Covenant Logistics Group Inc (CVLG) 2004 Q3 法說會逐字稿

Good morning. My name is Lawanna and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the third quarter conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period. (OPERATOR INSTRUCTIONS)

At this time, I'd like to turn the conference over to Mr. Hogan, Chief Financial Officer. Please go ahead, Sir.

Thank you. Good morning, everybody. I will begin with financial information and our current expectations for the remainder of 2004. And David will follow up with his perspective of the current freight environment, as well as some efficiency measures and driver and equipment updates.

I'll state in advance that this call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. And this information is in accordance with the Company's current expectations and is subject to certain risks and uncertainties and I want to encourage you to review those risks in the Company's filings with the Securities and Exchange Commission.

As usual, I would like to begin with some miscellaneous financial information that was not covered in our press release.

First of all, we ended the quarter with 238 owner operators. That accounted for about 8 percent of the miles this quarter versus 11 percent of the miles last year. For the quarter, our capital expenditures net of dispositions were $18 million. We averaged for the quarter about 1,040 teams which were 170 fewer than the third quarter of 2003 and about 40 fewer than the second quarter of 2004.

Revenue equipment rental expense was 8.8 million in the third quarter compared to 6.9 million in the third quarter of last year. And approximate 150 mile per load reduction in our length of haul was a contributing factor in our deadhead or non revenue miles increasing about 120 basis points to 8.9 percent from 7.7 percent last year.

The actuarial study of our claims accruals that we previously announced has not been completed. And we expect the results of the study to be available during the fourth quarter.

The third quarter of 2004 includes interest related to a proposed disallowed deduction by the IRS that resulted in expense of approximately $400,000 or 2 cents per diluted share. Excluding the interest expense charge, our earnings would have been 34 cents for the quarter.

Additionally, last year, we had a 1 cent per share benefit from a FAS 133 adjustment. So we had about a 3 cent per share swing in interest expense that's not related to our operations.

Regarding expenses our after tax cost per mile increased 11 cents to $1.242. The three areas that comprise the majority of the increase were driver pay, fuel net of surcharge revenue, and insurance. Salaries and wages are up 4.4 cents a mile due to the result of three driver pay increases we instituted this year. And the result of our owner operator fleet being down versus a year ago, our Company trucks ran 92 percent of the miles this year versus 89 percent of the miles a year ago.

Several factors negatively impacted our net fuel expense which we define as fuel expense less surcharge revenue. It increased by $2.5 million or 10 cents per share. Diesel prices averaged 39 cents per gallon higher than the third quarter a year ago and our fuel economy was about 2 1/2 percent worse than a year ago due to the growth of the 2002 emission-compliant engines as a percentage of the total fleet.

Our fuel surcharge revenue did help us recover 79 percent of the increased cost of fuel.

The amount we're not able to recover continues to grow as the gross cost of fuel grows as well as the fuel economy of the trucks is worse today due to the new engine-compliant engines.

During the fourth quarter, we will be discussing our new fuel surcharge program with our customers. Our cost of fuel net of surcharge revenue for the quarter was 21.3 cents per Company mile versus 18.9 cents per Company mile in the third quarter of 2003 which is a difference of 2 1/2 cents per Company mile or 10 cents per share.

Insurance and claims expense is up 2.2 cents per mile versus the same quarter last year. Our accident expense this quarter was good and was about the same as last year's quarter. However, we had unfavorable development regarding some larger older claims that impacted this year's expense. The combination of workers compensation, which is included within salaries and wages, and insurance in claims expense on a per mile basis was the same as the second quarter of 2004.

From February 2001 until March of 2003, our deductibles went from $5000 per occurrence $2 million per occurrence. Due to the rapid increase in deductibles and the size to which our claims accrual has grown, management felt it should obtain an independent study of its reserves and accrual processes, one factor to use in evaluating the adequacy of our reserves.

The review began in September and we expect it to be completed in the fourth quarter.

For the quarter our balance sheet debt remained essentially constant at $60 million and we paid down $6 million of off-balance sheet financing. As of the end of September, we had 202 million in stockholders equity which resulted in a debt to total capitalization ratio of 23 percent while our book value per share ended the quarter -- ending the quarter increased to $13.63.

