Covenant Logistics Group Inc (CVLG) 2006 Q3 法說會逐字稿

At this time I'd like to welcome everyone to the third quarter conference call. [OPERATOR INSTRUCTIONS] . After the speakers remark, there will be a question and answer session. Thank you, Mr Hogan, you may begin your conference.

Thank you. We would like to welcome everyone to our third quarter conference call. Joining me on the call her today are David Parker, our CO and Chairman, as well as various members of our senior management.

Before I begin, This conference call will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended in Section 21E of the Securities Act of 1934. Forward-looking statements are subject to risk and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. Please review our disclosure and the filings with SEC. Due to the length and degree of discussion on our acquisition and third quarter earnings update call on September 15, and an additional detail financial and operating statistic are posted on our website. Our prepared comments will be very brief today and then we'll open up the call for questions.

In summary and as discussed in the press release, quite simple, the pick up in seasonal demand typical seen during the third quarter did not happen. Although our revenue per truck, our main measure of asset productivity increased sequentially over the second quarter, 0.5 % of 1%, we typically see anywhere from a 2% to 3% increase in the third quarter over the second quarter. Average freight revenue, per tractor, per week, did improve 1.8% over the third quarter of 2005, being driven an a 1.6% increase in miles per tractor.

Although our improvement in revenue per truck was less than our target of a 5% improvement, we're nevertheless pleased by progress in this area. For fourth quarter of 2006, we expect to see sequentially improvement in revenue per truck over the third quarter and modest improvement over the fourth quarter of 2005.

From a cost standpoint, there were really no major issues or surprises during the quarter except for that fuel dropped $0.30 per gallon over the last few weeks of the quarter. This helped our earnings come in better than expected at the time of our printout, that spent on September 14. For the fourth quarter, we expect costs to be pretty stable, versus the third quarter except for fuel and the usual concerns regarding accidents as we move into more weather related periods.

Even though the price is expected to average at or slightly below a year ago, fuel went down dramatically during the fourth quarter of 2005 which included the usually lag benefit of fuel surcharges. Unless fuel goes down significantly during the fourth quarter of 2006, this difference will produce an unfavorable comparison versus the fourth quarter 2005.

From an earnings standpoint, for the fourth quarter, the Company expects sequential earnings improvement over the third quarter of 2006. The tractor fleet should end the year at about 3650 trucks the combination of the acquisition of Star Transportation and the reduction of the Covenant fleet by another 200 trucks by year end and a reduction of a 150 positions within the Covenant division should solidify nice earnings improvement over the third quarter of 2006.

Until the network realignment process stabilizes, we continue to expect that utilization will grow at a faster pace than rates, because of changes of in mix. In the end, we continue to build a company for the long-term and are less concerned about a particular quarter's earnings and establishing a foundation for long-term success.

David will now give you a quick update on the Covenant Division realignment and the transition of the Star acquisition.

Thanks Joey. The realignment of the Covenant Division continues to make progress. No doubt slower pace that we'd all like to see it, but as we discuss before Joey stated just a minute ago, we continue to be focused on establishing a foundation for the long-term success.

As we focus on rebuilding the network, improvements in miles per truck, lower non-rev miles and lower driver turnover during the quarter continue the momentum going into 2007 is what our desire is. The reduction of the Covenant fleet by the end of the year will allow us another opportunity to maximize the network going in to what good be a tough winter freight environment.

I do regret that in relation to the reduction of the Covenant tractor fleet in the second half of the year, we had to eliminate about 150 positions, but unfortunately the down sizing was necessary the corresponding cost of the lower fleet size. This reduction will contribute to ours earnings beginning in the fourth quarter. As we stated in the release, we are very pleased with the transition of the Star acquisition. Based on our experience with the SRT acquisition we were confident there would be a minimal disruption within the customers, drivers, and in-house personnel at Star. The management at Star has a lot to be proud of as they begin planning for their 2007 year.

I would also like to mention the success we've had with SRT a refrigerated carrier based in Texarkana, AR. They completed construction and moved into a new location in Texarkana, Arkansas. During the quarter Tony Smith and his staff completed a construction and moved into a state of the art facility located in Texarkana. The facility has been built to operate a 1,000 truck fleet with ample expansion area once that goal is met.

