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Covenant Transportation Group, Inc. (NASDAQ:CVTI)
Q2 2019 Earnings Call
July 25, 2019, 10:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Excuse me, everyone. We now have all of our speakers in conference. Please be aware that each of your lines is in a listen-only mode and at the conclusion of today's presentation, we will open the floor for questions and at that time, further instructions will be given as to the procedure to follow if you would like to ask a question.

It is now my pleasure to turn today's conference over to Mr. Richard Cribbs. Please go ahead, sir.

Richard Cribbs -- Executive Vice President and Chief Financial Officer

Thank you, Carrie. Good morning. Welcome to our second quarter conference call. Joining me on the call this morning are David Parker and Joey Hogan. As a reminder, 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 and our most recent Form 10-K and our current year form 10-Q. We undertake no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. A copy of our prepared comments and additional financial information is available on our website at covenanttransport.com under the investors tab. Our prepared comments will be brief and then we will open the call for questions.

In summary, the key highlights of the quarter were our truckload segments revenue, excluding fuel, increased 4.2% to $151.2 million due primarily to a 486 or 18.7% average truck increase, partially offset by a 12.2% decrease in average freight revenue per truck in the 2019 period as compared to the 2018 period. Of the 486 increased average trucks, 467 trucks were contributed by the Landair acquisition as Landair contributed $20.6 million of freight revenue to truckload operations in the second quarter of 2019.

Versus the year ago period, average freight revenue for total mile was down 1.8 cents per mile or 1% and our average miles per tractor were down 11.3%. The main factor impacting the decreased revenue per total mile was a higher percentage of lower rate dedicated freight revenue at Covenant Transport, Southern Refrigerated Transport, and Star subsidiaries, partially offset by the Landair dedicated fleet's higher average freight revenue per total mile.

The main factors impacting the decreased utilization include the softer freight environment in our one-way truckload business and the impact of Landair operations on the combined truckload division, including an approximate 640-basis point decrease in percentage of our total fleet comprised of team-driven trucks, partially offset by a lower average seated truck percentage.

Landair's shorter average length of haul and dedicated contract solo-driven truck operations generally produced higher revenue per total mile and fewer miles per tractor than our other truckload business units. Versus the prior year quarter, freight revenue per tractor at our Covenant Transport subsidiary experienced a decrease of 11.1%. The SRT subsidiary experienced a decrease of 7.8%, and our Star subsidiary experienced a decrease of 5.1%.

The truckload segment's operating cost per mile net of surcharge revenue were up approximately $0.07 per mile compared to the year ago period. This was mainly attributable to higher professional driver wages, group health insurance claims cost, net fuel expense, operations and maintenance expense, and the impact of Landair truckload operations higher cost per mile model.

These increases were partially offset by a reversal of $1.8 million in compensation expense related to certain equity grants accrued between January 2018 and March 2019 as reduced earnings have made performance testing not probable for such restricted stock grants.

Our managed freight segment's revenue, excluding fuel, increased 70.8% versus the year ago quarter to $43.7 million from $25.6 million. Of the $18.1 million of increased revenue, Landair contributed $21.2 million of revenue, offset by a $3.1 million reduction in freight revenue from our brokerage subsidiary. Our minority investment in transport enterprise leasing contributed $2.4 million to pre-tax earnings or $0.09 per diluted share in the second quarter of 2019, compared with a $1.8 million contribution to pre-tax earnings or $0.07 per diluted share in the prior year quarter.

The average age of our tractor fleet continues beyond 2.2 years as of the end of the quarter, slightly up from 2.1 years a year ago. Since December 31st, 2018, total indebtedness net of cash and including lease obligations has increased by approximately $39.9 million to $294.5 million. As of June 30th, 2019, our stockholders' equity was $351.7 million for a ratio of net indebtedness to total capitalization of 45.6% compared to a 42.6% ratio as of December 31st, 2018.

In addition, our leverage ratio has increased 1.8 times as of June 30th, 2019 from 1.5 times as of December 31st, 2018. The main positives in the second quarter were improvement in the operating income at our managed freight segment, including successful integration of Landair's warehousing and transportation management service offerings, two, improved year over year earnings contributed from our investment and transport enterprise leasing, and three, consistent demand and profitability from our growing dedicated businesses and Landair and Star.

The main negatives in the quarter were the operating margin declines of our expedited and solo refrigerated service offerings to an approximate 10.6% decrease in average freight revenue per truck for our truckload segment, excluding Landair's truckload operations versus the second quarter of last year, and increased truckload operating cost on a per-mile basis, primarily from the increased professional driver wages, improved health insurance, net fuel costs, and often maintenance expense.

