Covenant Logistics Group, Inc. (NASDAQ:CVLG) Q4 2022 Earnings Call Transcript

Covenant Logistics Group, Inc. (NASDAQ:CVLG) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Welcome to today’s Covenant Logistics Group Fourth Quarter Earnings Release Conference Call. Our host for today’s call is Tripp Grant. I would now like to turn the call over to your host. Tripp, you may begin.

Tripp Grant: Thank you, Ross. Good morning, everyone, and welcome to the Covenant Logistics Group’s fourth quarter 2022 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. Copy of the prepared comments and additional financial information is available on our website at www.covenantlogistics.com/investors. I’m joined on the call today by David Parker, Joey Hogan, Paul Bunn. Before jumping into the quarter, I’d like to first take a moment to reflect on 22 as a whole.

As it’s a remarkable year for us in many ways, it marked the second consecutive year of record earnings, record revenue, capital returns and safety results. We repurchased approximately 20% of the outstanding stock of the company and acquired a small but highly profitable specialized truckload carrier, all while maintaining moderately low debt leverage. We also made progress on our operating model through improved contracts in our Dedicated segment and grew the core business in our Asset-Light segments comprised of managed freight and warehousing. Although the tailwinds of a strong freight cycle may well be behind us, we believe the combination of our improved operating model and our strong balance sheet has us well positioned for the future.

Our company today is much improved, and we are grateful to all of our team members whose dedication and commitment made this possible. Focusing now on the fourth quarter. On an adjusted basis, we believe our team performed well during a market of transition. Consolidated revenue was essentially flat compared with the fourth quarter of 2021, while improved revenue per tractor and brokerage margin more than overcame the significant inflationary cost to generate a better adjusted operating ratio and higher adjusted net income. Through acquiring and successfully growing AAT, working with long-term customers to improve the stability of contracted capacity in our expedited fleet and selectively downsizing our least efficient dedicated operations, we did more with less.

On an adjusted EPS basis, the impact of our capital allocation towards share repurchase was considerable, with adjusted EPS growing 28%. These results were earned in a difficult environment. Freight rates were up year-over-year but are under sequential pressure. Freight volumes turned negative prior to the fourth quarter and are continuing to feel soft. In addition, cost inflation and availability of equipment and parts continue to provide headwinds. And — looking ahead, we expect difficult year-over-year revenue and income comparisons for the first time in many quarters. In this environment, our playbook remains consistent and our urgency is high. The primary adjustments to our reported results resolve around our tractor fleet, particularly a group of underperforming leased units that needed to be removed from operations due to negative driver, customer and cost considerations.

Several factors transpired in the quarter, including receiving over half of our 2022 new tractor order in the period. delaying lease turn-ins due to parts availability for trade prep on used tractors, whose lease terms have expired and parking additional lease tractors with future lease maturity dates, which have been the source of significant operational cost headwinds throughout the year. The abandonment of these units in the period before the expiration of the leases caused us to write down the right-of-use asset in the period and accrue any estimated future disposal costs on these units, resulting in a lease impairment charge. Although costly in the quarter, we believe this is our best opportunity to start the new year in the most cost-efficient manner possible.

Key highlights for the quarter include adjusted net income increasing 8% to $19.5 million and adjusted earnings per share increasing 28% to $1.37 per share compared to the year ago quarter. As a percentage, earnings per share growth outpaced net income growth due to the shares acquired throughout the year under our share repurchase program. During the quarter, we repurchased approximately 450,000 shares, bringing the total to $3.4 million for the year. Total freight revenue declined by 4.4% to $255 million compared to the 2021 quarter. Our asset-based truckload freight revenue grew 11% with 76 fewer trucks — our asset-light Managed Freight and warehousing segment’s combined freight revenue declined by 22%, primarily because of the combination of a muted peak season and reduced volumes of overflow brokerage rate compared to the prior year.