I could not be prouder of their efforts, though a move this size, and they were able to maintain their better than industry average margins.

We'll be quiet now and we'll just go a ahead and open it up for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Ed Wolfe, Bear Stearns.

Hi, guys. It is actual Rob Farley sitting in for Ed. How are you doing? I wanted to talk first about the upside [inaudible] with two weeks left in the quarter, you kind of reported or guided towards a break even type quarter, but then you ended up reported $0.06. Can you talk about what was in that $0.06 that you weren't expecting. Was that all fuel, or was there anything else in there?

As we basically said in the release, that was the main factor. There's no doubt that Covenant with our length of haul is a little more exposed to changes in fuel than the public peer group, but when fuel goes down frankly $0.30 a gallon, and during that week of the 14th at the end of the quarter, that's a big move for all of us, not just Covenant. That is by far, the majority of what pushed us potentially that break even perspective to make a little money in the quarter.

Okay, and you mentioned in the release that the 150 employees that you down sized was about a penny drag in the quarter? Can you talk about kind of the size of that benefit that you might see going forward now in fourth quarter and on?

The mix of those jobs were some of them clerical in nature, a few middle management positions, several middle management-type positions, when you reduce the fleet you have fleet manager and things of that nature associated with that. The savings, on an annualized basis should be a minimum $4 million and could approach $4.5 million on an annualized basis.

Annual? Okay. And then can you talk about pricing? Kind of what you're expecting in fourth quarter and into '07. I think you talked about sequential improvement in revenue per truck. How much of that should we see on the pricing side?

Rob, you will see sequential increasing on pricing, but it's a harder environment out there. It's, excluding, because you've got so many balls in the air, Rob, when it comes to rationalization of freight, having more broker freight than what you wanted because of the rationalization even thought the broker freight is starting to come down. I'm proud to see that. As you go after the regular, your regular existing customer-base, it's in that 2% to 4% number that we're getting at rate increases.

But the other side of that, again, is the rationalization and taking certain lanes from Virginia to the East Coast, or from Ohio to the East Coast, that they're paying $2.20 a mile that you're not doing anymore and you're shutting that down and at the same time you're replacing it with a better traffic lane, say from Ohio to Chicago, that you're going to get more revenue per truck, more rev on that truck for that week, but the rate's going to be some number a $1.50 per mile and you replaced with $2.20 a mile you had before and you replaced it with a $1.50.

That's what I mean by rationalization. The best thing for me to say is there'll be sequential increasing in the rates and existing business that we've got is 2% to4% rate increases, but it's too many balls in the air to say is the total going to be 4 or 2? I don't know.

Okay. That's fair. On the used truck market I saw your gains on sales looked decent. We heard from Werner that the used truck market was softer than expected. Rider said it was holding in there. Any experience on how the used truck market is holding up and how you expect it to in the fourth quarter?

Yes, we did hit a softer patch as we came through the third quarter. September, we saw our sales soften up a little bit, not in pricing, but volume. Because we expected the market has to come back especially with you consider, has to, that's a strong word, when you consider the new engines coming out next year. It has, here in October, especially in the last couple of weeks, it's really picked up again. Pricing is holding.

I just think we hit a little patch there where the customers were waiting to see some of the same economic environment that we're looking at and tried basically delayed some decisions. Here the last couple of weeks, especially this week has been strong. I think it's back. Pricing has held, but volume did slow up a little bit late in the third quarter.

Okay. And then, kind of one last one, David, you mentioned the realignment's been going along slower than expected, do you have any firm targets that we should be looking for in terms of next year? I know internally you're reporting these divisions separately now, will we see these reports, or there any other mile stones we should be looking for?

We're not planning on reporting any of them individually, Rob,, it'd be us discussing them on the conference calls. The only reason why it's not making the headway we'd like to see is because if we had any wind at all in the sales we'd be seeing that because we have made some nice improvements. Take the regional, the revenue per truck is up 7%, but it needs to be up 20%. So we'll get there, 7% is better than 0. So we've made improvement in that area and if we, if the economy, in my opinion, is not a 2% kind of numbers, we'd be seeing nice improvement in that area.

