Covenant Logistics Group Inc (CVLG) 2008 Q3 法說會逐字稿

We now have our speakers in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of today's presentation, we will open the floor for questions. At that time, instructions will be given as to the procedures to follow if you would like to ask a question. I would now like to turn the conference over to Joey Hogan. Mr. Hogan, you may begin.

Thank you, Tiffany. Good morning, everyone, and welcome to our third quarter conference call. Our comments this morning will be brief, but joining me on the call this morning is our CEO, David Parker, via telephone and our CFO, Richard Cribbs, as well as other members of our senior management.

This conference call will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21A of the Securities Act of 1934 as amended. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. Please review our disclosures and our filings with the SEC.

As a reminder to everyone, a copy of our prepared comments and additional financial information is available on our website. Due to the depth of our disclosure within our September prerelease and the final release, our prepared comments, again, as I said, will be very brief and then we will open up the call for questions.

In summary, our employees continue to make meaningful, measurable, long-term improvements to our operations that will benefit us as we battle through this recession. As David stated in the release, the quarter was a time of great promise, while also great frustration for the Group.

On the positive side, we were able to improve our revenue per truck 6.5%. Also, we continued to aggressively grow our non-asset Solutions subsidiary. Although fuel costs were up on average $1.45 per gallon versus the third quarter of 2007, through various fuel savings initiatives we were able to offset that increase completely. Our DOT reportable accidents per million miles was the lowest in eight years. As well as finally, completing our long term financing plan was a major accomplishment.

On the negative side, we had a small number of severe accidents that impacted us by about $0.16 per share. We also had a non-cash charge of $0.03 per share related to the above mentioned financing.

From a freight standpoint, October has not been a good month. On the dry side, in all markets, freight began to weaken in late September and has continued throughout October. Freight for our temperature controlled product although, has been doing reasonably well and we are considering shifting more dry assets to that division. Additionally, although our total fleet size was down almost 5% during the quarter compared to year ago, due to the recent weakness in the freight market, we will continue to seek the correct balance of freight and capacity in our model.

We fully expect fourth quarter utilization to be a very difficult comparison to a year ago, with no expectation of a meaningful 2008 fourth quarter peak shipping season. Based on discussions though with certain of our larger shippers, it appears there may be at best a small peak season between Thanksgiving and New Years. On the positive side, the recent drop in diesel prices should be a meaningful benefit to earnings when compared to the third quarter of 2008.

Our major initiatives during the quarter, amongst several others -- but our major ones during the quarter include the determination of the fleet size for 2009; the completion our rate increase initiative; and finishing our long-term information technology strategic plan.

Tiffany, that's all of our prepared comments and now we'll open up for questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Tom Albrecht.

A couple of different questions. It really seems like you're committed to growing the teams again and I'm just wondering how big that might become and how does the profitability of the team business stack up with the consolidated results that we see?

Tom, last summer we made a strategic long-term decision inside the Covenant division that we needed to refocus on the strength of that company, which was our teams. We've continued to allow it, if you will -- that's probably too strong of a word, but it continued to slowly decline. And the question could be asked, well how small could this thing be? You know, if we wake up three, four, five years from now, will we have 200 or 300 teams? And at the time, it was 700 to 750 teams.

And we spent a long time talking about that and basically said that's our backbone, that's our heritage, that's what we do well inside the Covenant, the transport piece of the pie. And so we decided we needed to refocus on that, in fact, grow it. And we felt that that would do a lot inside the organization from reestablishing who we are; raise the service bar and several other things that we wanted to accomplish. Plus, frankly, it was still a profitable piece of the product, so we made the decision to grow that.

Where do we stop? Or when can you have too many? That's probably a different question. In the last six weeks or so, we have limited the growth in our teams and we haven't grown them much at all over the last six weeks. We've plateaued that and actually capped it, if you will. Because you can have too many, especially in a recessionary time.

