Covenant Logistics Group, Inc. Q3 FY2025 earnings call

Management Statement and Operational Highlights

• Business remained resilient in Q3 despite margin compression. Consolidated freight revenue increased by 4% to $268.9 million, while consolidated adjusted operating income shrank by 22.5% to $15 million.
• Net indebtedness as of September 30th increased to $268.3 million, with an adjusted leverage ratio of approximately 2.1x and debt-to-capital ratio of 38.8% due to share repurchase program and acquisition-related earn-out payments.
• Expedited segment noted for 93.6% adjusted operating ratio, with focus on margin improvement via rate increases and exiting less profitable business.
• Dedicated segment saw fleet growth but plans to reduce exposure to commoditized end markets and invest in value-added services.
• Managed Freight team showed resilience through difficult cycle, with strategy to grow and diversify the segment.
• Warehouse segment expected to see top line growth from upcoming large customer start-up in November.
• Minority investment in TEL affected by bad debt and capacity exit in general freight market.

Segment Performance

• Expedited: Yielded a 93.6% adjusted operating ratio. Fleet size shrank by 31 units (3.4%) to 861 average tractors. Focus on improving margins through rate increases and exiting less profitable business.
• Dedicated: 94.7% adjusted operating ratio. Fleet grew by 136 tractors (9.6%). Plan to reduce fleet in commoditized end markets and invest in value-added services.
• Managed Freight: Exceeded revenue and adjusted operating income y/y but fell sequentially due to loss of a short-term customer. Team resilient, strategy to grow and diversify.
• Warehouse: Freight revenue and adjusted operating income slightly below prior year, adjusted operating ratio 92.1%. Anticipates top line growth from large customer start-up in November.
• Minority investment in TEL: Pretax net income $3.6 million for Q3 vs $4 million prior year. Impacted by incremental bad debt expense and capacity exit in general freight.

Guidance

• Anticipates Q4 to remain challenging due to soft freight market and company-specific factors, including increased claims accruals, U.S. government shutdown impact on DoD volumes, and accelerated TEL customer bankruptcies.
• Optimistic about freight market recovery driven by capacity exiting, government policies (e.g., English language and non-domicile driver regulations), monetary easing, and settlement of trade tensions.

Risks

• Short-term soft freight market conditions.
• Company-specific challenges: increased claims accruals, negative impact of U.S. government shutdown on DoD volumes, and accelerated customer bankruptcies at TEL.
• Potential brokerage margin compression due to capacity exiting and government regulation.

Question and Answer

Q: So I want to start where you wrapped up just talking about the capacity backdrop and maybe just give us some color on what you're actually seeing in the market with respect to capacity exits? How big of a deal do you think this is going to have? And then I don't know maybe just like -- there's certainly more talk in the market about this. Why don't you think we're seeing any impact on like national spot rates? I know there's a lot of talk about local markets getting tighter, but why do you think this isn't showing up necessarily in national spot rate data?

