Covenant Logistics Group Inc (CVLG) 2017 Q2 法說會逐字稿

Good morning, welcome to our second quarter conference call. Joining me on the call this morning are David Parker and Joey Hogan. This conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. Please review our disclosures and filings with the SEC, including, without limitation, the Risk Factors section in our most recent Form 10-K and Form 10-Q. We undertake no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances.

As a reminder, a copy of our prepared comments and additional financial information is available on our website at ctgcompanies.com under the tab Investor Relations. Our prepared comments will be brief, and then we will open up the call for questions.

In summary, the key highlights of the quarter were: our asset-based division's revenue, excluding fuel, decreased 1.1% to $128.9 million due primarily to a 0.4% decrease in average tractors and a 0.2% decrease in average freight revenue per tractor. Versus the year-ago period, average freight revenue per total mile was up $0.009 per mile or 0.5% and our mile per tractor per week were down 0.7%. Freight revenue per tractor at our Covenant Transport subsidiary experienced an increase of 2.7% versus the prior year quarter. While our refrigerated subsidiary, SRT, experienced a decrease of 1.6% and our Star Transportation subsidiary experienced a decrease of 6.5%.

The asset-based division's operating cost per mile, net of surcharge revenue, were up approximately $0.045 per mile compared to the year-ago period. This was mainly attributable to higher employee wages, capital costs and casualty insurance expense. These increases were partially offset by lower net fuel cost.

We recognized a loss on disposal of equipment of $2.1 million in the second quarter of 2017 versus a gain of $0.6 million in the second quarter of 2016. The asset-based operating ratio was 98.2% in the second quarter of 2017 compared with 95.5% in the second quarter of '16.

Our Solutions logistics subsidiary increased revenue by 18.1% versus the year-ago quarter. Purchased transportation decreased as a percentage of revenue, however, other operating expenses increased greater as a percentage of revenue resulting in OR deterioration to 90.5% from 89.5% in the year-ago quarter. With the increased revenue, the result was an increase of operating income contribution to $1.6 million in the current year quarter from $1.5 million in the prior year quarter.

Our minority investment in Transport Enterprise Leasing contributed $0.8 million to pretax earnings or $0.03 per share. The average age of our tractor fleet continues to be young at 2.2 years as of the end of the quarter, although up from 1.7 years a year ago. Since December 31, 2016, total indebtedness, net of cash and including the present value of off-balance sheet lease obligations, has decreased by approximately $22.3 million to $204.4 million.

The main positives in the second quarter were: one, sequential tractor utilization improvement throughout the quarter; two, deleveraging with a $10.7 million decrease in our total net indebtedness; and three, our tangible book value per basic share increased 7.5% to $12.97 from $12.07 year ago.

The main negatives in the quarter were: one, increased operating costs on a per mile basis, including unfavorable employee wages, capital and casualty insurance costs, partially offset by the lower net fuel cost; and SRT operating at a loss for the sixth consecutive quarter.

Our fleet experienced an increase to 2,577 trucks by the end of June, a 7-truck increase from our reported fleet size of 2,570 trucks at the end of March. Our fleet of team-driven trucks averaged 1,012 teams in the second quarter of 2017, a 0.9% increase from 1,003 average teams in the first quarter of 2017.

Our second quarter freight improved sequentially on a monthly basis. April started off weak, resulting in year-over-year April miles per tractor being down 2.8%. After replacing customer freight we reduced in April, May miles per tractor finished even with compared with the prior year. In June, capacity tightened resulting in a 0.5% year-over-year increase in average miles per tractor, despite our Star subsidiary experiencing a 6% reduction due primarily to automotive plant shutdowns in its network.

For the third quarter of 2017, we expect a favorable year-over-year comparison in freight revenue per tractor. It is still too early in our continuing discussions with peak customers to provide guidance regarding freight yields for the fourth quarter of 2017.

For the remaining half of the year, we expect year-over-year net fuel expense savings, a flattening of year-over-year impact of the changes to our depreciation policy adopted in the third quarter of 2016, somewhat offset by higher maintenance expense and professional driver wages. At SRT, we expect additional progress in the 2 remaining quarters of 2017 versus 2016.