So it's really more of a Covenant Transport piece of the pie. It's still inside the Covenant product. Our Dedicated products is our most profitable right now and it is profitable and our Expediting group is right behind that generating profits. So, we would like to continue growing it at the right time and we're right in the middle of that process, trying to decide how we handle our teams throughout next year. It's really going to be an economy call and an economy question.

Okay. And then, you mentioned you're likely to continue shifts of trucks to the refrigerated business. Is that business profitable? I know the old SRT has always been solid, but after it had been force fed a lot of trucks it seemed to deteriorate. Where is the profitability of that and how many trucks might you be talking about?

When we talk about temperature control it is only SRT. I mean, Covenant is running a few teams in the produce side of the business, but basically our temperature control product is all SRT. It is.

The few severe accidents we mentioned in the release, one of those was SRT. Absent that, we feel that SRT is knocking on the door of getting back to where it was historically. And we made a decision to shift 50 trucks or so to that division. Some of them right now, the rest of them kind of late winter to early spring. That unit is doing well and we're pleased with that.

Okay. And then I guess just a few factual questions. You usually have in the stats the percentage brokerage freight, but I didn't see it this time and do you have any thoughts on 2009 CapEx, what 2009 depreciation might be and any tax rate thoughts?

Brokerage freight, we've decided not to disclose that. That number is kind of tricky to calculate, because it has a lot of influence from how much of it is from our Solutions group and how much of it is from outside. It's relatively flat with the second quarter.

Okay, and that was like 11%, I believe.

It was slightly down from that. We continue to improve that area, especially if you look at what we're doing with outside the group, so outside of Solutions, that continues to improve.

And on CapEx, we're still finalizing our plans on our equipment plan for next year and how much we're going to replace, etc., how much we're going to maintain our fleet size versus decreasing it slightly. But we're looking at a range of anywhere between -- it's a pretty big range, but between $65 and $80 million of CapEx net of disposals next year.

Okay. And how about a depreciation figure?

Depreciation and amortization combined probably right between $42 and $48 million for the year.

All right. And then on the tax rate, normally as core profitability declines that goes way up, but after this quarter I'm not sure what to think.

Well, it changes. You know, we've got our per diem. We talk about that a lot -- market per diem plan, which is per diem payments are only 80% deductible and so as that changes -- and we've really increased our per diem participation. One of our subsidiaries went to 100% participation on that, late in the second quarter. And so, as that increases it has even more impact on the tax rate. And what we really find is the closer you are to zero is the bigger impact that has. And so as you have either further losses or further gains from that, you're going to get closer to the average effective tax rate of 40%. But it's always going to be different because of that per diem amount.

Right. I guess the reason I was asking, I believe your tax rate was really low this quarter, unless I'm looking at something wrong here.

It was probably about 16%.

Yes. And so, that was my point. Normally when you don't have much profitability, the per diem impact helps to elevate you to a really high tax level, and yet here you had a really low one, so I'm just looking for some comments or guidance on what to do for the fourth quarter and beyond. Should we kind of go back to well north of 40% or what? Because 16% or 18%, I'm sure is not sustainable.

Basically, I would take about $9 million of your salaries and wages and call that per diem and then only make that 80% deductible and see what that does for you. That will get you to the right answer. It will be real close anyway. We actually had a 0.3% tax rate in the second quarter and then 16% this time.

But there were no unusual items in the quarter, positive or negative on the tax side.

No, very small adjustments.

Our next question comes from Ed Wolfe.

Joey, is David on the call?

Yes, I'm here.

Can you talk a little bit about -- you said the world stepped down at the end of September and October. You guys obviously have a lot of puts and takes with what you're doing internally, but what's the pricing environment feeling like right now, relative to when things felt like they were tightening in May and June, and really the whole year?

You know, Ed, think about CTG and all the three companies, we have not seen any pressure on lowering rates, even in this environment, so I think that the customers have really gotten to a point where they believe that they don't need to be lowering or putting the pressure on the carriers to lower pricing. So we're not sensing that. We're not seeing or even hearing it. We've only got a couple of bids that are on the table as we speak and we don't hear of customers that are really planning on big -- any type of bid activity in the next three or four months that we know of anyway. So I do think that the downside of pricing is in pretty good shape from that standpoint.