I guess it's probably whatever you take is on the economy next year. Is it a 2% number or a 3% number? The lower than the longer. We truly believe that in 12 months from now, that we will be having a lot of, a lot of wind in those sales that we'll be showing some nice improvements in these divisions and that's, I say that because that truly is the way in which I believe.

We are seeing internally, some improvements. You are seeing a little bit of it in the revenue per truck, but you're not seeing the total. I guess we're more excited right now of what we see happening, than what we are able to produce on a quarterly basis for the last two quarters as we've done the realignment.

Okay, I'll let someone else on the floor. Thanks for the time

Your next question comes from Justin Yagerman, Wachovia Capital Markets.

Good afternoon, gentlemen. I just kind of took you back a few of the questions Rob had. The truck, this position, the divestitures of these trucks, it's going a bit faster than you thought it would on your Star call.

What been the factor there? Has the market picked up for the trucks or have you just decide to wash them out quickly or is the environment bad enough that you're willing to take a lower price on them? What's going on there? You guys have given kind of through middle of next year now, it sounds like by the end of this year the 450 trucks are out of the system?

Well, let me make sure I clarify. First of all, the 450 truck goal we had was a comparison from the end of June since we hadn't announced third quarter yet to the end of the year. We planned some of that fleet reduction in the third quarter. It ended up being 235 or so. The difference will be in the fourth quarter. The question is how much we have in inventory to sale. We're going to pull them out of the fleet basically upon that schedule. Have we disposed of them yet? Sold them? Received the cash and taken them off our books? So, that's the question. How long will we be able to see the cash from the reduction in the fleet?

The actual operating truck number will be at 3650 at the end of the year, but we'll have some number of trucks, probably not that many, I expect it could be 2 to 300 in inventory, because were selling at 2000 this year. We've got 150 to 200. We need to move them on. Again, I said sales slowed a little bit. I expect it could be instead of 150 to 200, it to be 200 to 300 by the end of the year that we may have an inventory that we still need to move.

Let me get it straight. You've got them out of the operating fleet, but not necessarily sold?

That's correct.

I was assuming once they're out of the fleet they're gone. We'll see corresponding cash as you're able to get rid of these things.

That's correct. If you notice on our balance sheet in the second quarter, we had an item called assets set for sale. Those were assets designated, pulled out of the fleet, for sale, tractors and trucks.

Just to clarify, those are no longer included in calculations like utilization, revenue per truck, per week and that kind of thing.

That's correct. Once we pull them their not. We got 200 that'll be pulled in November, December. We don't take them out of the calculation until they are pulled, Justin.

That's fair, I'm trying to get a sense of timing.

If you remember, when we announced the down sizing of the Covenant size, we said it would probably take us until second quarter to get rid of all the equipment and I think that we'll probably be ahead of that schedule, but that's the way it works. At the end of the day, the fundamentals, the new engines, the fundamentals haven't changed.

The people are going to buy low mile trucks whether they put it on poles like in September or for the month of January, once they decide to buy a truck, they're going to have to look very hard at what we've got to offer versus buying a whatever, 7 or $10,000 increase in a new engine. Next year, keep in mind we have only got about, 2000 this year, Justin, 500 next year. It will work its way out whether it is in January or March.

No, that's fair. I understand. When it comes to rates, I mean, obviously you guys have started talking about it, it sounds like the environment is getting a bit more complicated. U.S. Express, when they reported and I mean they see different things than you guys, but mentioned something along th lines of seeing in-house fleets competing in the third party market, which is something I hadn't heard from anybody before. How much more competitive has the environment gotten out there in a last couple of weeks and what are you guys seeing and what are hearing from your customers?

I think in the last couple of weeks, it's the same ol' same ol'. We start seeing a slow down, it happened in July and then, usually by August 15, quote the season will start and get stronger as the week goes buy and you just have not seen that. We're having a pretty good week this week, but not like the week you'd like to have. I don't think that necessarily in the last two weeks all of a sudden everything is ran through and everybody is trying to figure out what to do with pricing.

