Earnings Call Transcript - CVLG Q2 2022

Joey Hogan, CEO

Thanks, Erica. Good morning and welcome to our second quarter conference call. As a reminder, this 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; actual results could differ materially from those contemplated by the forward-looking statements. We ask you to please review our disclosures in our filings with the SEC, including without limitation, the Risk Factors section, and our most recent Form 10-K and our current year Form 10-Qs. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances. A copy of our prepared comments and additional financial information is available on our website, at www.covenantlogistics.com in the Investors section. I'm joined this morning by David Parker, Paul Bunn, and Tripp Grant. To start with, we are grateful to our teammates for again producing record earnings per share for any quarter in our history. The transformation of the company that we have been working on for the past five years continues to build our confidence in our direction and leadership team. Our asset-based truckload operations led the charge in the second quarter, improving its operating income by 76% despite a significant headwind in operating costs, primarily insurance claims expense and less gain on sale. The combined increased costs have affected us by $0.20 per share in the quarter. Additionally, the small acquisition we made in the first quarter, plus the continued pursuit of investing in our undervalued company stock contributed nicely to the improved results versus the year-ago period. Despite the murky economic outlook, we are bullish on Covenant. In summary, the key highlights of the quarter were: our freight revenue grew 15% to $267 million compared to the 2021 quarter. Adjusted earnings per share increased 70% to $1.63 per share from the year-ago quarter. Our asset-based truckload’s freight revenue grew 16% versus the second quarter of 2021 with 80 fewer trucks. Our less asset-intensive or asset-light managed freight and warehouse segments combined grew 14% compared to the second quarter of 2021. On the safety side, our DOT rate was 2% higher than a strong quarter last year, but development of a small number of prior period claims contributed to almost $0.06 per mile increase in insurance expense. Gain on sale was only $400,000 compared to $1.9 million in the year-ago quarter. Our TEL leasing company investment produced another record quarter, contributing $0.33 per diluted share, or an additional $0.17 per share versus the year-ago period. Due to the strong cash flow in the quarter, our net indebtedness increased only $10 million after utilizing $28.5 million of cash on share repurchases. We finished the quarter with a leverage ratio of 0.43x, debt to equity ratio of 14.6%, and return on invested capital of 15.7%. Now Paul will provide a little more color on the items affecting the business units.

Paul Bunn, CFO

Thanks Joey. For the quarter, our asset-light businesses comprised of managed freight and warehouse were 37% of total freight revenue and 34% of consolidated adjusted operating profit. As we have discussed in the past few quarters, the managed freight revenue growth versus a year ago is beginning to cool as the market softens and the surge in demand recedes. However, the net revenue margin continues to be strong and we have an active pipeline for new business. By the end of the third quarter, our warehouse team will have established three startups for the year, primarily in the second quarter. We will focus the remainder of the year on maximizing the revenue and margin opportunities to grow income. The asset-light group remains a priority for growth, focusing on talent acquisition and technology enhancements. The expedited division was 35% of consolidated freight revenue and 55% of adjusted operating profit in the quarter. It grew its revenue by 23% versus the year-ago quarter due to strong revenue per truck improvements and growth of 40 trucks. The first quarter acquisition contributed significantly to revenue growth. Expedited produced a record adjusted operating ratio of 83, a 310 basis point improvement over the second quarter of last year. Our freight network is not overbooked but remains balanced. Maintenance, insurance costs, and less gain on sale were major headwinds in the quarter, but we feel driver pay is in good shape at the present time. Our expedited leadership team is doing a great job of managing through this economic transition. The dedicated division was 28% of consolidated freight revenue and 11% of adjusted operating profit in the quarter. This division continued its steady improvements, with adjusted operating ratio improving slightly versus the first quarter and 360 basis points from the year-ago period. Revenue per truck per week grew 17% compared to the year-ago quarter, while cost increases in maintenance and insurance and lower gain on sale also consumed some of the margin improvements. The weed and feed process continues with another 122 trucks planned to be upgraded in the third quarter through either replacement and/or revenue per truck pricing improvements. Based on what we see today, we feel good about our goal of a 200 basis point sequential operating ratio improvement in the third quarter. The pipeline for the remainder of the year remains robust, supporting our expectation that margin improvement will continue. Our minority investment in TEL continues to produce strong, positive results. TEL’s revenue in the quarter grew 33% and pretax operating profit increased by 123% both compared to the second quarter of 2021. TEL decreased its truck fleet by 60 trucks to 2,013 and grew its trailer fleet by 117 to 6,869. Our investment in TEL, included in other assets in our consolidated balance sheet, grew $7.1 million to $58.1 million. As a reminder, TEL focuses on managing lease purchase programs for clients, leasing trucks and trailers to small fleets or shippers, and aiding clients in the procurement and disposition of their equipment through a robust equipment buy, sell, and maintenance program. TEL contributed a total of $0.33 per share to our overall results, or an additional $0.17 versus the year-ago quarter. We expect the second half of 2022 to exceed the adjusted earnings per share of 2021, bringing the full year 2022 to a minimum of $5 per share. We do believe there will be market headwinds from continued inflationary pressures and softening freight demand, but based on company-specific factors, the investments we have made in the sales team, the small acquisition, the share repurchases, and returning insurance costs to more normalized levels, we are very confident in the second half and planning for 2023. Over the last five years, our customer base has been intentionally moved to less cyclical industries through our full-service logistics focus. We said last quarter that 2023 will be a breakout year for Covenant, and we remain firm on that statement and confident that we will continue to produce cash to maximize opportunities for our shareholders. Thank you for your time. And we will now open up the call for any questions.