And then we're still being able to take some pricing up. It's not where any of us would want it to be, but it's got the potential to be a 1% to 1.5% kind of number out there that we are getting some rate increases. So, we're definitely having discussions with all of our customers and we're getting some. It's not 3 or 4% like we would have liked to have had, say in June-July when freight was in good shape, but I do expect us to get 1% to 1.5% kind of numbers.

So you think even if we're in a recession for '09 you can get 1% to 1.5% from the--?

It does seem like it. We've got customers that are continuing to give us the freight. The freight is down, without a doubt, but we're not getting cut off and we're not aggressively -- we're just going to speak to our customers. I think you've got a lot of customers that are finally concerned about the industry.

I'm hearing similar things. Are you also hearing requests from some of the bigger customers for longer-term contracts or not? The couple of bids you're in, are they for multiyear?

No. Is that correct, Joey?

Well, most of the ones we have, the three or four large ones are contemplating multiyear, two to three-year type of arrangements, but--.

But not with flat rating. But with the ability to raise prices?

Yes, with some kind of escalators built into that.

Generally some kind of CPI escalators--?

Yes. Just some type of escalator that's in there. I think one of the things I would add on to David's comment is remember that our customers are receiving or getting the benefit of $0.20 to $0.25 a mile in less fuel surcharge and so, it's helping our customers' costs as well, significantly. And I would 100% agree with David, we're not feeling big pressure to lower rates right now, but there's nevertheless less freight -- quite a big less freight.

How do you look at the net fuel benefit in third quarter and then relative to fourth quarter, assuming fuel keeps coming down but not as fast from here? I guess WTI at $64 and diesel is probably lagging a couple of weeks, so assuming that that occurs, is there a bigger benefit year-over-year in third quarter or fourth quarter and what was the benefit as you see it in third quarter?

Well, assuming the same fuel prices, and we've kind of steadied our fuel surcharge recovery, we're looking at probably a $0.03 to $0.05 per mile improvement from third quarter to fourth quarter, and that's approximately between $0.15 and $0.25 per share of improvement. For the third quarter from the second quarter, we saw about the same. We saw about a $0.05 per mile improvement, and so that was roughly $0.21 a share or so.

But that was offset by higher costs to some degree?

That is a net number. That's net fuel -- fuel expense net of fuel surcharge recovery.

Okay, so you're seeing kind of a similar fourth quarter versus third quarter shaping up from that perspective?

Yes.

Okay. On the insurance side, having the higher claims activity, can you discuss a little bit about what happened there and what from that might be ongoing versus what's not? Do you have higher deductibles or anything like that as a result of what's going on?

Ed, we had the same deductibles as we've had. There's been no change there. And what we said in our release was for very specific purposes. I really don't want to comment how many is a few and I don't want to get into how much is attached to each. But nevertheless, we did have a few severe accidents that we feel that the reserves that were set up in our financials were reasonable for those accidents and we're just too early in how those -- you'll probably, by the time the Q comes out, see some more disclosure on those. But, they're within a couple of the subsidiaries inside the group were involved in separate accidents. So they weren't assigned to any one division or things like that.

So could we see $0.80 a mile again for insurance and claims in the near-term or are we going to be over $1.00 for a while?

You mean $0.08 a mile?

I'm sorry, $0.08 versus over $0.10.

We've got -- I should let Richard comment on that, kind of what our ongoing experience is. How do you feel about that?

Third quarter we were over $0.10 -- a little over $0.11 actually, but we do feel like the reserves that were set were adequate to cover all the accidents that occurred during that period, as well as any past accidents, any changes that we've had in any reserves there.