We're pleased about the continued margin improvement that we exhibited in the third quarter. We are still not planning on adding any growth to our fleet until we achieve at least a 90 operating ratio.

During the fourth quarter, we expect the fleet to be about the same as the third quarter, but will be down versus the fourth quarter of 2003 by 4 to 5 percent. For the fourth quarter we expect a revenue per tractor to -- per fleet -- per week, excuse me, to be up about 1 to 2 percent over year ago and our cost to be up about 1 percent sequentially from the third quarter 2004, mainly because of the fourth quarter affect of the September driver pay increase.

We expect our earnings for the fourth quarter will be in the range of 30 to 34 cents per share excluding any effects of the actuarial study we have mentioned.

Capital expenditures, net of proceeds from dispositions, are expected to be in the range of $50 to $55 million for the year, of which we have spent $27 million through the nine months of this year.

Depending on how we finance the acquisition of revenue equipment, the capital expenditure amount may be off-balance sheet in the form of operating leases.

Due to the complications of forecasting the business and the time and energy required to monitor internal forecasts compared to external expectations, the fourth quarter of 2004 will be our last quarter of giving out future expectations. Nothing will change regarding our responsiveness to analysts and shareholders questions, request for investor meetings, or anything of the nature. We will just not be giving out any public guidance any more beyond the fourth quarter of this year.

That concludes my comments I will turn it over to David.

We continue to see positive moves within our profit improvement objectives in that we are able to improve our operating ratio by 130 basis points even with a 10 cents per share negative impact versus a year ago in fuel. Even with 5 to 6 percent of our fleet unmanned and even with freight slowing slightly during the summer, the middle of July to about the middle of August, as we saw a little pause that took place; and with us working also through four major storms in the Southeast during the quarter.

Our main accomplishment during the quarter was that we were able to grow our revenue per loaded mile by 15 cents per mile or 12 percent during the quarter which followed a 10 percent increase in the second quarter. These increase -- helped produce an increase in our revenue per truck per week at slightly over 2 percent to $3,035 per truck.

Truck capacity continues to be very tight and requests for dedicated capacity also continues to come in a very high pace.

We believe the combination of improvements and our positive philosophy and the continuation of the current relationship between truck and demand will enable us to improve our revenue per truck per week throughout the remainder of 2004.

On the negative side, our utilization was down. The main issues are a shortage of drivers, fewer teams, and a shorter length of haul. The combination of having 5 to 6 percent of our fleet unmanned versus virtually zero last year and that we have 170 fewer teams than a year ago negatively impacted our utilization by 7 1/2 percent over a year ago.

The open truck situation continues to be a major focus of ours. We have raised driver pay three times this year, while examining traffic lanes and growing our dedicated vision, in order to improve our drivers' quality of life. After the accessorial (ph) pay increase this past January and then across the board pay increase that we implemented in March, we instituted an increase effective September 1st, focused on retention of drivers.

A little bit about customers and rates.

For the quarter our top 100 accounts represented 83 percent of total volume and grew by 26 percent. We have 28 new accounts in the top 100. Excluding the new accounts the remaining top 100 were up 8 percent. Obviously, our freight revenue and total being flat with a year ago and our top 100 accounts growing greatly, we are concentrating our capacity with customers who will pay us a fair price and work with us to increase efficiencies within their supply chain.

For the quarter, as a percentage of revenue, transportation was 32 percent; retail, 23 percent; paper and packaging, 12 percent; food and beverage, 9 percent; manufacturing, 8 percent, floor coverings, 5 percent; consumer goods, 4 percent; auto, 3 percent, housing materials, 2 percent; and electronics, 2 percent.

As we have said earlier, our rates are up 12 percent over a year ago. We expect rates for the fourth quarter to be up about one percent sequentially versus the third quarter or about 8 percent over a year ago. We expect our rate of growth over a year ago to begin to narrow future periods because rates really began climbing for us in the fourth quarter of 2003. In fact, rates grew sequentially of almost 3 percent per quarter from the third quarter of '03 to the fourth quarter of '03.