Our fleet size remained basically flat sequentially with 3,101 trucks at the end of June. For the second half of the year, our focus will be on identifying opportunities to improve the performance of our one-way truckload service offerings and adding profitable contract logistics service customers with more predictable long-term contracts and our dedicated truckload transportation management and warehouse service offerings.

Thank you for your time. We will now open up the call for any questions.

Questions and Answers:

Operator

Thank you. At this time, we'd like to open the call for questions. If you would like to ask a question, please press the * key followed by the 1 key on your touch tone phone now. Questions will be taken in the order they are received. If at any time you need to remove yourself from the question queue, that is *2. Again, *1 to ask an audio question.

Our first question will come from Jack Atkins with Stephens.

Scott -- Stephens -- Analyst

Hi, David, Joey, and Richard. This is actually Scott on for Jack. I guess my first question is on what you're seeing in July from a freight market perspective, demand and supply. I know you talked about in your release you're starting to see early signs of capacity correction. I'm wondering when you can start seeing the market start to rebalance itself, what your expectations are from this point.

Joey Hogan -- President and Chief Operating Officer

Hey, Scott. This is Joey. I think a couple things -- we saw the one-way market -- I call it bottom about the middle of May. It was a pretty precipitous decline from early February to the middle of May on the one-way side. You started to see it move up from the middle of May through the end of June. The first couple weeks of July, you felt it step back a little bit. I think that July 4th being on a Thursday combined with general freight market situation, it did drop back. I'm not saying it went all the way back to where it was in May. The last week or so, you feel it trying to move again back to the positive.

When do we expect -- that's the big guess. We know that capacity is coming out, just networking heavily with our manufacturers, our OE truck manufacturers. We know that's all public. Orders are dropping quickly. Cancellation rates are increasing. One OE, I don't want to name the name, it doubled from a normal rate. So, that's a good sign of let's call it capacity rationalization on the truck side.

Then through our brokerage operations, you're seeing that -- let's call it bankruptcies for a second or folks kind of exiting the market continuing to increase. We're seeing signs of the capacity rationalizing itself. We've kind of thought through and now our current view is we think, if it continues, we think it's sometime this fall, but that's just a guess for a lot of reasons. There are several macroeconomic issues that could impact if I want to get into all those politically and things of that nature.

We are holding our course on our truck plans for this year just because we're trying to get as many automatics in the fleet as we can. Our used equipment sales are still good. So, we're still able to move equipment to continue our plans. We're not planning on growing any between now and the end of the year on the truck side. We may take it down slightly depending on opportunities and what we're able to bring on in the business from a new business standpoint. So, it's just kind of a feel from where we are.

Scott -- Stephens -- Analyst

That's helpful. Thanks. I guess a follow-up question for Richard -- you mentioned your leverage ratio ticking up slightly. As you think about your more steady contributions from Landair and cash that should be more stable, how are you thinking about the balance sheet, capital allocation, and returning shareholder value?

Richard Cribbs -- Executive Vice President and Chief Financial Officer

Well, net capex should be -- it was over $60 million in the first half of the year. I expect that number to finish the year somewhere between $80 million and $85 million. So, there's going to be a lot less net capex, as we have more proceeds coming in from trucks being disposed of than what we're bringing on in the last half of the year. I think there's a good opportunity to continue to pay down some debt in the last half of the year.

As our capital allocation has moved to trying to grow the less capital incentive businesses of the brokerage and the transport management and the warehousing business, we're also growing the dedicated side, which is capital intensive. We're trying to grow the others at a faster percentage. Then I do expect you'll see our return on investor capital start to climb a little bit, especially as you look forward into future years.

We're really trying to also grow those that will also reduce the volatility as well as it's not the only reason to do it. We do believe that it will provide a better return for our shareholders.

Scott -- Stephens -- Analyst

Great. Thanks. That's all for me.

Operator

Our next question will be from Jason Siedl with Cowen and Company.

Jason Siedl -- Cowen and Company -- Analyst

Thank you, Operator. Good morning, guys. I wanted to touch a little bit on the refrigerated side, maybe if you could talk to us about some of the trend that you saw. Obviously, we had a very late start to the produce season and that probably wasn't a good thing for that division, but if you could give us some color there, I'd love to hear it.

Joey Hogan -- President and Chief Operating Officer

Yeah. We were just talking about that before we got on the call. David's got some handy numbers there. It was late. Some of our larger shippers that we participate in produce with were behind in April and May versus their commitments to us. June came back quite nicely, met commitments, and July thus far is OK from that standpoint. So, we did see a late season. There's no question about that. We still feel really good about the business there trying to look for some solo opportunities in the produce market to supplement our team size. It did start late this season, no question about that.