Ongoing, with our lower DOT accidents per million miles, at that rate we should be experiencing between $0.065 and $0.08 a mile on an ongoing basis. You expect severity to track along with frequency. If you have less accidents, you should expect to have less severe accidents. And with that being the case, we're looking at pretty strong results going forward for fourth quarter and for 2009, probably between that minimum $0.065 but up to $0.08 a mile, barring any additional fatalities, etc.

Okay. And so far in October nothing major?

No, nothing near the magnitude of kind of what we saw during the month of September.

Okay. Last thing, do you have any cash flow information in terms of maybe cash from operations? I know it was $29 million net CapEx in the quarter.

Let me pull that here. For the quarter, our operating cash flow was approximately $12 million. But, I will say that a large part of that negative cash flow in our sales, cash flow in our equipment purchases was in July. We were negative $14 million in the month of July. So out of that net negative $17 million, most of that was July. If we look at the months of August, September and October, we are cash flowing ourselves. We are positive, including paying down on-balance sheet and off-balance sheet debt. So, we're at a point now where we are cash flowing ourselves.

Our next question comes from Justin Yagerman.

This is Rob Cannon on for Justin.

What are you thoughts on the fleet size, given your recent reduction in tractors, which was somewhat offset by increased team?

Rob, we're right in the middle of finishing that. It's not going to go up next year and I think there's a good likelihood that it could go down somewhat between now and late first quarter, it's just how much. We're not really ready to say how much yet.

Certainly that's fair with that regard. During the quarter you'd seen some impairment charges with regard to reductions in the fleet size for tractors that you put up for held for sale as well as some trailers out there. Do you feel like where the fleet is currently, if you do decide to reduce it further, could there be a possibility for further impairment?

Rob, that would be reduced quite a bit. A lot of the impairment that had related to some older tractors that we had held for sale. Literally they were 2005 models that we did not have turn-in values for, related to the manufacturer. Any tractors that we pull now will be 2006 models and we have an amount that we can turn those in actually for freightliner to freightliner for that would hold those values up to about where they are currently or where they've depreciated down to. So I don't see that large of an impairment for idle equipment that we had in the third quarter.

The tractors, those 2005 models, did those also have residuals on them or were those kind of with--?

They did, but they expire after a certain amount of time. And at the time that we were making a decision whether to turn them in or to sell them, the values were still holding up, and so we had decided to still sell those outright. And that's what we're still doing, but we had to reduce the value on those, because the market value has decreased over the last three months.

Used truck market, Rob, in the last 60 days, has weakened.

That's kind of what we've been hearing out there as well. On the brokerage side of things with your Covenant Solutions, it looked like you guys continued to generate quite a bit of growth as well as net revenue increases at strong profitability levels. What are your thoughts with regard to that division as we look out to the fourth quarter and then 2009 and beyond?

Our goal is to continue to grow that division. Our goal is to continue to look at in-house abilities as well as agents out there. So, our goal is to continue to grow it.

You've got, Rob, in the fourth quarter for Solutions there is a lot of special project work in there in the fourth quarter that our group has done, as well as asset subsidiaries have done a great job of supporting it in the fourth quarter. And I think that some of those projects you get, some of them you don't.

The large one that we got last year, we've been able to get again this year and we're real pleased with that. Our customer was very pleased with our service. And so that's a big wild card for Solutions kind of going into fourth quarter is how much project work it does. So we are diligently trying to grow it the right way and to grow it profitably. So, we made some large investments early part of the year and we're in the middle of evaluating those investments -- did we go too far, did we go far enough, company stores versus agent operations, as David mentioned. So we're trying to build this thing the right way for long-term sustainability as well as to maximize opportunities for all the group companies.

We did also have a large project in the third quarter related to the hurricanes down in Louisiana and Texas, and so there's a little bit of headwind to grow into the fourth quarter because of the large amount of volume that we got from those.

That's a good point. Kind of what we believe is that there's always the opportunity for two or three one-time events during the course of the year, whether it's a hurricane problem or a Christmas situation, but Richard is exactly right, Rob, the hurricane did assist them a lot in the third quarter.