To the extent, mandatory ELD implementation and resulting lower truck numbers or decreased daily driving time for newly-compliant carriers remove industry-wide freight transportation capacity and economic growth spurs volumes, we expect the supply-demand environment to improve later in 2017 and then to 2018. However, the timing and magnitude of these changes are difficult to predict and may be different in each of our markets. Our goal remains to deliver earnings improvement for the second half of 2017 as compared to the second half of 2016.

Thank you for your time, and we will now open up the call for any questions. Stephanie?

(Operator Instructions) Our first question comes from Brad Delco with Stephens Inc.

David, last quarter you gave us an update on commitments you've made of capacity for peak season, and I believe it was one of the earliest times that you've committed capacity. Can you talk to us a little bit about any updates to that? Have you committed more capacity or what your thought is now just given what appears to be a little bit of an inflection with the supply-demand dynamics?

Yes. Interesting, Brad. Other than last quarter, we were -- the earliest that we've ever committed any type of peak capacity. At that time, there's nothing that has been added from a confirmation. But another way that I would tell you though is that just in the last 2 weeks, including as we speak, we have got -- we've already -- we've had about 4 or 5 more meetings. And so you can see in us what the industry is sensing right now from a freight uptick in business. You can see in us that our peak customers are starting to drive the conversations much more diligently in just in the last couple of weeks. Like I said, we've already had, I think, we've had about 4 conversations in the last week of peak. So I really believe that if we had this call 2 weeks from now there would probably be something else, some more light to add to that. I'm confident that we're going to get what we want and what we're trying to accomplish as a company. One of the things that we're trying to deal with to be honest with you, is that as we're seeing freight picking up the way freight is picking up is how much excess -- we're going to be a major player of peak, number one, but how much excess is or we're trying to internally to balance that out. Can it be as big as it was last year or not? Or do they need to be smaller, or how are we going to take care of all the existing customers that we've got as their business has started to increase? So I'm excited about peak, but we're not there yet from a standpoint that we've came to any more agreement than we've had last quarter, but we will get there.

And maybe just to sort of clarify that response. Is there any thought to maybe not fully committing your capacity because the spot market may be robust enough to be a better allocation of assets?

Yes. One of the things -- your answer is, yes, that is absolutely on the table and the discussions that we're in the process of having with our customers is that even though I love last year's peak, and peak was great, all that wonderful stuff, and we all know that it's a helter-skelter storm for about a 1 month period of time there, but cancellations and add-ons, and cancellations, it's a moving target. It was very, as I've said I think in the first quarter, is my most difficult peak that I've ever experienced last year. And so I think as you're seeing some of the customers coming out today or in the last few weeks, then they got to do things different in the peak and they got to get paid for this or get paid for that, et cetera. Well, besides the rate that we've always charged peak rate, but there's other things, much, much more as important that we have got to have, and we are having major discussions with our customers, and that is the flooding in of trailers at origin that their expectations and then volumes are missed by 20%, 30%, 40%, 50% of projection. And yes, we're getting a high rate. We're getting a higher-rate for a lot of that, but there is a number that it doesn't cover. And so we got to have those kind of conversations, which we are having those kind of conversations, we just haven't ironed out what all that means yet.

Brad, this is Joey. Let me add to that. I think that we are confident to say, about adding on to David's statement, that we've got to do peak differently from a standpoint of the tremendous amount of costs that has been added over the last 2 or 3 years to service it, and it's been too much. And so what David, I think I'd add to that is that, we're looking for committed capacity or committed trucks, if you will, more dedicated trucks, less ad hoc trucks, less gas on the projection and hope you have it. If we don't have it, there's too much cost for that. You can't hope that a customer fulfills a forecast, and it's too costly anymore. And so I think, as we think about peak, we're thinking a lot about committed -- commitments, we're thinking a lot about dedicated trucks, [hop-up] trucks, much less trailers, just way too much money we spent last year on trailers. And so as David said, we're going to be a major player, continue to do that, but we're going to be thinking about it differently because we weren't happy with the margins as we came through peak last year. And so I think you're seeing the shipping community respond over the last 2 or 3 years to the cost of peak on the revenue side. And I think you're going to see the providers respond to peak over, say, little bit last year, more of this year and more in '18. So you got to shift from, "okay, we're paying too much for peak, we've got to do things different." The vendors are now going to be saying, "we're spending too much on peak, we got to do things different." And I think that's the transition that you're going to see over the next couple of years, in my opinion.