A: Scott, it's David. Yes, I mean, this is something that didn't drive me crazy trying to figure out where all this is going. And I would say a couple of things because great first question. From a standpoint, I'm more excited. I've been in this thing 53 years. I'm more excited right now than I've ever been in my entire career for the next 2 to 3 years. I see some things that we've never ever been in a position, where we are starting to get the government that is now starting to get concerned about who's driving trucks and why should they be driving them, and you are sensing that, and I just see an avalanche that's in the process of happening. And as I think about from spot rates, I mean, we have seen compression on margins on our brokerage side in the last 3 weeks when all this stuff started. And it is right now defined to a lot of individual states. And I met yesterday with our brokerage group and California, Texas, Oklahoma, Chicago, those are states and cities that keep coming up over and over. And you have got third parties that are scared to go to those states, right, wrong or indifferent. And that's the reason why you are seeing instead across the board that you are seeing, I believe, spot areas of the country, where it's becoming tighter and rates have gone up in those areas because a lot of these truckers are still going to go. I'm not going to Oklahoma. I heard Oklahoma pulling over 135 trucks and [ sending by the ] jail and all those stories that we're all hearing. I'm not going to Laredo, Texas. They're going to stop everybody that can't speak English. And so that is really leading the effort. Now that said, will it be a red versus blue states, red being aggressive, blue not being as aggressive. But I'm here to tell you that if they continue to have -- if we all continue to wake up every day, with another fatality accident by illegal immigrant, it is going to spread throughout the United States. And as I look at this, as I look at non-domiciled CDLs, as I look at the English-speaking issue, as I look at ELDs, there is more cheating going on and toggling is unbelievable guys to what's going on with ELDs. And so far, the government has suspended 5 or 6 companies. I'm here to tell you there's going to have to be hundreds -- there's about 950 that are approved ELD suppliers, and they need to look at every one of these ELD suppliers. We all thought that when we went to ELDs that everything was going to be legal and you're not going to have log books and everybody is not going to be cheating. Well, I'm here to tell you, us big guys, we love the ELDs. We love not having log books. But when you got toggling going on, it's rampant cheating that is happening. I run a truck 100,000 miles, they're running trucks 140,000 miles. And so the government is just now for the first time ever that it's starting to go down this road And so, I feel very confident that over the next 6 months, 1 year, 2 years, whatever it's going to be, it's going to be a snowballing effect that we are going to have less drivers on the road. We're going to have safer drivers on the road. We're going to have English-speaking people that can have the ability to speak English and understand it. We are going to have ELDs are going to be in much better shape, get rid of the multiple MC numbers. Guys, it's rampant with shutting down this, opening up that one. Today, I shut down tomorrow, I open up another one. We're just now learning about this and just now starting to do anything about it. So as I look at capacity, one of the things that strikes me is this is coming to a head. It's going to be -- it's in the process of exiting. But as good as anything, I'm here to tell you the funnel is stopping coming in. whatever that number is, that's leaving, whether it's 1,000 or 200,000, they're going to leave, but there's not going to be a flood of entries coming in And so, that is extremely encouraging that for the first time in my 53 years, there's actually a constraining of supply that's happening. And there's not going to be a bunch of new drivers from all over the world that's entering the truck driving workforce. I looked at that, Scott, and I'll shut up here in a minute. You asked the first question of what I've been [ alive ] with for the last month. But as I look at this supply, then I start looking at what the Fed is doing on interest rates. They're going to continue to lower interest rates. They're going to continue to pump the economy up. This physical -- the stimulus package that we all hear Trump talk about $17 trillion, $20 trillion [indiscernible] I don't know what the number is. One thing I do know it's gigantic. And there is a lot of freight on these plants that are being built in America, even if it takes 2 years, there is a lot of business that's coming to America that's got a lot of freight in it from these new plants that are going to be coming up. So as I look at supply, I am more excited than I've ever been. There is no doubt. I think we and the industry, we got some jump to go through. What do I mean by that? Brokerage, margin compression is happening now. I see it in our business. All the brokers are going to see it in their business. As I look at used truck market as we speak today, it's less than what I want, but I believe it's going to turn around fairly soon, maybe next year because nobody is going to buy a Class 8 truck. We don't know what we're going to pay for a Class 8 truck. I'm at ATA next week in San Diego, and I can't tell you what a price of a truck is right now or if我'm even going to buy one. So it's going to drive up the used truck prices. So that我'm happy about that. This government shutdown. It hurt me on my Department of Defense business, but I'm a month into it. We'll see what happens there, but it's not helping. Eventually, it will -- eventually will go back to work and everything will be good there. But -- and lastly, I was just telling the guys here before we got on here, one of the things that I'm really excited about, as we all know, our industry has not raised rates in 4 years. I haven't raised rates virtually at all in 4 years. And I was in a meeting in the last couple of days with sales and both on our legacy dedicated and on our expedited, we got 8 or 10 accounts that we have asked for rate increases and actually have been given 2.5% to 4% in the last couple of weeks. That excites me. Is that something that's going to happen on every customer I got? I don't know, but I haven't seen it in 4 years, and I'm starting to see it. I'm starting to see bids at all-time highs. So you're seeing the customers -- our bids are up 17% since August. Well that don't happen. That's a November, December, January, February event, and it started happening in August and September. Why is that? It's because our customers are concerned about capacity, even though we all need freight right now. So Scott, I'll shut up. As I look at it, I'm more excited than我've ever been about '26, '27, '28. If anybody is ever going to buy a trucker, it's now. If they don't buy truckers now, they don't need to be buying truckers. So that's where I'm at.

Q: So I want to start where you wrapped up just talking about the capacity backdrop and maybe just give us some color on what you're actually seeing in the market with respect to capacity exits? How big of a deal do you think this is going to have? And then I don't know maybe just like -- there's certainly more talk in the market about this. Why don't you think we're seeing any impact on like national spot rates? I know there's a lot of talk about local markets getting tighter, but why do you think this isn't showing up necessarily in national spot rate data?

A: [David Parker's response as above] Q: Jason Seidl from TD Cowen: I wanted to touch a little more on 2 different things. Can you talk a little bit about the government shutdown in the DoD? You said that business is down about half. Sort of how should we expect that to flow through the P&L? And once the government does reopen, whatever that may be, how quickly do you expect that freight to come back? And then I have a question on sort of capacity.

A: [Paul Bunn's response as in transcript] Q: Jeffrey Kauffman from Vertical Research Partners: Just some quick kind of look ahead here. What are you expecting to hear from the other carriers at ATA that might be a little different than what you were thinking a couple of weeks ago?

A: [David Parker's response as in transcript]