I think it's been the pressure and I think that's why you've seen pricing on existing pieces of business from all carries go from 4 to 7% down to the 2 to 4% numbers because I believe the existing piece of business that truckers have that they are getting 2 to 4% of increases. So, but it is, it is more competitive. I mean, usually by now you've got your, you've got customers that screaming for trucks and they're not screaming for trucks this year. [ Inaudible ]

I got it imagine, that's not spot market pricing.

That's correct. The spot market pricing, Justin, has definitely taken a hit.

Is it squarely down year-over-year at this point?

Yes.

And I guess the last question I had was, you know, with--

It's out of the equation.

Would you guys wash these trucks out of the operating fleet at this point? Have you lowered the percentage of the broker freight that you guys are taking on Is that less of an issue as Star's got its lanes more balanced and you rely more on those for the regional revenue?

Going forward you will see that. We did the Star acquisition September 15 or so. You will start seeing that. Star will happen just because of what you just said there, but only been in it for a month now.

Covenant itself is starting to see, we dropped about 1% from second to third quarter, it's still too high. Still about a 9% number. Last year we were about 3.5% number. First quarter we were 11 or 12%. Took it to 10, we took it down to 9, Covenants itself will probably from 9 to around 7 in the fourth quarter and then you'll get a better bump on the Star side of the equation because of the way in which they run their network which is ahead of our network.

Okay.

Does that make sense to you?

Yes, it definitely does. I appreciate your time guys. Thanks.

Your next question comes from Rey Wium BB&T Capital.

Hey David, hey Joey.

Hi.

Could you talk a little bit, it looks like in the release you grew your longer haul business in the quarter and reduced regional business. We talked about that. Do you think it will continue in the near term?

We are schedule to continue to reduce the OTR regional side of the business. That's a lot of where the 450 trucks have come out of. That division will end up at about 570 trucks by December 31. We've brought it down from about 850 trucks. It's running about 700 trucks to give you an idea. The vast majority of the reduction is coming out of the OTR which includes the regional divisions. You know, we basically have got the southeast division down to where we want it to, which is running about 85 trucks in the southeast division, but those 85 trucks are on traffic lanes that are doing very well, or doing well, and we will continue to increase, not increase, but continue to maximize those 85 trucks.

But other than that, let Star continue to grow. We've already given star 20 or 30 trucks in their fleet. They'll be growing more next year in the southeast regional. We won't completely do away with southeast regional, but it will have to produce X amount of revenue. If they start going to 34 or $3500 worth of revenue, we'll figure out how to give them trucks. That's what's happening on the OTR. The beneficiary of that had been the long haul and the dedicated division.

Okay, okay. Can you talk a little about the temperature control business. Where do you foresee that going?

Yes, temperature control is doing pretty good. SRT and Covenant. They have continued to make pretty nice progress within the temperature control of Covenant. If it wasn't for the southeast region, which is predominantly where they're having problems at is in the southeast on getting enough freight out of here if they can correct that they'll be doing pretty decent.

They've only got a couple of areas in the country that they're really sluggish in. We have seen a little bit of a slow down on the refrigerated side as well, which is Covenant Refrigerated and SRT but it's not dramatically. It's not dramatic, but it is a couple of points, a couple of percentages.

Okay, to switch over to the margin side. Where do you guys see the biggest opportunities to reduce your costs?

I mean the biggest opportunities still remains increasing utilization and lowering fixed cost per mile. We feel like we've got, still to this day, we feel we have a fairly strong surcharge program, insurance feel we have a fairly strong surcharge program, insurance we've had two quarters at $0.08 a mile which is, as a percentage of revenue, around 5.8%, 6% of revenue.

So we're getting much closer to the good industry average so we pretty much seen two good quarters of that. I think we've been frankly, probably on the aggressive side of depreciating our equipment over the last four or five years. I think that's something that we need to take a look at on a go-forward basis, but I think the main thing is improvement utilization. That will be meaningful from a cost side as we , about 90%, let's say $0.90 out our $1.36 to $1.37 after tax cost per mile is variable cost. So as we, now that's obviously the majority of that, but as we improve the utilization, we'll chew up that fixed cost faster in incremental in improving the margin is greater. I think that's the main area where we are right now.

Okay, thanks. Two quick modelling questions. What was your operator number for the quarter and how should we look at the tax rate in the fourth quarter?