Jason Siedl -- Cowen and Company -- Analyst

Talk a little bit about -- I don't know if you touched on it because I had to hop on a little bit late from another overlapping call -- touch on driver recruiting, particularly on the team side and what you're seeing in terms of the difficulty level and also on the pay level as well.

Joey Hogan -- President and Chief Operating Officer

The team side, we've actually increased a few teams over the last 90 days, I would say, probably 20-ish, 30-ish or so. Getting teams is extremely difficult. There's no question the largest part of the market is solos. Teams are just a small percentage of the overall freight market. Demographically, it continues to be a challenge. The way to get a team or an individual interested in teaming is you've got to make sure the pay is significantly over what they could make as a comparable solo operation and that's a challenge.

Some markets, shippers are willing to pay for that and some they're not. That's some of the challenge with an expedited product is it's much, much more cyclical. When they need it, they need it in a hurry, when they don't, they don't. You look for the 52-week freight that you could build a network around, but it is volatile.

In our experiences, to be able to grow teams, your team business or your team pay needs to be at least 20% higher than what a comparable solo opportunity is in your fleet. If it's not, those drivers will lean themselves to the solo operation because it's not worth it to try to match up with someone that they may not know. That's a constant battle, what would your customers be willing to pay for that service versus what you can offer to your teams.

I think if you look inside of CTG and think of the mix out of the 3,100 trucks, today, we're a solo fleet from an enterprise standpoint, 2,300 of the trucks are solos and 800 of the trucks are team. That's kind of a simple way to think about it. So, our solo fleet is three times the size of our team fleet.

So, as we think about diversification inside our portfolio, that's what we're doing is putting the strategy of growing our dedicated model because it is -- when those folks are tired of teaming and they like the company but they're just tired of teaming, "What options do you have for me?" Obviously, the majority of the options are solo. So, we're trying to make sure we have a good competitive product that can keep those professional drivers that want to stay with enterprise there.

So, teams continue to be a challenge. I think long-term, we would like to grow them a little bit, but I'm not going to say a lot. We continue to look for those shippers that value that service and are willing to pay for that service. The cost of capital is higher. It's much, much higher. So, making sure we've got a good return on that asset is critical. We've had some years over the last two or three that we've achieved our OR targets for that fleet, but obviously, this year, it's backed up quite quickly with the market that we're in.

Jason Siedl -- Cowen and Company -- Analyst

That's some great color. I have one more and then I'll turn it over to the next person. In talking to your customers, especially the retail ones, have they expressed any details about the tariffs and how that's impacted the flow in their supply chain in the first half of the year and how they would anticipate the second half of the year playing out?

Joey Hogan -- President and Chief Operating Officer

David, I'm going to let you take that one.

David Parker -- Chairman and Chief Executive Officer

I think, Jason, most of them. There's no doubt, as we all know, that 2018 was a roller coaster as it related to build up of inventory because of tariffs. I was talking to one of our customers about a month ago. It was interesting.

As you know, the tariffs would go into effect when the boats hit the ports, LA or Long Beach, wherever they're going to, it's basically 21 days from China into LA and this particular customer as the tariff was getting ready to go, the last time that it went up, which was, I believe, in January, 10%, they said that we -- the boat was running one day behind. It got there the 22nd day and on the 22nd day, the tariff went into effect and it cost them $10 million on that boat. Unbelievable when it comes to those kinds of discussions that you have.

So, there's no doubt that they played it. All the truckers felt it. You saw it, inventories. I think one of the things is capacity exploded in 2019 -- all of 2018, but the end of 2018 and 2019, inventory levels have had to start working their way down and they have but slowly, it's nothing dramatic and they'll continue. I think most of the retail customers out there today have got it positioned where they want it. They're just now working off of inventories.

I think if we see another heightening of insecurity of not getting a China deal done, I think it will happen. As soon as they get inventory levels to an acceptable number, they feel like tariffs will be part of the future, we relive another 2018 as it relates to the tariffs in China and the increase in inventory levels.

Therefore, it will become another feast or famine. Right now, we'd like to have a feast. Give me a feast. I'd like to have some feast going on, but I'd say the best thing I feel, Jason, is that as it relates to the whole economic environment as it pertains to trucking, if eel very confident that the industry has hit the bottom. I think that we hit it sometime in May and I think that we started seeing it increase to stable off a lower base but I think that at least we have found the bottom and we're working our way back up is the way I feel.

Jason Siedl -- Cowen and Company -- Analyst

I've got my fingers crossed that we have. Gentleman, I appreciate the time as always.

Operator

Thank you. Our next question will be from Scott Group with Wolfe Research.

Scott Group -- Wolfe Research -- Analyst

Hey, thanks. Good morning, guys. Can you talk about the underlying yield and utilization trends in the quarter, ex-Landair and then maybe what you're seeing in July and what you expect for the third quarter in yield and utilization?