Truckload related cost headwinds continue to play a major role in our results for the quarter, increasing $0.20 per total mile on an adjusted basis compared to the prior quarter. Salaries and wages, maintenance and insurance all contributed to this increase. Gain on sale of equipment was $1 million in the quarter compared to $0.1 million in the prior year. On the safety side, we are proud to report that our DOT accident rate per million miles for the year was a new company record, beating last year’s previous record by approximately 6%. The — despite 2 consecutive years of favorable safety results, unfavorable development from a small number of prior period claims contributed to almost a $0.06 per total mile increase in insurance expense compared to the prior year quarter.

Photo by Marcin Jozwiak on Unsplash

The average age of our fleet at December 31 was 26 months, a 3-month reduction from September 30. For 2023, we have been able to increase our original tractor order, and we anticipate sequential improvement to the average age of our equipment throughout the year. Our Tel leasing company investment produced $0.21 per diluted share compared to $0.23 per diluted share versus a year ago period. Our net indebtedness at December 31 was $46.4 million yielding a leverage ratio of 0.34x and debt-to-equity ratio of 10.9%. Return on invested capital for 2022 was 15.3% versus 12.8% in the prior year. Now, Paul will provide a little more color on the items affecting the individual business segments.

Paul Bunn: Thanks, Tripp. Taking a moment to dive deeper into what drove the consolidated results for the quarter, our expedited operating our expedited segments freight revenue grew 26% compared to the prior year quarter as a result of the combination of a 16% rate improvement and operating 67 additional tractors. The increases are related to the AAT acquisition we had in the first quarter and the loosening driver market, allowing us to seek more tractors. We are pleased with expedited rate and utilization in the quarter, which was improved by FEMA freight in October that resulted from Hurricane Ian. Cost headwinds from increased sores and wages, maintenance and insurance continue to play a major impact in the quarter and condensed our margins.

We believe the combination of our work to resolve a significant number of prior period claims and the impact of the equipment replacement plan will help improve costs in this segment going forward. Driver pay remains stable at the present time. Our Dedicated segment had a 5% reduction in freight revenue compared to the ’21 quarter as a result of 143 or 10% reduction in the average number of total trucks in the period, offset by a 5% increase in revenue per truck. Although we are pleased with both the year-over-year and sequential improvement to the margin, we fell short of our profitability target, primarily because of the same cost increases, which were impacting our expedited segment. The fleet reduction we’ve experienced in this segment is a product of 2 factors: intentionally exiting unprofitable business and reducing fleet counts with existing customers based on reduced volumes.

We continue to work diligently to improve margins in this segment by improving our customer mix, contractual terms and operating a younger, more efficient fleet. Managed Freight experienced a 30% reduction of total freight revenue and a 20% reduction in operating profit. The significant reduction in revenue was the product of less overflow freight from our asset-based truckload segments, a reduction in peak revenue, offset by them of freight in the quarter compared to the prior year. We are pleased with the fact that Managed Freight was able to hold margins for the quarter, but we are now experiencing a much more aggressive environment with competitors aggressively competing for volumes at the expense of margin. We anticipate significant margin compression in this softening environment.

Our warehouse segment, although the smallest of all of our business segments saw a 31% increase in revenue compared to the prior year, resulting from the start-up of 4 new customers in the year, the largest of which became operational in December. We are pleased with the top line revenue growth we’ve achieved in this segment, and the team has done a phenomenal job in executing these start-ups, which are both intense and time-consuming. However, despite the top line growth in this segment, we’ve seen sequential deterioration in margins throughout the year. Our focus in 2023 will be to continue to grow this segment and restore profitability to the mid- to high single digits through improved labor utilization and rate increases with existing customers.

Our minority investment in TEL produced pretax net income of $3.9 million for the quarter compared to $5.2 million in the prior year period. Although the fourth quarter is typically soft for tail, it was especially soft due to an adjustment to accelerate depreciation on a specific group of equipment that is expected to be sold in the near term. The adjustment negatively impacted the quarter’s results by approximately $1.5 million. TEL has a strong track record of producing gains on sale of equipment throughout good and bad cycles, and we believe this adjustment is isolated to a specific quantity of similar make and model equipment. TEL’s revenue in the quarter grew 47% and pretax operating profit decreased by 22% versus the fourth quarter of ’21.