Our 2004 objectives of growing our rates and our dedicated vision continues to unfold throughout the third quarter. Even though our length of haul has declined about 150 miles versus a year ago, and contributed to our rate increases, we have raised our rates nicely into all lengths of haul. Particularly, we have raised our rates in our medium-haul tweener loads by 9 cents per mile as the percentage of loads have decreased from 28 percent in the third quarter of '03, down to 24 percent in the third quarter of '04.

Our dedicated division has grown by 48 percent or 180 trucks to 557 trucks since the first quarter of 2004.

Also, we are working hard this quarter to roll out a new fuel surcharge program that, if successful, will cover the majority of those rising costs of fuel, diesel fuel and the reduced fuel economy of the new '02 emission-compliant engines.

A little bit about the new engines. We currently have in-service almost 2300 or 69 percent of our Company-owned fleet equipped with new emission-compliant engines. We continue to be pleased with the performance of the engines versus our expectations. We currently are seeing approximately a 4 percent fuel degradation and no significant maintenance increases versus the pre EGR engine.

This concludes our prepared comments and we now open it up for any questions.

(OPERATOR INSTRUCTIONS). Ed Wolfe. Bear Stearns.

What is it about right now the long haul market that you and US Express reported 16 percent revenue per mile, you're at 12 percent. That is well above where kind of everybody else is right now. Is there something in that longer haul market that improves the mix for you guys? Or is there something else that I'm just missing and it's a coincidence that you and Express are much higher than everybody else?

Well, I think it's probably just three things. There's no doubt that the long haul market is definitely taking a lot of nice rate increases. Predominantly, for years as you know, the long haul market consisted of a lot of mom-and-pops. And a lot of those mom-and-pops are not in business anymore. And so pricing has gone up very nicely in the long haul market. Whereas a year ago we were still not seeing pressure but we were not able to raise our rates on a scale of 1 to 10. Our long haul was basically close to a 10 and we were getting some but it was a couple of pennies here and those kind of things that, in the last 12 months with the mom-and-pops not as many of them out there running in the long haul market, you're able to increase the rates in that market. That's one thing.

I think a second thing is that we continue to grow the short haul market. That definitely carries a higher rate per mile so that's part of it. As that percentage becomes bigger, that's helping us with our length of haul being down. That's probably whatever number -- nobody really knows -- that's probably 3 cents or so that just the shift in freight in our lanes is probably helping us about 3 cents.

And then with the tweeners themselves being up very nicely, what was it? Almost 10 cents, 9 cents I believe on the tweeners and I put still think there's a lot of room left on that tweener side.

So really it's all those combined, Ed, because, like the tweeners when I say they're up 9 if you remember a year ago I thought we were underpriced by 10 cents a mile. We were on the low end so we had some room for improvement. Maybe more than some other people in the tweeners. And so you're starting to see that. I think you'll continue to see that.

Okay so what I take from that is about 20 percent or so this has to do with mix and maybe 20 percent or so of this has to do with the tween drivers coming around off the low base?

I would not disagree with that.

As you look to '05 on the rate front, you said the comps get more difficult obviously. You can't get 3 cents every quarter forever. What's a fair expectation in '05 to get revenue for mileage, as you go out there?

My opinion, Ed, is the one equation that all this hangs on. If GDP is a 3 percent or greater you are going to continue to see nice increases.

I don't think any of us are building that into budgets because we don't know what next year holds, but I think the key to it is that the (indiscernible) at 3 percent; Covenant will do a very good job and you'll see some very nice increases.

But entering this year in January of '04 if you would have said nice increases we would have said 3, 4 percent is historically very nice increases. Is now a very nice increase 12 percent? Is that the bar? Or is it 3 or 4 or is it somewhere in between?

It's 5 percent or better.

Can you talk a little bit about the dedicated business? It seems like everybody that we talk to is focused on growing that business, because it's a little more driver-friendly. Can you talk about, in your own business, the dedicated business versus equal length of haul drive and business in terms of margins and returns? Are they similar? Are they less? Are they greater?

Dedicated, Ed. We continue to be very pleased with our returns in our Dedicated Division. It and our Refrigerated Division are pretty similar as far as returns. Better than our overall average obviously. Our two best teams are right there with it. And we can continue to work hard on the regional solo freight.

The issue with Dedicated, we wish we could grow it faster. It's just a matter of they're a longer sale and there's a lot of different pieces to that pie you've got to be very careful about.

How the drivers respond, is it the right lanes? What are the terms of the contract that you got to make sure about the length of time. All the various accessorials, minimum mileage guarantees. It just takes a while to put those together. But it's something we are pushing very very hard. It's just growing 50 percent since the first quarter, that's a pretty good clip.

But we would like to grow it more but we are extremely happy with the returns on that business.

Sure, but given no other variables which I know nothing ever happens in a vacuum that but no other variables if you're going to sign a big chunk of incremental kind of your regular business or the Dedicated business, would we see the margin overall improve or go down on that new business?

I think right now I know that I know, if we sign Dedicated it is going to prove our overall margins. I feel very comparable with our pricing philosophy on all our lanes of freight now.

So I expect any new business that we bring on whether it's Dedicated or irregular route freight, it's going to be good margin business. I just feel longer-term, because Dedicated is such a longer-term contract, that it is probably more certain long-term that that will impact our margins consistently over time versus irregular rate freight.

I think also, Ed, just in your mind, Dedicated, Refer (ph) and our teams all operate very nicely. Our single medium tweener, that single side of the business a year ago is where we say we got problems there. I'm going to tell you though, we are making drastic improvement in that. And as Joey just said, now it's to the point we here today brought on a short haul account, it's not something that is scaring you; it's not something you think 'Oh no, we're going to dilute something because we don't know how to operate in that traffic lane.'

It's improving. It is not as good as the Dedicated; it's not as good as the team; not as good in the refer, but I'm here to tell you it's only a couple points behind.

One last thing and I'll let someone else have it. You had 200 tractors basically (indiscernible) at the beginning of the quarter, you ended the quarter about the same. Utilization is getting mauled as a result of that partially.

Why not sell the 200 tractors at this point? Improve the utilization in the margin? Is that something in the equation or potential? Just get rid of the tractors?

Have we thought about it? Yes. Is it in the equation right now? No.

As you know, you really have a not hiring time starting here about the middle of November. You have a little uptick there in the fall. And those kinds of things when we did the September retention deal, which now as we're seeing that starting to work now. Our turnover ratio since September has come down on a weekly basis as these guys are getting on their check. Listen if you say stay 90 days, here's $3000. You know and it's starting to accumulate on a weekly deal and that's really what -- some of the deal we did.

So we will start looking at bringing, being able to bring on drivers in our opinion around Thanksgiving and then you really are able to bring them on in January and February based upon years past.

If we were not successful in that, then, yes, what you said there are things that we talked about. But our goal is to fill these trucks if we possibly can. But at the same time it's stupid to have 200 out here costing you money.

I think the other point, too, is that it's kind of like, are we making improvements in our operating margins? And as long as we're making improvements in our operating margins we've got the freight. I mean there is no question. We can move the trucks assuming we have drivers.

So it's a balance of are our margins are improving? Yes it could improve greater assuming we sold those trucks, but as David said, this new increase we just put in with the -- you have a little period in the fall that can impact it. We just decided we need to ride this out because you hit the big period in January.

So as long as our margins are improving 130 basis points which they did in this quarter, we're making progress. We know a big chunk of it is those open trucks. So we got a big period of time here in the next six months which we fully expect to try to make an impact to that.

So as long as our margins are improving, so far we've held the line in not decreasing our Company trucks.

Now we have allowed the fleet to decrease as we've lost on our operators. We haven't attempted to replace those because we couldn't.

So that's why you're seeing versus a year ago in the fourth quarter, our trucks will be down 4 to 5 percent. Even though, sequentially, to the third quarter it's going to be about flat. And so, you're really going to start to see the impact here versus year ago in the fourth quarter as losing these on our operators throughout this year.

That all makes sense. It is very logical. Thank you very much for the time, guys.

Donald Broughton. AG Edwards.

I know most of the major truckload carriers have started experimenting with the use of the rails, doing a little bit of intermodal to share the services. Where are you and tell me about the development of that service?

Donald, we've had internal discussions but that is not what we're focused on. Our focus is strictly on getting Covenant back to a 90 or better operating ratio in our Truck Division.

Once we achieve that then -- we've looked at that, we've seen it on -- we've got it on the bulletin board back here and that is something that does interest us. But we don't want anybody, I don't want any person in this Company starting from me on down to take their eye off of what we're starting to achieve.

So, right now you're not putting any of your trailers in intermodal?

Absolutely not. They've been here. We've had discussions. But that's as far as it's gone.

Fantastic. Would I be right to assume that the drop in maintenance cost was solely linked to the average age of the fleet coming in? Or, is there something else?

That's the main thing, Donald. I mean we've been beating that area up hard for the last two or three years but the main thing contributing to it is reduction of the age. But there are several other smaller things.

We are operating at the best maintenance, I mean the best number of mechanics per truck that we've ever had. Even when we're at a 36-month cycle back in the late '90s just because we're doing a few things differently. But the main thing driving that is the aging.

I know you've been making a shift towards more regional away from more long haul over the last several years. And in a lot of ways that's been dictated by the necessities of the market. Long haul demand just hasn't been there. But we're getting reports that long haul demand is definitely coming back. Is there a point at which you shift course and go back to more towards the way you came here?

That's still -- the long haul is still our bread and butter. 1100 teams or so that we've got (indiscernible). A major major piece of our business and it will always be. I think it's going to be like anything else. As that continues to get tight, you are going to see rates continue to go up very very nicely in the long haul.

And so, we will treat it as we do anything else and that is, let't let capacity be tight and let's increase our rates on that area.

The second thing is, driver situation just makes it difficult to be able to get two drivers to a truck. On our teams when you got a couple hundred trucks out here open, it's hard to get them.

Tom Albrecht. BB&T.

That's Tom Albrecht. Joey, did you give a preliminary 2005 CapEx figure?

No I did not.

Are you able to share that today or are you still going through the budgeting process?

Tom, what we said --

I heard the '04 so --

We are going to, after the fourth quarter, we are going to not be giving out any more guidance for the future.

Okay so on things like CapEx and that too? I understood that on the earnings side, but --

Well I haven't thought through that but I think CapEx is going to be similar to what -- when we are on the tail ends of our budgets, but it's going to be in the range of what we're doing this year.

Nothing is really significantly going to change until we start -- until our margins get closer to 90 and we move our open trucks and we think about growing the fleet again.

And then, David, a question for you. Retail was 23 percent of the business. We know how that's grown very nicely the last 2 1/2 years. Where do you see that sort of flattening out? Would it be 30, 35 percent? Or is 23-ish about where you're going to max out on your overall retail exposure?

I think that you're probably, it's probably higher. It's probably in that 25 to 30 percent kind of numbers. I mean there is just still lots of opportunities. I was with retail companies yesterday. And there is still a lot of opportunities in that marketplace. And it will probably be higher than what it is right now. Probably 25 or 30 percent.

Joey, I missed the first couple of minutes. Did you give ending owner-operators?

Yes. 238. We ended the quarter, we averaged actually 265 for the quarter. But we ended it to 38.

And how about a length of haul?

It was right at 900. It was down 150 miles per load versus a year ago.

All right and then I think that's it. So I appreciate the comments. Guys, thanks.

Michael LaTronica of Excaliber Group.

I kind of wanted to circle back to Ed Wolfe's -- one of his opening questions about the rates in the long haul sector.

Am I understanding it right, David, from your comments that, because that has been a mom-and-pop market and there's been a bleed off there, that that is helping your rate structure? But also isn't it that long haul carriers such as yourself and Express have migrated equipment and capacity to that tweener market so that is also helping you? It's a self-fulfilling prophecy?

That's correct. You are exactly correct. It is mom-and-pops that have exited the marketing place has helped as well as the tightness of capacity in that lane, because of going to shorter lengths of haul. And so that is true.

Okay and my other question is, with 130 basis point improvement in the O. R., two more quarters gets you to that 90 O. R. or thereabouts. Do you think that maybe by midyear '05 you're starting to look at more capacity?

Two things. When we look at more capacity, when we get to 90 or better at least to 90 O. R. -- that's what we've been saying -- then it will be our goal to look out there and make decisions based upon what is the right thing to do for the Company.

For instance, Michael, if we've got 200 open trucks at that time, it's crazy to add 200 more trucks to 200 open trucks. That is one area that will have to be looked at.

Or do you look at acquisitions and those kinds of things and once we get there, then we will make that decision. To be honest with you, other than three or four of us thinking about that quietly, we don't even talk about it. Because our focus is strictly on O. R.

Okay. Fair enough. At the Georgia Tech Logistics summit, there was discussion about one of the top issues facing the industry and, obviously, there's some differences. But everybody pretty much agrees on driver compensation.

With Wal-Mart paying 75 grand to a driver in their private fleet what is it going to take to get a driver that does long haul to a competitive salary so we can solve this problem permanently?

There's two ways, two ideas there, Michael.

Today I think personally the number has got to be around $60,000. And that has got to be the goal that we have got set. No one has the gut, including us, to sit here and say, let's do it tomorrow. Let's take it from 42 to 60,000 because if it didn't work quite frankly you're probably out of business or losing a lot of money.

So therefore, no one, I don't think, is going to do that. So then, you have to say, 'Okay, if it's at 42 now 43 and we've got to get to 60. We are committed to doing it on a yearly basis.' If it takes you five to six years to get there, does 60 become 80?

Are you always going to be chasing your tail? That is a real question that is there.

The other side of that equation, Michael, is that I truly believe some of these barriers of entry that are there, not that it's a zero barrier of entry, but -- or nobody coming in -- but there's not a whole lot of them coming in.

And I personally think the opportunity is there but that is a career change. We may not see it like it used to be ever again. And I'm going to tell you with the pressure on drivers to get them that in itself creates a lid that makes sure that none of us do anything that is stupid and go back to the days that we used to be in.

Yes, but it seems to me that this is all intertwined, obviously, additions to capacity and drivers. And it may just be that when shippers can no longer move their loads to keep their stores stocked, they come to you and say, 'What does it take?'

And you have a discussion and nobody wants to raise the pay to a $60,000 level if they can't cover it.

But you're guaranteeing yourself a 120 O. R. if you do that. So does the shipper ultimately come to you in your opinion and say, 'What is it going to take to move my load so I can sell my merchandise?' And at that point is there a major notch up in driver pay?

Yes.

I think, too, remember the industry is kind of paying the price of not doing much. From spring of 2002 to the winter of '04, the industry didn't have to raise pay because our trucks were full. And all of that, during that period of time, it takes a while to get back recruiting -- not saying we've always been concerned about drivers and retaining them, but it takes a while to get that ball going again. No. 1.

No. 2, the rest of the markets for our particular drivers have moved. Construction has continued to grow pay, warehousing's continued to grow pay, LTL's continued to grow pay and truckload hasn't during that period of time.

And so, we are kind of playing catch-up. So that is why that two and three types of raises this year is catch-up. Driver pay this year has grown 15 percent. I think around the industry it's going to be in the range of 10 to 20. Ours is going to be up again and be around 15 percent.

And so, we're paying a little catch-up until we get this number moving again. And I think it's going to settle. Hopefully next year won't be 15, but it could be as David said.

So it is fair to say that we will see this slow notch up as we play catch-up for that couple of year period? But at some point in the future, there's a possibility that we see a large-scale change in the way drivers are compensated?

I don't disagree with your statement a little bit earlier and that is in my opinion things -- GDP 3 percent. And with these barriers and with nobody doing no growth hardly, there's going to be -- payment is not want to move. The railroads having their own -- there's freight that is not moving right now and it is going to get worse so you've got to believe that the shippers will come to you and say, 'Give me a price to move this freight.'

Then you're going to have a major decision you've got to make. It says, okay, first thing I'm sure everybody will do is ship capacity to the people willing to pay until they are all willing to pay it, but over a couple year period of time there's major issues.

And I think what you're going to see first of all is this industry get very healthy before any of the scenarios you talked about. But your scenario is a very valid situation that, some decisions are going to have to be made. And I don't know what the answer is.

Thank you very much for the time. Both of you.

At this time, there are no further questions.

Well, we want to thank everybody for joining us and we look forward to the fourth quarter numbers when we have our next conference call. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.