Jason Seidl, Analyst

Hey, thank you, operator. Good morning, guys. And congratulations on the quarter. Wanted to talk about some of the puts and takes for the second half of the year in terms of some of the tailwinds you might see versus some of the headwinds. On the tailwind side, how should we look at gains on sale for the second half compared to the first half, and then how should we look at the insurance side of things? I imagine since you had a not great insurance quarter, the expectations for the third quarter would be coming down.

Tripp Grant, CFO

Yes. Jason, this is Tripp. Hope you're doing well today. Yes, so I think you're going to see some pretty strong gains on sale of equipment in the second half of the year, particularly on the tractor side. If you look back, the last four quarters have been very, very light. So you'll see some tailwinds there. From an insurance perspective, I think you'll start to see that normalize a bit. We're not going to run a $0.20 insurance each quarter; that was exceptionally strong during the third quarter, but I think you'll start to see that soften. Just for a little perspective, on average last year, our insurance was about $0.15 per mile. I'm not saying it'll go to $0.15 per mile in the third quarter, but I think you'll see it somewhere between where it landed last year and in the $0.20 per mile cost for Q3 or Q2.

Jason Seidl, Analyst

Okay. That's very helpful, Tripp. And how about some of the headwinds? Can you talk a little bit about the contract pricing marketplace, sort of how it trended through the quarter and what you're seeing in early 3Q?

Tripp Grant, CFO

Yes, well, then I'll turn part of that over to Paul. But I think from a cost headwind perspective, we're continuing to see new equipment costs coming in pretty strong. We also see operations and maintenance costs continue to be cost headwinds that have haunted us for the majority of this year. But as we get that new equipment in and we're working on to get as much as we can, you'll start to see the average age of equipment decline a bit, which should help that front and back half of the year, and the beginning of next year perspective. And Paul, do you want to talk about a little bit about the contract?

Paul Bunn, CFO

Sure, Jason. A couple of things. Yes, on the contract business, I would call it flat. We're not having a lot of customers come back on the contract side of the business asking for rate increases. I think just a reminder, we said it a minute ago in the script that we moved to a lot less cyclical top customers, and really didn't overstep our bounds in the last 18 to 24 months. Thus far, that's paying dividends on folks sticking with us through times that are no doubt softer than they were earlier in the year. So on the straight-up contract pricing, I would say flat. I mean we're not getting a lot of rate increases, but we're not facing a lot of pressure either. On the managed freight side of the business, as we've said before, that's where our exposure to the spot market is, and we are seeing things soften up. I think you'll see dedicated margins improve, expedited margins hold to maybe get a little worse, and you're going to see a deterioration in margins on the managed freight side in the second half of the year. So I would say that's a headwind.

Jason Seidl, Analyst

No, that makes a lot of sense. Tripp, I want to revisit your share repurchase program. It clearly benefited you this quarter, allowing you to buy back a significant amount of stock. How should we view the second half of the year? I assume there will be less activity, but to what extent do you anticipate engaging in the market, considering the positive reaction to the stock? While this is a good development, I'm analyzing it from a modeling perspective.

Tripp Grant, CFO

Yes, so it's, let me just, I don't know if I can answer your question directly. But here's what I will say. We put this program in place, which is a fairly large program, a $75 million program in place in May. And we designed it specifically for the longer-term duration, and we built in some parameters to help. We can't control what's purchased once a plan goes into place. But what I would say is, as long as we're trading at what we would consider a lower tangible book multiple and have what I'll call moderate to low leverage from a debt perspective, we're going to continue to repurchase shares. Now, to your point about the uptick in the stock price just over the last few weeks, you'll start to see that soften because our tangible book multiple will start to go up. So I don't think, I'm not going to predict what the stock price is going to do, nor could I if I tried, but I think you'll start to see that soften a bit. But we've been purchasing at a really good clip, as we've disclosed from a historical perspective. We even had some July numbers out there that were pretty strong. So if we slow down the purchase, that doesn't mean the plan doesn't go obsolete or we turn the plan off. We'll continue to keep it in play and be opportunistic about repurchasing shares in the future, but buying will slow down in the second half of the year.