All right, guys. We'd like to congratulate Doug Cook on his recognition at the ATA for being named the Safety Director of the Year and appreciate the time.

Our next question comes from Chaz Jones.

Most of my questions have been answered, but maybe just kind of a 50,000-foot question here. With fuel coming in -- and maybe we're not quite there yet, but if fuel comes back down, gets in the $2.00 range, any sense with increasing your team exposure if there's been any shift at all or any hint at all about shifting some intermodal freight back to the road?

No, I would not say any hint so far. I think our customers have been excited that we made a decision to reemphasize the team product inside Covenant Transport over the last year, but we have been through it before in our 20 years. There's times when you can have too many. And so that's the balance that you have to watch, not only for utilization but for drivers. So no, we haven't seen that yet.

Yes, there will come a point to where when the economy -- whenever your opinion is on that, when supply and demand cross and if fuel is low, is there a point to where there will be some freight coming back to teams? It will, because that's the way it works. Freight gets jammed up and the teams do very well.

Number two is, is there a sustainable change of view from a shipper on what's best from their inventory management standpoint. And another thing that plays into that is interest rates -- is interest carry. And so there are two big questions that go into that from what we've seen, it's not only the cost of fuel, is inventory carry, those two go hand in hand with that. And so, we're just continuing to refocus that, stay close to our customers.

A lot of our customers that have intermodal freight are very pleased that we've made the decision, and in fact, would love for us to take some of their intermodal freight if that "would help you guys." And so we're trying to figure out when and if it's the right time to introduce that product and the complication there is obviously it's a communication challenge, if you will, for our teams and the freight that our teams do haul.

I guess I can imagine over the last three or four months that that spread has narrowed significantly with fuel coming down, intermodal in trucks.

That's right.

And then maybe just a follow-up on the equipment question. It sounded like if equipment values kind of remain fairly flat here that you guys are okay, but I guess maybe taking it a step further, if we have another leg down in the used equipment market related to either a second wave of bankruptcies, things of that nature that perhaps take used equipment values down 30% or 40%, much like we saw back in that 2001-2002 timeframe, does that raise the possibility of future impairment charges if we see another leg down like that?

Right now, Chaz, the way to think about it is exactly what Richard said. We don't feel that our assets held for sale on a go-forward basis is exposed to any what I call sizeable amount of any potential impairment. The reason is, we'll continue to sell equipment, albeit slow, and the things that we pull going forward, the large majority of those, if not most of those will be traded with our OEM. And so, any impairment will be isolated to, for the most part, on the equipment, to assets held for sale.

And so, I think with the adjustments that we made in the quarter, which a lot of those that's just a point in time. And the market has slowed so rapidly the last 60 days, we made a decision some time in the past, okay, should we trade this in or should we sell this? And we made a decision to sell this and so we expired beyond the "trade back value time" and we just got a (inaudible) next timeframe. And so we made those adjustments appropriately and we're going forward.

So, I don't think that -- you don't need to be worried about large impairment amounts in the fleet, because most of the things going forward will be traded back, because the market is so slow and we have no choice. We're not going to pile up inventory out here and so we're going to have to trade the majority of those back.

And I apologize, Joey, if you said this, but did you guys distinguish, and not in a specific dollar amount, but was that more geared towards tractors or trailers, the impairment charge in the quarter?

We didn't state that. A good piece of it was tractors. There was a portion of it which was trailers. With trailers, going forward, if we have any issues with those, we can just put them back on the road. We have a pretty young trailer fleet and we can utilize those further with our customers if necessary. And so if that's the case, we would probably just put them back into operation.

(OPERATOR INSTRUCTIONS) Our next question comes from Nick Farwell.

I just wanted to follow-up on a cash flow question that was asked earlier. Richard, when you commented about the negative cash flow of $14 million from July and then it was positive in August, September and October, I'm assuming that's net cash flow, net or gross, including CapEx, depreciation, etc.?

That is operating cash flow net of our CapEx.