TEL increased its truck fleet in the quarter versus a year ago by 243 trucks to 2,237 and grew its trailer fleet by 654 to 7,149. After receiving more than a $7 million distribution during the quarter, our investment in tail, which is included in other assets in our consolidated balance sheet was approximately $55 million. As a reminder, TEL focus is on managing lease purchase programs for clients, leasing trucks and trailers to small fleets and shippers and in clients in the procurement and disposition of their equipment through a robust equipment by sale program. Due to the business model, gains and losses on the sale of equipment are a normal part of the business and can cause earnings to fluctuate from quarter-to-quarter. Regarding our outlook for the future; there is no doubt that 2023 will be a challenging year, but it’s also a year our team has been anticipating and working hard to prepare for.

We view it as a test of the resiliency of our operating model and opportunity to identify areas where we can continue to improve. As such, our primary focus remains a continued progress on our long-term strategic plan. We are also focused on aggressively improving our operating cost profile. With our equipment replacement plan and strong safety results, we see opportunities to improve cost in the short term to improve fuel economy, reduced operations, maintenance and insurance costs in an environment that will be pressured from both at a rate and margin perspective. We expect market headwinds from a softer market during the contract renewals as well as continued inflationary pressures. However, based on company-specific factors, including investments we have made in our sales team, the AAT acquisition, share repurchase program and the equipment upgrade plan and reduced insurance casualty costs resulting from our improved safety results, we expect less earnings volatility than in prior periods of economic weakness.

Over the past 5 years, our customer base has been strategically shifted to less cyclical industries through our full-service logistics focus. Even with a heavy equipment investment year, we expect our cash generation, low leverage and available liquidity to provide a full range of capital allocation opportunities to benefit our shareholders. Thank you for your time. I want to open up the call for any questions.

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Q&A Session

Operator: And our first question comes from Jason Seidl from Cowen.

Jason Seidl: Paul, I wanted to kick things off and talk a little bit about managed freight first and then jump in the truckload. On the managed freight side, you said that basically prepare for significant margin compression. I guess maybe can you give us a range of what you consider significant? And then maybe walk us through maybe some of the puts and takes to just how bad it is out there? Because it seems like all of this is coming from competitive pressures out in the marketplace.

Paul Bunn: Yes, Jason. Here’s what I’d say on the managed freight side. The market is crazy competitive out there right now. As far as — I would say it’s going to return to historical truckload brokerage margins. I think not just us, but a number of our competitors have been running margins in these brokerage businesses that are multiple times more than the historic margins that truckload brokerages operate. And I’ve seen several others out there. Everybody is kind of returning back to pre-pandemic pre-supply chain issue, brokerage margins levels. And those are mid-single-digit kind of numbers. And so we’re seeing it just like our peers return to those numbers. there’s no doubt there are folks out there trying to buy volume in this space right now.

And a lot of logistics departments, traffic departments are trying to go back and recoup costs from the last few years. That said, a lot of these rates we’re seeing are just unsustainable where they’re 10%, 20%, 30% below what a small carrier can run at. And it’s just kind of a purge. I think the whole industry on the brokerage and the truckload side is going to have to go through. But some of these small carriers stacked up some money running the spot market the last couple of years, and they’re making it. But you can’t run 10% or 20% below what your cost start forever.

Jason Seidl: No, no, that’s clear. And what’s your percent of business between contract and transactional right now?

Paul Bunn: Probably 65%, 70% contract, about 30% spot in that business right now.

Jason Seidl: And is that just more from the spot the spot market drying up in terms of loads?

Paul Bunn: Yes. And contract rates to the brokers — those are folks keep doing many it, get a number and then they do another bid and that kind of stuff.

Jason Seidl: Okay, that’s good color. I want to jump over to the asset-based side now and maybe talk a little bit about some of the deterioration you’re seeing. We held a call a bunch of private companies earlier this month, and they basically said that the market has deteriorated a lot in the last 60 days. What are your expectations for sort of the pricing gains that you’re going to get out of the contracts that you signed here during this bid season?