes from Jeff Kauffman from Vertical Research Partners.

There are many developments this quarter. Can you clarify your comments on the equipment change, specifically moving equipment to for-sale status and adjusting your sales price expectations? Will this result in either a significant loss or gain from the sale of this equipment in the first quarter?

No, Jeff, this is Tripp. I don't think there will be a significant loss or gain. What we did with the equipment is essentially evaluate its market value, as required by accounting, since we pulled that equipment early and specialized in a time when capacity is decreasing in the market and there is an oversupply of used equipment. The appetite for used equipment is minimal. Therefore, we reduced its value to what we considered fair based on our channels for disposing of equipment. Looking ahead to Q1, we do not typically depreciate our equipment to reflect historical losses or gains. Instead, we aim to eliminate that fluctuation from our calculations. I expect things to remain stable in terms of depreciation going forward, with adjusted depreciation remaining flat from Q4 to Q5. It has been consistent throughout the year. Our gains and losses from equipment sales show we are nearly at breakeven, with a possible loss of around $300,000. While we may need to accelerate depreciation on some equipment being retired in 2026, the market is challenging to navigate as it changes quickly. Overall, we will have less equipment idling and depreciating. Consequently, what we anticipate is a neutral outcome. However, on a cents-per-mile basis, you might notice a slight increase, but in absolute dollar terms, I expect flat depreciation with no significant variance in gains or losses in the next quarter.

Okay. Question for Paul and David. Thank you, Tripp. So can you help us understand, I guess, two things: number one, where should we be thinking about fleet count for Expedited and Dedicated post the 4Q adjustments? And then as we integrate Star into the new business, not all of that is going to be managed freight. There's going to be an element of that, that affects Expedited. Will that require an equipment increase as a result of that? Kind of how should we think about the Star revenues basing across your divisions?

Yes. Regarding the Star revenue across the divisions, we won't need to increase our resources. Any business that shifts to the team side can be managed with our current teams. In terms of brokerage revenue, we previously mentioned losing a customer in the third quarter, so I anticipate that managed freight revenue will remain flat or increase each quarter moving forward with the acquisition. As for fleet count, we might see a slight decline in our Expedited account, perhaps reducing by about 25 trucks per quarter as we optimize operations. There is great freight available, but some does not justify the capital required to operate the teams, so strategically, we are attempting to redirect that freight to managed freight. If it doesn't make economic sense to continue running it on our assets, we are working to transition those contracts to managed freight. On the dedicated side, we plan to focus on improving our non-Ag business while continuing to grow the Ag business. Therefore, I expect the truck count to remain relatively stable, but we aim to enhance the margin profile in that area. Did that answer your question?

Yes, very much so. And then one other question. So looking at the metrics, it looked like the rev per mile ex fuel dropped by a fair amount in Expedited. And I'm assuming some of that might be related to the government shutdown and the lack of...

So it's all related, yes.

Okay. So we treat the fourth quarter more as an anomaly and kind of go back to the third quarter...

Yes. There are likely a few operational points to consider, and it probably ties back to the exact cents per mile rates you're interested in, particularly regarding the government business.

Okay. And then switching gears to Managed Freight. I think we understand what happened with spot rates and gross margins in that business. You mentioned new customer contracts coming in on your contract business. How long do you think it will take to get the Expedited freight margins back to where you want them to be? How long will it take to kind of adjust this pricing to customers for the new reality of the market on the Managed Freight side?

The statements you've made, Jeff, provide the answer regarding how long it will take to restore our operating margins to acceptable levels. This will be achieved through rate increases. We will always seek to cut costs, and that effort will continue. However, it's clear that the industry and we need to see an increase—whether it's 5, 6, 7, 8, 10, or 12 percent—to enhance our margins. Overall, I'm pleased with our performance in the first three weeks of January and hope to maintain this momentum as we engage with larger accounts and secure new business, which is likely to be priced 7% to 8% higher than our current rates. This is our strategy moving forward. I aim for the current 3.5% to be sustained and then begin to rise in March and April, particularly since the second quarter is crucial for us regarding rate increases with some of our larger customers.