Okay. So the pay-down in debt was a net pay-down in debt?

That's right. For the August, September and October time period, if you combine those three months.

Right. And can you just give us some sense of what that amount of pay-down was? Are we talking a couple of million bucks or--?

That's approximately $6 million.

Okay. And the second thing I wanted to ask was if possible either David or Joey could just size the company now by major divisions and how you see it evolving? I realize the marketplace is dynamic, but how you see it evolving say over the next year or so? I don't need exact numbers, say if Joey, you're going to do that, just some sense of the Covenant, the Dedicated, Expedited, Refer and Solutions. Obviously we know what Solutions is now.

In the quarter -- and Nick, we have some financial statistics that we publish on our website. The Covenant piece of the group was around 68% of consolidated revenue and inside of that, Expedited was the largest piece. 30% of revenues is the Expedited piece of that.

I think as we go forward we're interested in growing that at the right time. We have been growing it in the last year. Our Expedited revenue is up slightly. It's up 4%, but nevertheless, we're interested in growing that at the right time. Our Dedicated product inside of Transport is about 18% of consolidated revenue. It's up some from the last year and across the group it's frankly our most profitable product right now across the entire group and it's doing well.

But again, you're subject to the whims of the market, if you will. I don't mean that disrespectfully to the market, but to the whims of the market on when is the time to add capacity or lock in capacity and not. Right now the bid volume is out there, but it's pretty slow right now. We are starting to hear -- get some questions from some fairly decent sized shippers that have some private fleets that want to either reduce private fleet and outsource some of that and actually a few small ones wanting to get out of it altogether. So we'll have to see how that plays out, out there.

SRT, we've already mentioned, which is our temperature control product we'd love to grow. And in fact, SRT, again, is up slightly again in the third quarter and I've already said we're going to probably shift some assets inside the group to SRT over the next fourth and first quarter. So we want to grow that.

Star, again, we've talked about it at length in the past. It serves the Southeast freight market and it's just been terrible. And so, Star is struggling through that. Its revenue versus year-ago is down, its equipment versus year-ago is down and we continue to work with the management team there to right-size that fleet to the market. And I think you might expect to see that further decline over the next couple of quarters.

And so, in summary, our temperature control product, we want to grow. Our Expedited product, we want to grow at the right time. Dedicated, we want to grow at the right time. And Star, it's just got to right-size it to the market and at the right time we'll grow it, but I don't foresee that changing anytime until housing really measurably moves. So Star is going to struggle through that. We've talked about diversifying Star a bit, maybe up into the Midwest, where Covenant historically has had a little bit of strength. Can Covenant work with Star to develop a pure regional type product up in the Midwest to help Star diversify a bit and we are doing that at a very small scale to take a look at how that might work.

Thanks, Joey. That's exactly what I was looking for. Appreciate it.

Our next question comes from Donald Broughton.

Let me just make sure I heard this right. Sequentially, I've got fuel for company trucks going down net $0.294 a mile to $0.247 a mile. Richard, did I hear you say that you're expecting the same type of sequential improvement in the fourth quarter?

Yes.

He said 3 to 5 sequentially from the third quarter.

And sequentially as I model rate per loaded mile, is it conservative to assume it would be flat sequentially?

I think that's slightly conservative. Joey keeps saying flattish. I think saying flat is slightly conservative.

You scored 30,753 miles a truck in the quarter, flat to slightly down in the fourth?

Yes.

And debt had 10.5% or less.

It should be probably a little less, right about the same.

So barring -- I don't want to make this too simple, but barring a severe accident or other unforeseen calamity, you'll make at least a couple of pennies in the fourth quarter?

If the economy stays the same, fuel stays the same, no major accidents, then it looks like we possibly could.

Very good, gentlemen. Good work.

(OPERATOR INSTRUCTIONS) Mr. Hogan, it looks like we have no further questions at this time.

Thank you, Tiffany, and we thank everybody for their time this morning and we'll talk to you next quarter. Thanks a lot.