In the financial statistics that we posted on the website, it shows on the operators end of the quarter, 142 and we averaged 147 for the quarter. It's about 4% of the miles during the quarter and about 5% of the miles last year. What was your second question?

In the tax rate in Q4?

That depends on what you estimate our pretax profits to be, which you'll have to answer that, but basically as general rule of thumb for 100 basis point improvement, an operating ratio it's about a 300 basis point improvement in tax rate. I think in the quarter, we are 58, 59% tax rate. So as our margin operating ratio improves 100 basis points from 97 to 96, you'd lower the tax rate from 59 to 56 for example.

Okay. Thanks so much for the time I appreciate it.

Next question comes from Chaz Jones, Morgan Keegan.

Hey David, hey Joey. Going back to the equipment whenever you take it out of fleet, tractors or trailers, do you continue to depreciate that equipment at all?

No, once it's pulled and designated for sale, we stop depreciation of that equipment.

Okay, if in the event the equipment market weakened and perhaps there was an impairment on it, do you come back and just take the impairment on it or, I guess I'm trying to understand that a little better.

You will take any gains or losses against that asset when you sell it.

Okay.

But I don't see what the values that we have placed on these trucks and trailers if there's, they're very, I mean, we've depreciated our equipment fairly aggressively.

Right, I mean based on a current market.

No I mean on a softer market, I'm saying based on a soft market.

Four year go markets.

That's, yes, we will, that asset sits there until we sell it and we'll take a gain or loss on that asset based on what we get. But we don't anticipate losses against that.

Okay, great, that's all I had guys. Thank you

Again, to ask an audio question, please press star one. Your next question comes from Andrew O'Connor, Wells Capital.

Good afternoon.

Hi Andy.

How do you see the operating ratio trending in the fourth quarter and first quarter as a results of restructuring that is being implemented, can you take a stab at quantify progress or quantifying goals over the next quarter or two? My math is correct, I got 98% as OR for the third quarter including fuel surcharge.

I think if you net fuel surcharge, you're right at it. We were 97.6%. We feel we're going improve earnings is all that we've said from third quarter to fourth quarter. We expect our margin to improve. And we have less, if the freight's exactly the same and utilization is exactly the same, we know we're going to have improvements in non-driver pay and, and that's one thing in particular.

So that will improve our earnings and typically we see, some improvement as we've already said in revenue per truck from the third quarter to the fourth quarter. So I'm not really answering your question, but we expect margins to improve and we fully expect again, with all that we've done,with the acquisition of Star that our margins in the first quarter should be better than the first quarter of last year. Freight, our first quarter was pretty weak.

I think that, you have to ask a question on what the economic situation would be, but it's clearly our goal to, to, we think that fourth quarter moving forward our margins should improve over the previous year's period. I'm not ready to put a target on that right now.

I think you for your take on how you think the business environment is because there's no doubt, as you're adding 2 plus 2, we do the same thing. We're going to be reduced 450 trucks going the first quarter. We've got a great operator on the regional marketplace. All of those are great positives. If the freight environment at least equal last year's first quarter freight environment, then it's going to be some nice numbers I would think .

Okay and then thanks for that, and secondly, would you say at this point you're staffing and the number of terminals you have, are they in line with the revenue environment?

No, that is something that we're continuously looking at. We do believe that as we close a couple of terminals, a month of so ago, that it did uh, ride us and correct us on where we should of been in lieu of the the 450 truck reduction and we believe the 450 trucks is the correct number and we'll be able to get our hands around it. If we can't, the ones that are left are the proper amount. We do think that we're very good shape from a standpoint of the terminal locations of where they should -- how many we should have based upon the size of the company and the traffic lanes we're serving.

Thanks very much.

Your next question comes from Tom Albrecht, Stephens & Company

Hey guys. Two quick questions. What's the approximate difference in the operation ratio between SRT and Covenant Refrigerated.

SRT is better, but we're not reporting that.

I think it's a lot better, but I'll leave that for offline.

No doubt that Covenant Refrigerated was one of just, it was trailers that were in the drive van. It was an ugly number. It's a number that has to have a lot of work done to it.