And I agree, the only other thing -- comment I'd make is that, we all know that this peak has been evolving in the last few years and it has truly became a Cyber Monday to Christmas Day, maybe Christmas week, that -- maybe Christmas week. But it's a 4.5- to 5-week event that is so intense, you've got to get paid correctly to cover those costs.

Yes. And if I could just add one quick question, and I'll turn it over. The release kind of talks about the strength you've seen or into July or at least we've heard it from a bunch of different truckers. David, is there any way you can put into context how unusually strong the month of July is versus norm? Or something to help all of us understand what's going on and what's driving it?

Well, one of the things that the last few years, the last, what, 2, 3, 4 -- 2, 3 years is that "whatever you want to call it", Christmas in July, and it's not just our friends in Seattle, but you got other retail people that are counter-attacking that, so they're all having somewhat of a Christmas in July. And -- so besides, wherever July 4, which is not good when it's a, Tuesday, Wednesday, Thursday interruption, as you know Friday and Mondays are much better, other than that, the Christmas in July is definitely assisting and helping the month of July from a freight environment, especially, say, on July 10 and beyond because the 4th really just wrecks you for that week. So get to July 10 and you're pretty satisfied. And I think that, that is becoming more of a norm out there in the last couple of years because of that event I said -- I've talked about. But there is no doubt in my mind that things are in the process of turning around. Things are getting better. We started noticing it August 2 years ago that things were starting to slow down, August of 2 years ago, and so we've all been in this industry, has been in this rut, not horrible, not depression, not recession, but having to work awfully hard for 2 years, and freight is now starting to happen once again. And I don't think it's a fake. I think that it is going to be something that is going to get stronger as we speak, that's my expectation. But I'm pretty, pretty happy about what I'm seeing out there right now.

Our next question comes from Jason Seidl with Cowen.

Let me switch it up a little bit, talk about SRT. It feels like, at least from the last time we spoke, that you might have taken a minor step back in the turnaround. It's improving, but not at the rate that you previously thought it was. Is that a fair commentary to where we're at right now?

Jason, we thought that we would be profitable in the second quarter, 4 quarters ago. We thought we would be, and they were close. They were close. They weren't quite there, but let's just say, a 1-0-0 kind of deal. And in the month of June, because I still thought before we got the books closed out in June, that we had a great shot that we would hit those numbers. But they had a couple of bad -- not bad accidents, but we had to put more money up on a couple of accidents in the month of June that we learned more about the accident. And then they had 2 claims of $250,000 of some [OS&D] on the railroad, our fault, their fault, whoever's fault, we're trying to figure all that out. But anyway, so we had to book $250,000 of claims. If you were to take those 2 things out or just divide them in 2, divide them by half, we would have been profitable and we'd be sitting here, saying, hey, we're seeing it, we are very, very close and I'm absolutely confident that we will see that turnaround and that the numbers will start supporting what we are sensing internally on SRT. So I'm happy about what I am seeing at SRT.

Jason, I'll add to that a little bit. If we just perform like we did in the second quarter, then we'll still meet that initial goal we stated of minimum of $5 million of operating income improvement. So if we do as well -- just perform exactly as we did in the second quarter for the third and fourth quarters, we'll be right at that goal. So we're still on track. And when we came out $5 million to $10 million operating income improvement, the $10 million was a stretched goal. The $5 million we felt like we could do, and I'm still saying it's between $5 million and $10 million, closer to that lower end, but we should still meet that goal. And so I think we're right on track.

Okay. So basically, ex a couple of things in the quarter, you'd probably be more towards the higher end of the range, but with those things toward at least the lower end of the range, all things being equal.

Yes, the lower middle of that range.