Jeff, I want to share a quick observation regarding these storms. I was on the phone three times last night and twice this morning discussing this with our teams. We are handling a lot of it through Managed Freight, and we're securing some very good rates. However, the capacity is extremely tight and requires a significant investment. It's tighter now than it has been in any of the first quarters in recent years. With the second storm approaching, we're having to request higher rates from our customers compared to last week. Additionally, the carriers are also demanding more from us. It's quite challenging at the moment. As we've seen before, spot and storm activity influence this situation. Customers are beginning to realize that moving some of these goods will come at a higher cost.

All right. So I guess the takeaway thought is a lot is going on right now, but this is more of a kind of clear the deck for future opportunities quarter.

And our next question comes from Reed Seay from Stephens.

I had a quick clarify from a previous question on the Managed Freight revenue, you talked about being flat to up through 2026. Is that on a sequential or on a year-over-year basis?

I believe that when looking at the sequential data, Q4 Managed Freight generated $80 million in freight revenue, which was influenced by approximately two and a half months of the new acquisition along with some peak activity. I expect that there will be a slight decrease in Q1, but thereafter, we should see growth that aligns with our projections. The main point of interest will be our performance in the third and fourth quarters and whether we can achieve the growth we anticipate. For Q1 of 2026, I expect revenues to be below the Q4 figures, but we should start to see gradual improvements in top line revenue after that, averaging around $80 million per quarter, depending on any additional business we generate in the latter quarters.

Got it. And then on the Dedicated and Expedited side, you mentioned in Expedited in 4Q, you had some headwind from government that you called out in 3Q as expected. How should we think about maybe your margin sequentially from 4Q to 1Q? And then I guess, what your goal would be for 2026 is maybe you have some stabilization of demand within that Expedited and as you continue to improve your mix within that Dedicated segment?

I expect to see improvement in the Expedited segment from the fourth quarter of 2025 to the first quarter of 2026. However, I must mention the possibility of another U.S. government shutdown and potential severe weather that could negatively affect us. Assuming all factors remain constant, with our government business performing well throughout the first quarter of 2026 and with some rate increases from select customers, I believe we have a strong opportunity to enhance our operating ratio in that segment during the first quarter compared to the fourth quarter of 2025. I’m estimating an improvement of around 150 to 200 basis points, but it's still early in the quarter, and we haven't yet seen numbers that confirm this outlook. It’s important to note that in such conditions, costs may rise even if revenue increases. There is still a lot to learn, but I’m optimistic about significant improvement. Typically, the first quarter is our weakest period, as it takes time for drivers to transition after the new year, and things often start slowly. However, good weather in February can help us gain traction, and March usually proves to be a strong month operationally. We remain hopeful for a positive outcome.

And then what was your question on Dedicated?

It was similar in terms of what the margin's progression you would expect throughout 2026. And I think Tripp answered it saying you'd expected some sequential improvement through the year? I guess last one, real quick. I appreciate you entertaining some near-term questions. But Dedicated and Expedited, you're making a lot of moves to improve the business here and your revenue quality. What long term would you target for your margin profile of both of these businesses if these initiatives continue and they play out as you expect?

I'd tell you, I won't be happy until Expedited is in the 80s. And I think that Dedicated is 88% to 90% is kind of where I think Dedicated is going to go. And I think Expedited is going to be in the 80s. Now when we get there, I don't know, Reed, but that's our goal, and that's where I expect it to be at.

And our next question comes from Scott Group from Wolfe Research.

I want to take a step back. David, three months ago on this call, you expressed a lot of enthusiasm about what was happening in the market with supply and regulations. Now, three months later, how do you feel? Are you feeling more convinced about this, less so, or do you have any new data points regarding how many of the drivers you believe have already exited?