Scott Group, Analyst

Hey, thanks. Good morning, guys. Nice quarter. I know you talked about the pricing environment, but maybe can you just share some perspective on how the demand environment played out throughout Q2 and what you're seeing so far in July?

Paul Bunn, CFO

Yes, I mean, I would say the demand environment, Scott, was good in Q2. I mean, it probably wasn't as good as Q1, and definitely not as good as Q4 last year. We were talking about July earlier; July is generally one of our top two to three months, but a lot of times it's two as far as kind of the second worst months with holiday and vacations and the lag before the get back-to-school. And folks start ramping up for the fall season and whatnot. And so there's seasonality to it. No doubt, July is softer than any month we saw in the second quarter, but it hasn't fallen off a cliff. Dave and I were talking and he said, well, we'll see how August goes. I think we'll be able to make a call when we see two or three weeks into August. August is going to show where really demand is. So July is worse than June, but July is always worse than June.

Scott Group, Analyst

All right. I know it matters less to you guys now. But any early thoughts about peak season?

Paul Bunn, CFO

Pretty muted. That's to your point, we've talked about peak has continued to be less and less of an impactful item for us. We've got a couple of customers, two or three customers that we do peak for, and those are commitments we make with them every year. And we'll do it again. So yes, there'll be a little bit of an uptick for peak, but nothing anywhere near as dramatic or material as what you saw in years past, probably a little bit like last year.

Joey Hogan, CEO

Hey, Scott. This is Joey. It's still going to have more than our other services. If you look back through history, I think it would show if expedited was presented as it was today, which is not out there; it's kind of the old company structure. But as we've gone back internal and looked back at expedited, as best as we can, you kind of see an 8 to 10-point swing in operating ratio from peak to trough. So what we've been working hard to do with some of the other things we talked about last year, throughout the year, is to solidify some longer-term relationships with some customers to narrow that down, take that from 8 to 10 to 6 to 8, kind of the range of that. Time will tell if we've been successful there. As you look at where expedited is today and where peak and trough are at an 83, the best we've ever done. I think probably as it stands today, with opportunities we have, I would say probably you will be working hard to keep expedite in the low 80s. So I'd probably say low 80s, and I would be hard to debate 92, 83 to 92 as a range. But again, we're working hard to keep that 92 down. I don’t think we have a shot to keep expedited in total in the 80s. But I think we need to kind of play out this cycle to see if that actually holds. But I think we're looking really good right now with the acquisition we made and some of the work that the leadership team has done on the base customers and legacy customers.

Jack Atkins, Analyst

Okay, great. Good morning, and congratulations, guys on these great results. So I guess, Paul, if I wanted to go back to your prepared comments for a moment, you referenced 2023 as being a breakout year for Covenant, and I'm guessing that's because you think you’re going to be able to show the resiliency of the business through a more challenging freight market to the degree that fully materializes. We've talked about $5 or more in earnings this year. Some companies have been proactive, kind of helping us think about what trough earnings power could look like. I'm just kind of curious if you guys can maybe help us think about trough earnings power for Covenant.

Paul Bunn, CFO

Jack, I think we're confident sticking with where we were last quarter, which is probably similar to a lot of our peers; kind of a 25% to 30% reduction peak to trough those numbers, as we've modeled them out, still hold. We still stand by those numbers. So wherever you think peak is, a 25% to 30% off of that, we think that's probably about where trough will be.

Jack Atkins, Analyst

Okay. And I guess maybe playing into that this cycle versus last cycle, you've got TEL, which is a bigger bottom line contributor. How are you thinking about that contribution in the back half of this year and as we kind of go into 2023? Are there some additional investments that are coming there? Can they grow that?

Paul Bunn, CFO

They continue to grow. If you think about it, Jack, trucks have kind of been limited; trailers have been limited in the market and TEL over the last four or five years has just grown dramatically. All of these equipment providers, what folks are getting allocated, it kind of uses that word allocated that you can buy is a percentage of your last three, four, or five years of equipment. They only need a portion of the trucks and trailers that they get to service replacement. So the other is basically just built-in growth, and there's high demand for what they're doing. They're executing incredibly well, whether it's leasing trucks, leasing trailers, I mean, it's not just small trucking companies; it is shippers, it's large trucking companies, it's private fleets, it's maintenance programs they're doing. We think TEL is going to be on a similar growth trajectory to what they've been on. We don't see TEL going backwards a lot, if any.