Okay. Well, that's fair enough. And if I could switch back to sort of the ELD commentary, because that's always ongoing when you're looking at the truckload space from an analytical end, C.H. Robinson had some commentary out there essentially saying that they are starting to see some impact from ELDs. Now mind you, they play more with the smaller carriers with that 50,000 carrier base that they operate off of. Are your shippers coming to you trying to talk about 2018 yet? How many people are worried about ELDs? I'm just curious what the vibe is out there? And has that changed any from 1Q as we move throughout the year?

Yes. It is in the process of changing. We are having more customers that are now starting to get concerned about ELDs. And we have got some that have started internally started putting some deadlines up when they're saying to their carriers have got to be ELD compliant, and so we are. And I think each and every month, the rest of this year, that we're going to see more of that taking place. So it's gone from -- I don't think it's going to happen in the 4, 3, 2 quarters ago in January. I don't think it's going to happen. I think that we'll come do away with it to better start getting prepared for it. And I think it will just snowball for the next 4 or 5 months.

Okay. And my last question here just kind of piggybacks on what we're talking about with peak season. Do you feel, given the current trends, the fact that you're not all booked up yet is actually a good thing because we're starting to see a tightening in the marketplace and your main sort of peak season partner is probably seeing that as well?

You know, it's interesting. I mean Joey has been a big advocate internally about let's make sure that we are not giving away 100% of what we think our capacity level will be. And so we're having that balance that it's there. So yes, I mean, it could definitely play into your hands positively. And so we will take a larger, no doubt, we will take a larger percentage of whatever we devote to peak and let it be in the spot market at the end of the peak season because we are not going to absorb. And I was happy with our fourth quarter numbers, don't get me wrong, I mean we've made some good money in our fourth quarter numbers, but as you all do or don't know, I mean that peak, you died during that time. I'm talking about you're 24/7 for a month that -- and the pressure is just unbelievable and I -- we're going to make more money than -- anyway, I'll shut up. We got to get our (inaudible).

(Operator Instructions) Our next question comes from Rhem Wood with Seaport Global.

So I'm trying to just triangulate a couple of things. One, you said that your fleet growth is expected to be flat to down for the year. You added a few tractors. I know you've had lost some older business and helped another customer kind of reengineer. But it seems to be you've got a solid level of peak demand, I mean -- so how do I think about that? And then how do you go into the discussions with, I guess, 1 or 2 customers in particular, where they want all the peak demand but they're reengineering their networks or pulling some freight in the quarter? How long would it take to replace that? And can you use the peak as leverage to replace that?

Well, yes, you can. And I would say that the decisions that we made, in particular in the month of April, on protection of yield on a couple of customers -- anyway though, all that has virtually been replaced that's why all our -- the industry is kind of seeing what we saw during the month of June, which was very strong. I'm very pleased with our June results. Most of our competitors were filling into May, and we were still replacing some decisions that we made, not a loss of the customer but an agreed-upon reduction of volume because we were going to protect yield in this highly intensified, expedited team market that we play in. And so that's the decision that we made. And that freight was replaced. It took us about 4 weeks to replace that freight, which tells you a little bit about the market, in my opinion. And we are also having conversations, including with all of our major peak costumers about the peak season, which includes some of the reduction that we took. Did I answer that correctly for you, Rhem, barely?

Yes, I think so. But would you still expect the fleet to be down in the back half?

Well, no. Actually, we were down year to date. We were down 1.4%. And so there actually has to be a little bit of growth. There would have to be some growth to get to flat on a year-over-year basis for the full year. And that's what we were given guidance on was the full year would be flat to down 1%. So you actually have to have a little growth in the back half to get to flat and to be about equal to be down 1% to where we are today of 2,570.

Yes. Okay. Can we go back to July for a minute. Have you guys seen any slowdown in the organic produce? Is that still going hot or beverage season? And then specifically in July, like what buckets are moving the best right now?

Number one, we haven't seen any slowdown on the produce side of the business. It's been an excellent, excellent year and it looks like it's just continuing to be a strong year. We've got another couple of months before you will -- kind of September 15, 15 is kind of a date that we use internally. So we got a couple of more months of what we think will be one of the best produce seasons that we've ever experienced anyway. And so that part, that part is good. And what was the other part of this question, I'm sorry? What was the other part of the question?

Any other category.