Yes, I'm definitely more excited now than I was three months ago, and I was already pretty enthusiastic back then. What I observed has only continued to improve, and I truly believe that we are in the early stages of the trucking industry rebounding. There are many positive indicators. Yes, it's January, and I have trucks ready to be loaded. I want to emphasize that there are plenty of encouraging signs. Bids are increasing, and we're acquiring new business at higher rates. We've secured some significant contracts in the last 48 hours, which is exciting. The rising bids and the capacity exiting the market are evident in our Managed Freight and across the trucking sector. Our margins are not where we want them to be, but that's expected considering that Managed Freight broker trucks will demand higher rates before we can obtain them from customers. However, we will secure these rates as this trend continues, and we are starting to adjust our pricing accordingly. There's an interesting statistic regarding the Department of Transportation. I think Duffy is an exceptional DOT person, and I had the opportunity to meet him in December. In my 53 years of experience, he stands out. There has been an increase in illegal CDL schools, which grew from 19,000 in 2019 to 39,000 during the Biden administration. Although DOT has eliminated 6,000 of these, we are still at 33,000. We're noticing this issue not only in our Managed Freight but also with our customers, which contributes to our ability to win more freight at higher rates. Our rates have increased by 3.5%, and that will likely continue due to capacity constraints. Regarding the economy, I believe GDP will be stronger in the upcoming quarters compared to the last four. Looking ahead to 2026, I see second-quarter GDP at around 3.4% and third-quarter GDP at 4.3%. Even with a potential government shutdown affecting the fourth quarter, I expect around 4% GDP growth. This is a significant increase compared to the past two years, where we experienced GDP growth of 1.9% and 2.3%. Capacity is also being reduced, and while I can't pinpoint whether it will decrease by 1% or 4%, I do know that even a 2% shift in capacity can significantly influence the market. Fewer drivers are leaving the industry, making it harder to enter. Overall, the economy will grow, and there are many positive signs. Did I address your question?

I think so. Okay. I guess my other question is, you have seen a significant shift towards LTL in Expedited over the past few years. What is your perspective on that end market? Does the transition to LTL limit some of the potential upside? How is the LTL mix changing? What are you currently observing in LTL? Additionally, how does this mix shift influence how we should view your potential operating leverage?

We have made significant shifts to LTL, especially in 2021, 2022, 2023, and even into 2024. However, that number decreased considerably last year as volumes and tonnages in LTL declined, which you have observed and reported. We may not have emphasized it, but we adjusted our LTL exposure last year due to the changes in the market. Consequently, our LTL presence is much lower now than it was in 2023. That being said, our LTL customers are relatively stable at the moment, although they are not achieving their desired performance. David, do you have anything to add?

No, I agree with that. But we also, though, in lieu of that is that we've gone to the market with a lot of our airfreight customers. And so I'm seeing a lot of that, that is building. I just think, Scott, at the end of the day, whether it's our LTL portfolio or whether it's our airfreight portfolio, freight forwarder portfolio that we do a lot of business with because of our technology and high security program that we've got, it's all about pricing. And when pricing is available to us to be able to pass on, you'll see returns coming back down or ORs coming back down, margins or whatever.

And our next question comes from Dan Moore from Baird.

I have a couple of quick questions. Many are curious about your model's flexibility to adapt to a potentially improving market. You've addressed some fundamentals that are showing signs of improvement in response to Scott's earlier question. The key concern is how your organization would adjust if demand rebounds in 2026 due to tax rebates or other potential catalysts. Specifically, if demand increases in April, May, or June, what is your go-to-market strategy in a scenario where there's a natural uplift in demand? How would the market dynamics change compared to the past three or four months, which have featured a unique supply situation?

Yes, Dan, I think in the first couple of quarters, whether we're in the process or getting ready to take action, you'll see that it's time for the industry to reclaim some of the profits we've lost over the last four years. I'm not looking to buy a large number of trucks to simply add more capacity. My goal is to increase my rates to acceptable levels, get my Expedited down into the 80s, and my Dedicated in the high 80s or 90s. I want Managed Freight to handle whatever remains to continue its growth. So I believe that once we reach that turning point, you'll see the industry becoming healthy again, and that is my objective along with the flexibility we'll have when the market changes.

Maybe same song, different verse. What percentage of the book, the total enterprise book renews in the first quarter? What percent in the second? What percent in the third? And in a market environment that gets better, would that look different? Would you be taking a second drink?

Yes, there are two key points to mention. First, the second quarter is significant for us, particularly in our poultry and Expedited sectors, as it always has been. We have customers who have consistently honored their commitments, even at lower rates, while we had to remain competitive with those rates over the past four years. If they contracted for 20 loads a week, they have generally fulfilled that commitment. We recently set rates through bidding, and we won’t revisit those until next January. About 40% of our customers are maintaining their agreements, while 60% will see two or three rate increases. Some customers who initially promised 20 loads a week ended up giving us only 7 and took advantage of the market, impacting our volumes. We will remain grateful to them but we need to secure additional funds. This situation represents roughly 60% of our business.

And gentlemen, at this time, there are no further questions.

All right. Well, we'd like to thank everyone for joining us today, and we look forward to talking again next quarter. Thank you.

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