Okay. And I guess, my second question is more hypothetical, but I'm just curious as you look ahead to the first quarter of '07 and in general everyone's had disappointing freight volumes. I think there's some nervousness with small and mid size carriers, if they weren't able to generate cash during the second half of this year, will they have what they need going into the rough spot of the year?

Already there's talk about reducing rates and trying to line up some volume. Philosophically how are you guys going to handle that? How aggressive are you prepared to be with rates? You have worked so hard to get rates up. Can you talk about the way your staff is looking at the world as you think ahead to the first part of '07.

Tom, unless we go into a recession, which I'm not predicting recession, I do think first quarter can be an ugly freight environment out there. But I think that we got a lot of things that are help, they're going to be assisting us personally and that is the reduction of these 450 trucks and keeping the vast majority of the revenue that's associated with those trucks.

And that should be a tremendous up lift for us on our, on our ability to be able to keep -- there's no doubt that -- in the fourth quarter, even if you kept every customer there was, reduced fleet by 450, when it comes first quarter, those customers aren't going to be at fourth quarter numbers, they're going to be at typical first quarter numbers, but if we can maintain most of that freight, which we believe we can, then that will benefit us and we will not be under the pressure of reducing rates.

I don't think that anybody out there is in the, in the position to say "hey, let's go out and reduce a bunch of rates." That's not part of ours. Ours is to maintain the freight base we've got, increase the rates as we can increase rates, it's definitely not going backwards on the rates.

Okay and then I, sort of a follow-on question with that. I know one of the tenants of turning around the Company is reduce exposure to freight brokers, particularly in the OTR business but as freight has been more sluggish this fall, have you actually started to see a little bit of an increase again in freight coming from brokers?

No, just the opposite. Our, broker freight was down 1% from second to third quarter and it is continuing to, right now kind of maintain that 1% number even though I think as we go forward in the next 6 weeks, uh, that we will be even less dependent. That's why I truly believe where it was a 9% number in the third quarter, it'll be a 7% number in the fourth quarter.

I think we'll continue to decrease. You take like the mid-west, as we did that region, one of our good successfully regional fleets, Tom, you remember that there was a lot of rationalization of freight and just to give you some, an idea, 40% of our freight in that midwest region as we started it this year and rationalizing to freight in between that midwest region, we were up to about 40% of the freight being broker and that number now is down to around 15%.

Okay, so yes you have come a long way.

Yes.

Density and all that. Okay, that's all I had. Thanks guys.

Your next question comes from [ inaudible ] leader investment.

Most of my questions have been answered, I just have a few follow-up questions. How do you count for expenses, for fleet of sale. Are those numbers in your P&L or where are they when you prepare 250 trucks for sale?

Expenses to prepare any asset for sale go against the cost of the asset. It's sitting on the balance sheet.

It's not in the operations of maintenance line.

No.

Okay, my other question, actually another one, when we talk to customers, what do they say? If they look at retail sales, [Inaudible] July and August sales were very week and then September seems like they picked up. When you talk to customers, how do they explain lack of volume in the market?

Are we talking in particular about retail or about customers?

Specifically retail or transportation companies that are holding freight for retailers and their customers.

The only thing, the biggest thing on the retail side that I've heard, even though now it's starting to get better, starting to get improvement in it, for five months now, gas price gas price gas price, that's what I've heard from all the major discount stores and those kind of companies. It's been the gas prices. I think it's true.

One thing we have found out, I believe in this country, is that $3 a gallon is going to slow retail sales, but we are starting to hear from some of those customers that they are starting to sense a little bit of an uptick because of the reduction of the gas prices. So that's really, you go into the meetings with these guys, the first 30 minutes is everybody crying. How bad their business is, their sales are off. You go into selling these construction companies that we do business with, it's the same thing.

Okay, and my last question is, if your restructuring goes well and first quarter and the public valuation declined, what would it take for you to go private.

I have no idea. Not something we're focused on.

Have you discussed that possibly at Board of Directors meetings?

I wouldn't want to comment. Our focus is turning Covenant around.

Okay, thank you very much for your time.

[OPERATOR INSTRUCTIONS]. And at this time we have no further questions, sir.

Okay, we want to thank everybody for joining us. We'll be back with you in another quarter with the latest update. Thank you.

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