Any other customers, yes. I'm going to tell you, I think you can see a little bit of the increase in the economy because, as we all know, LTL manufacturing is what they haul, we see it hit, the manufacturing hit the LTL market first, that probably whoever goes down they lose it first as well. So our LTL business has been extremely strong. It has probably been the leading, leading factor for the second quarter, which I relate to manufacturing for them.

Okay. That helps. And then what kind of a contract rate increases have you been seeing more recently? If you could just ballpark that.

Yes -- no, we're in that flat to up a little bit. But we are just now, we are just now deciding that there is an opportunity in the marketplace of which I have a 0 problem with because, as we all know, rates for the last couple of years has not been that well. And so we are putting together our plan, as we speak, that we think that the market is there, that we - it's time to raise some rates. And that's what I'm expecting from all of our companies -- or at least non-dedicated companies.

Okay. And then last one, I'll turn it over. How much spot exposure do you currently have? And where do you think is the ideal amount as we go in the back half of the year?

Spot runs 3%, 4% kind of number. And I think we all sit there and say, well, when the spot market is going crazy, going up, we all want to be at 10%. When it's going down, we all want to be 0. I don't see that, that is going to change. We are thinking about on the peak side, letting it change. But we'll probably stay in that 3% to 4% and still try to have regular relationships with all of our customers and the expectations in volumes and those kinds of things.

Our next question comes from Joseph [Mulally].

So I was wondering if, forward-thinking a few years, the expansion of the East Coast ports due to the expansion of the Panama Canal, have you given that any thought? Do you see any benefit or harm to trucking routes?

There's a couple of things. We are excited about what has happened to the -- that has, and it is going to continue to happen to the East Coast ports. I mean it is, in particular -- we thought probably about 2 years ago, Joseph, the new -- even the East -- New Jersey, Baltimore, Virginia port increase, when California had its issues on labor, we started seeing a shifting. Some of that was back to California, but not all of it. And it truly made the East Coast an outbound state instead of a just-get-me-out-of-here kind of area that it was before, and it became one that you can get a decent price score now. So that thrilled me 2 years ago when I saw that. And being at Savannah, in particular, Savannah tossed a bit, in particular, Savannah did had just in the last year, continues to explode. It continues to get big and it is really taking a lot of pressure off the State of Florida, which we all know is a bad outbound area. And the pricing out of Savannah has held up very nicely. And so I'm excited about what's happening on Savannah and what it's going to do to the South. California is still hanging in there pretty, pretty decently because, at the end of the day today, it's still the quickest route to a destination, as we all know, it's California. But I'm thrilled about what's happening on the East Coast ports.

Yes. And it looks like they're predicting a 10% shift from the Asian, U.S. shipping route by 2020. So 10% is a big number coming East.

Yes. Yes it is. Yes, I agree.

(Operator Instructions) Our next question comes from Scott Group with Wolfe Research.

David, I just wanted to follow up on that what you just said about pricing. You feel like it's tight enough where you can start kind of going back to the customer mid-cycle and get some increases. What magnitude of increases do you think the market can bear if you start doing that?

God, I mean, that said, that said, we have not had officially had our first meeting on that. And there's no doubt that the customers, and I don't have the percentage here on top of my mind right now, but there's no doubt that the customers that have lived with us on a yearly contracts, they're in the good, the bad and the indifferent, we're not going to them. If theirs don't expire until next March, we won't go to them and ask for nothing. I'm talking about one's that's supported -- even if they supported me with 1% numbers 6 months ago or 1.5%, I'm not going to go back to them and say, hey, just because I think I can get forward down the rate, we'll wait until next year. As they treated us correctly, we will treat them correctly. But it will be the ones that we have virtually have had 0 or downward pressure for the last 1 to 1.5 years, we will go to those customers. And again, you're asking me a question that I have not even have one meeting with. Why do I think a 3% is a good number, that I think is achievable. But I may get 2 weeks into it and say that it's not achievable, I don't know. I just feel -- I just sense that it's time to go talk. And when I sit and watch what's happened to our depreciation on equipment and what's happened to our insurance and we need more driver pay not less, I mean, it's time to go and share this with my customers and say I need some help, and that's what we're going to do.