Tripp Grant, CFO

And just to add to that, last quarter we talked about them having some exceptionally strong gain on sales of equipment, which is all true. I would say for the last two quarters they have, and that's part of their business model, as Paul mentioned, is a sale of equipment, and they always have a gain on sale of equipment. It's just probably been a little bit higher recently with the equipment market. But what I would say to that, and people are worried about TEL falling off a cliff, that’s not true, because to Paul's point, they're growing other aspects of their business, which may help offset some of the reductions as the equipment market softens a bit, you'll start to see pickup from other areas of their business.

Jack Atkins, Analyst

Okay. That's great. And I guess, maybe last question, the ATT acquisition is clearly paying some nice dividends. I guess as you sort of look out at the market, and maybe what could be coming to market over the next maybe three, four, or five quarters. Are there other businesses like ATT that you think you could acquire that would make sense? I'm just trying to think through capital allocation, buyback versus maybe deploying that into strategic M&A.

Paul Bunn, CFO

Yes. I mean, here's what I think. If it's a niche high-margin business, I think it's something that has a strategic fit with one of the other business units, then absolutely, that's something that we would look at. Are we just going to chase something just for the sake of growing revenue? No, it's going to need to be something that's solidly accretive, has a strategic play with something else that we're doing, is niche and has minimal integration risk. So that combined with probably where our stocks are trading at that point, we'll put that in the blender and see what comes out the other side.

Bert Subin, Analyst

Hey. Good morning, guys. Hey, it’s probably for Joey but maybe Paul as well. So Walmart took down its guidance last night and called out inflationary pressures that they said are eating into general merchandise sales. Are there any freight categories that you guys would call out as being weaker in recent months and perhaps some that have been stronger than you initially expected? In addition to that, can you give some color on what you're hearing from your customers today around the back-to-school and holiday season?

David Parker, COO

Hi, this is David. We can't specifically identify this segment, but our business with Walmart continues to perform very well. As you know, we focus on the Walmart side, managing their produce that comes from the West Coast, and their store operations have also been doing quite well. Our relationship with Walmart has been extremely strong. Have there been challenges? Yes, particularly with staffing; we are unable to get all the necessary workers to the warehouses. However, the freight has remained as robust as it was six or eight months ago, and we expect that to persist. We visited a couple of weeks ago and didn’t discover any issues. Our retail business is highly expedited. For example, we have a significant retail customer that has relied on an expedited approach for the past year, leading to increased inventories. They have decided they are comfortable with a slower pace, meaning it doesn’t need to arrive in 48 hours. This allowed us to shift that business to our managed freight side, using a solo operation rather than expedited methods. We maintained the business and the margins, simply reallocating from one category to another. As Paul mentioned, July has its own trends. I’ve been in this industry for 50 years, and July is always July; it has slowed down. However, I anticipate that August will show an improvement as we head back to school and into the holiday season. I do expect an upswing. So far, we've not experienced any loss of business; any lost business has been fully replaced with new opportunities. So as we wrap up July, we are not disappointed at all. August will be interesting and will provide insights into future expectations.

Bert Subin, Analyst

Thanks for that, David. Maybe just dovetailing on that on the expedited side, obviously, that's been brought up a couple of times, and that's been very strong both on the revenue and the profit side. You guys do a fair amount of LTL line haul business there. It sounds like that's held in there quite well. Do you have the expectation that that can persist just if we start to see durable demand, industrial demand start to wane a little bit? Do you have any colors sort of what you're hearing from your LTL clients?

David Parker, COO

Yes. I think on the industrial side of the business, there's going to be pressure. We have seen some of our LTL customers decrease. We have just been fortunate enough to spread because at the end of the day, when we in 2020 took out 500 solo trucks out of this expedited operation, it forced us and the customers to answer a question two and a half years ago, two years ago, that said, do I really need these teams or not? Because we all know there aren't a whole lot of them in the marketplace. We've got a lot of agreements with many of our customers, not all of them, but a lot of agreements with our customers that even if their business slows down, we will be the last person standing from an obligation standpoint. So I feel very comfortable that even though some has been reduced, it's not earth-shattering to us so far.

Bert Subin, Analyst

Great. Thanks so much, David. And then just one final question probably for Paul. If 2023 ends up being a weaker year, whereas I think most people are speculating, would you expect revenue per truck per week to still be positive on the dedicated side, or do you think there could be some pressure there?

Paul Bunn, CFO

So thank you. Flat to positive. I don't think it'll go backwards next year.

Joey Hogan, CEO

Okay, Erica. We appreciate everybody's time this morning, and we look forward to sharing how we did in the third quarter later. Everybody have a great day.

Operator, Operator

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