Richard Cribbs -- Executive Vice President and Chief Financial Officer

Yeah, Scott. Without Landair, utilization was down about 7.9%. Overall consolidated was down 11.3%. You can see the impact of the Landair miles. As we move forward, we purchased Landair July 3rd of last year. So, we basically have a good full comp versus last year going into the third quarter.

I still expect utilization to be down slightly versus last year, but more in a probably 2% to 3%, 4% range, nothing like the 11% and 12% and really a little better than the 7.9% we saw as we were talking about April and May. We're well below our seasonal expectations and things have picked up a little bit. That's really where I see it going into at least July but really, for the full third quarter.

Scott Group -- Wolfe Research -- Analyst

And the same thing for price?

Richard Cribbs -- Executive Vice President and Chief Financial Officer

Yeah. Rate per mile, rate per total mile without Landair in second quarter was down 2.9% and I think that we'll see that drop a little further on a consolidated basis. It was down 1% on a consolidated basis. So, for third quarter, I think you're going to see that number down 5% to 6%, 5% to 7% on rate per total mile for the group. That's all I can tell you for third quarter. Peak, we haven't really contracted anything yet. There are some talks. I don't really have any indications on fourth quarter yet.

Scott Group -- Wolfe Research -- Analyst

Okay. That's helpful. Third quarter, sometimes earnings are better than second, sometimes worse than second. Is this one of those years where you think third quarter earnings are going to be worse than second?

Richard Cribbs -- Executive Vice President and Chief Financial Officer

I don't know. We didn't really give any guidance on third quarter in the release. I think we have some headwinds and tailwinds that are kind of going equally both ways. Without saying exactly where I think that will end up, I do think we have equal forces coming sequentially from Q2.

Joey Hogan -- President and Chief Operating Officer

One of the things, Scott, I would add to Richard's comment -- if you kind of break down the various service offerings, second quarter to third quarter, we believe our one-way business is going to be better sequentially in the third quarter than the second quarter. It was pretty rough early part of the quarter. As I said, early February through the middle of May, it was a drop. Where is the bottom of this thing on the one-way side?

You've already heard -- I've said it, David said it. I think sequentially, the one-way side should be better. Our dedicated side, we had some executional issues at a couple of our locations that I think we've done a good job of improving those. So, let's just say dedicated in total, I believe sequentially should be a little better. Our brokerage operation is going through a lot of growth.

Compared to a year ago, there's a lot of noise in there from a big agent that we lost that we had last year, it's a pop-up business with a large customers that we don't have, but if you strip it out and go apples to apples, kind of what we had last year, excluding the business is up dramatically. There are some neat opportunities coming, I haven't closed them yet, that could help them nicely later in the third quarter. So, I feel pretty good about that.

Our managed freight business and our warehousing business -- let's just say kind of flattish because those are long sales cycles. The pipeline looks pretty good. I won't say it's robust, but it looks good. So, let's say that's flat. I think you put that in the hopper and kind of think about it from a business standpoint -- forget EPS for a second -- we are feeling better sequentially from the second quarter to the third quarter, just because of where we feel the one way market is and kind of addressing some of the dedicated issues we had with a couple of the locations. So, that's some color around what Richard was talking to relative to expectations.

Scott Group -- Wolfe Research -- Analyst

Okay. That helps. Lastly, can you talk about gains on sales and expectations there and then what you're seeing in the used truck market?

Richard Cribbs -- Executive Vice President and Chief Financial Officer

Gain on sale in the second quarter was $65,000.00, down from $400,000.00 last year. Expectations are that we're going to have a good bit more proceeds in the third quarter. So, I expect that number to be closer to $500,000.00 to $600,000.00 in the third quarter. Like Joey said, we're still seeing used truck sales hold up pretty well. I think used truck pricing is down a little bit, but maybe not so much on the later model trucks that we are able to sell versus what's out there in the full market. So, we're still seeing decent returns on those as well as on the few trailers that we're selling.

Scott Group -- Wolfe Research -- Analyst

Thank you, guys.

Operator

Thank you. Once again, that is *1 to ask an audio question now.

Richard Cribbs -- Executive Vice President and Chief Financial Officer

If there are no other questions, that will wrap up our call today. Thank you for your time and interest in our future. We'll look forward to speaking with you again soon.

David Parker -- Chairman and Chief Executive Officer

Thank you.

Operator

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

Duration: 28 minutes

Call participants:

Richard Cribbs -- Executive Vice President and Chief Financial Officer

David Parker -- Chairman and Chief Executive Officer

Joey Hogan -- President and Chief Operating Officer

Scott -- Stephens -- Analyst

Jason Siedl -- Cowen and Company -- Analyst

Scott Group -- Wolfe Research -- Analyst

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