Okay. So you're not sure if market will bear it, but if the market feels good enough you're at least willing to try?

Yes sir, that's exactly what I'm saying.

Okay. Makes sense. And then I know a bunch questions on peak, but if you had to guess, is your pricing with your peak customers up or down this year?

Our peak pricing with our customers will be -- definitely not down, flat to up, as I'm thinking about all of them. Flat to up is what I would say at it because, I think, much more important to us than what the rate -- because we get good rates on this stuff. And as Joey said earlier, it's the cost side. It is -- guys if you're going to have anything of whatever, anything over a 20% cancellation, I got to start getting paid some money. If those -- anything -- if you want me to spot 50 trailers at this origin, then I need to be -- it can't just be staying, it's in the rate, which it has been in the past, but peak is evolving. And if you want me to spot 50 trailers, I need to be paid not only the agreed-upon rate but here is trailer movement. So it's those kind of things, more than it is, shall I raise peak pricing 10%.

Really, looking at it on a margin base, we're really trying to make sure that we improve our margins on that freight, whether it's in the rate side or whether it's in the additional cost we have to build up around extra trailers and all those type things in order to make sure we just do it, make a better margin.

And do you think your margins will be better than a year ago with peak customers?

Yes. Margins will be better. Pricing, probably flat to up a little bit. For instance, I mean, I was -- we will take -- we will be happy to take even a lower, a lower peak rate, that's why I'm saying flattish, but a lower peak rate if they're furnishing all the trailers. You furnish all the trailers, you put them everywhere you want them, here's my capacity, here's my teams, et cetera, and I will take a lower rate on that. But at the end of the day, when it comes out the bucket, my margins are going to be better.

Okay. Okay. And then just last question, what should happen or what's happened to Star in the past when the auto cycle kind of starts turning against you? How quickly can you replace auto business with other business? Meaning, is there -- I guess I'm trying to figure out, is there a risk that 6 months from now or a year from now and we're talking about Star like we were talking about SRT?

I don't think so at all. Here's kind of what we have seen in the last -- since, really '09, the automotive industry has been going up from a 9 million number of orders billed, up 17.5 million, 18 million orders billed, and we think it's going to be around 17 million. It's definitely plateaued. None of us, or anything I read, we don't expect anything to go down dramatically. Now what we have seen is that, I think, that it affects Star by 3 to 4 operating port -- points. Now that said, they have consistently operated in the 80s, to give you an idea. And so I think it is a 3 or 4 point. And we're seeing that -- and we've seen that in the last 6 or 8 months, really, the last 3 quarters that we've seen that. And what ends up happening over there is that when you see automotive go from, say, 18 million to 17 million car builds, what happens, Scott, is that, instead of the Saturday loadings, it's Monday through Friday instead of Monday through Saturday, and so you have a lot of Saturdays that get cut out which hurts your utilization by that one day. And so as you said, that's what you saw in the second quarter, some -- not many Saturday day works because they're readjusting the load volumes there. But now I think it's a -- it is a 3 or 4 point number, but it's also still a very strong number.

And Saturday is not a full production day, so it's not like it's dropped by 6.

No, that's right.

When you lose a Saturday, you might lose the 3% to 5% utilization. And then when there's additional temporary shutdowns, like the Chevy Malibu in Kansas City, for example, then you have a little additional utilization loss for those weeks as you replace that freight during those shutdown time, and you might even get a better rate but your cost is higher, too, and so your margins aren't quite as good when you have those temporary shutdowns, but you are -- we are able to replace good amount of that freight during those weeks.

We're also being very blessed on, more fortunate that it's happening, is that there's a lot of the Southeast tier, on the plant tier, that they are cranking up on truck and SUV with that. Those orders are not going down at all, and so that is playing in. Because as we speak, that is something we got in the future coming on that it is going to be very helpful. Now what we're doing is we're looking at all our existing automotive business and making sure that we are having conversations with them about their truck and their SUV plant to make sure that we're a bigger player in those areas.

(Operator Instructions) There are no questions at this time.

Okay. We will just wrap it up, and thank you for listening to our call today, and we'll talk to you again next quarter. Thank you.

Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect.