Covenant Logistics Group, Inc. (CVLG) Earnings Call Transcript

Good day, everyone, and welcome to the Covenant Logistics Group Third Quarter Earnings Release and Investor Conference Call. [Operator Instructions] Now I'll turn the call over to your host, Trip Grant. Please go ahead.

Good morning, everyone, and welcome to the Covenant Logistics Group Third Quarter 2026 Conference Call. Joining me today are CEO, David Parker, President, Paul Bunn and COO, Dustin Koehl. Before we begin, please note this call will contain forward-looking statements under the Private Securities Litigation Reform Act, which are subject to risks and uncertainties that could cause actual results to differ materially. Please review our SEC filings and most recent risk factors. We undertake no obligation to publicly update or revise any forward-looking statements. Our prepared comments and additional financial information are available on our website at www.covenantlogistics.com/investors. Now shifting to the results of the third quarter. During the quarter, we capitalized on the strong freight market to advance our strategic priority, improving the long-term durability, consistency and quality of our business model. Key accomplishments included expedited transitioned expiring one-way over-the-road contracts to multiple-year committed capacity business with new and existing customers. Dedicated, expanded our pipeline of multiyear dedicated truckload business exited historically unprofitable or marginally profitable business and executed start-ups with new customers. Managed Freight grew top line revenue and margin and improve the operating efficiency of overflow capacity within division. The continued refinement of our business model and allocation of assets where they are most productive are critical to our long-term success and aligned with our strategic plan. While we expect this process to be ongoing, the percentage of our fleet we reassigned during the quarter was more significant than normal. As a result, our truckload operating margin was negatively impacted, while our managed freight margin more than made up the difference. We are confident in our strategy, the market is supportive of aligning more assets with committed customers, and we believe our structural revenue improvements will overcome transition and efficiencies and general operating cost inflation in the near term. With sustained tightness of industry driver capacity and strong execution, we believe we can significantly expand our operating margins through steady gains rather than a sharp increase. With that background, I will move on to the quarter's statistical review. Consolidated freight revenue increased by 17.2% or approximately $46.2 million to $315.1 million, primarily as a result of the brokerage assets acquired in the fourth quarter of 2025. That are now being operated as Store logistics solutions within our Managed Freight segment. Partially offset by approximately 3.4% less freight revenue from our combined truckload operations as a result of fleet reductions. Freight revenue per total mile improved by approximately 19.8% and freight revenue per average tractor per week improved 6.1%, compared to the prior year quarter in our combined truckload operations. Given the year-over-year shift in operations to lower mileage committed contracts, year-over-year revenue statistic comparisons can be difficult to compare. Consolidated adjusted operating income improved by 5.7% to $15.8 million. The largest contributor was the growth of both revenue and margin on our Managed Freight division. Adjusted net income improved by 14.6% as a result of the growth in adjusted operating income and higher pretax earnings from our minority investment in TEL partially offset by higher interest expense. Our net indebtedness as of September 30 decreased by approximately $12.4 million to $283.9 million compared to December 31, 2025, and yielding an adjusted leverage ratio of approximately 2.1x and debt-to-capital ratio of 40.2%. The average age of our tractors at September 30 was 26 months up from 23 months compared to a year ago. This growth is in line with our life cycle management plan for our assets based fleet and consistent with year-over-year reductions to our high mileage expedited fleet. On an adjusted basis, return on average invested capital was 5.2% for the trailing four quarters versus 6.9% for the same period in the prior year. Now providing a little more color on the performance of the individual business segments. The Expedited segment reported an adjusted operating ratio of 94.1%, approximately 50 basis points above the prior year quarter. Over the past 12 months, this segment has undertaken a considerable amount of transition. While the fleet was reduced 21.4%, freight revenue per average tractor has improved by 12%. Driver compensation and related costs spiked in the quarter for our expedited segment. The cost to recruit, onboard and see new drivers for our growing committed capacity business has not come without cost. As we work to convert this segment to serving more freight under multiyear agreements, we are confident that profitability will improve to a level that meets our expectations. Going forward, we have line of sight to sequential improvement in this segment's profitability during the fourth quarter of the year. Over time, our goal is to average a double-digit adjusted operating margin across the freight cycle to generate an acceptable return on capital. Dedicated's adjusted operating ratio of 96.1% was 140 basis points above the prior year quarter and fell short of our expectations. During the quarter, we experienced growth in instructors escalating driver pay cost and escalating equipment-related costs. In addition, several of our operations within our agricultural-based fleets experienced significant volume headwinds as a result of the severe heat in the quarter, diminishing our ability to absorb certain of our fixed costs. Freight revenue per average tractor for the period improved 6.2%. Cost headwinds in the quarter included depreciation, maintenance and driver compensation-related costs, offset improved freight revenue in this segment. Going forward, our goal is to steadily restore adjusted operating margin to double digits, grow the fleet serving high service niches, improve profitability with certain legacy customers as contracts renew, and if applicable, reduce any part of the fleet that is not adequately returning capital in line with our expectations. Managed rate grew freight revenue 68.4% compared to the prior year. primarily as a result of the brokerage assets acquired in the fourth quarter of 2025, but also as a result of the team's effort to improve balance and efficiency and overflow asset-based freight. In addition, due to the combination of rate increases received from customers during the year, increased overflow volumes from expedited and improved availability of third-party capacity. We were successful in growing our adjusted operating income by approximately 133.3% compared to the prior year. As we look ahead, our goal is to continue to grow top line revenue organically within this segment, and maintain mid-single-digit margins. The Warehouse segment performed in line with our revenue expectations but disappointed us by failing to improve margins sequentially as a result of a continuation of labor and efficiencies with a new customer. Looking ahead, we remain committed to continued organic growth within this segment and are focused on enhancing our adjusted operating margin with a target of reaching high single digits. Our minority investment in TIL exceeded our expectations for the quarter by contributing pretax net income of $5.7 million for the quarter compared to $3.6 million in the prior year period. While pleased with these improved results, we anticipate that TEL's fourth quarter's pretax net income will fall within a range of $3.7 million to $4 million. As a result of seasonally soft used equipment volumes and a bad debt adjustment expected in the near term. Regarding our outlook for the future. Our third quarter adjusted earnings per diluted share increased both sequentially and year-over-year for the first time since 2022. Through strong coordination and capitalizing on available freight and capacity Managed Freight offset transition and inflationary costs in truckload, while TEL exceeded expectations. The good news is we believe there is significant runway to improve truckload margin from here. Starting with the fourth quarter, we expect modest sequential improvement to our adjusted earnings per diluted share through improvement in our combined truckload margins, partially offset by a reduced contribution from Tal. In the meantime, we continue to exit unprofitable freight and expand mutually beneficial multiyear customer relationships with well-planned and executed start-ups with exceptional service. With this approach, we are confident in our ability to continue to improve our margins and the durability of our business model over the longer term. Thank you for your time, and we will now open the call for any questions.

[Operator Instructions] First question today comes from Basket Majors of Stephens Inc.

Can we talk more about the growth businesses you're seeing in expedite. What are the structure of these contracts in duration how do they protect you on, say, empty miles or fuel or some other downside risk? And what economic levers are in those agreements that had to come true to give you the most upside?

This is David. Thank you. There's no doubt that the expedited side, we went into this year with about what, 25% of our trucks running in the dedicated from an expedited standpoint. And our goal this year will probably be up around 75% or 80% as the year comes to a close. And it's a mixture of everything. I mean there is anywhere from regular customers that you wouldn't think are wanting long-term contracts and expedited, but they are because of inventory levels to high security loans. And we were talking this morning internally, a lot has changed in the expedited side of our business in the last couple of years as the market has changed. I mean when I first started covering it, it was this high service levels with high utilization. Our #1 lane was running from the south to the West Coast, and back and running 5,000 and 6,000 miles on a truck. And that has been transformed in the last couple of years to the customers only are looking at service is never leaving but a security. And because as we've seen the computer age and systems and data centers and -- but high-value loads from -- anyway, you know what I'm saying. The technology loads has just been exploding. And it's not just the data centers, but it's across the board there. And we have really grown into that as well as what our customers are acquiring us of. And these are long-term contracts multiyear contracts. I'd say the least is two years and upward, but there's a lot of 4-year contracts that are there as well. They all got minimums. As long as our truck is available, we're going to be able to get minimums. And utilization is not high because they're paying again for security. To give an example, we will pick up freight at airports waiting on airplanes to get there. So our truck is sitting, waiting and then we go to destination. And so there's a lot of dwell time that is there, and we're literally having to back to back into what these drivers are paying getting paid. Because utilization is running a lot lower, probably 25% lower on utilization because of dwell time and because of security. In some of you have, there is no doubt in my mind that we have the best security department of any truck in the United States. We've had it for 25 years I had a load of fill in more stolen in the year 2000, it costs me $1.6 million, and I thought I'd better do something and we started security department that is morphed into what it is today, which is the best. We have now -- and thank God for this, we have gone, we're approaching 600,000 loads without a sale. I don't care to say that because my whole goal in life is for the robber to go pick on somebody else and not pick on me. because of the systems that we've got in place. And hopefully, that continues. But that itself brings a lot of high security type opportunities to us. And this year has rarely -- and once exploded it in a good way is because gotten going to tell you, what has been hit the hardest because of the driver situation, what FMCSA has done and where they are continuing to go has been the team aspect. There's not no teams. And it's very difficult to get the teams. And they're seeker sauces to why we have as many teams as we guide and one of us is because we've been doing it for 40 years. it'd be very difficult to start a company today and say, "I'm going to get in the team business. It's hard. It's tough, it's difficult, but we've got the infrastructure to be able to do that -- but that as well as -- and FMCSA is only a first base on this. We all know this. Everybody on this phone knows this. The biggest cheating out there is the ELDs, by far that we have learned in the last year. I would tell you that 30% or 40% of the trucks running up and down the road today are cheating on ELDs. Those trucks used to run as solos because they never run hours, and because they always cheat it. And so they would compete against us if they didn't have a team with a solo driver. So that also has played into our availability of our team side. And but there's a lot -- this year, as we've grown that, let's say, from 25%, we end at 75%. There's a lot of cost -- there's a lot of cost which somebody said they want 10 trucks, 20 trucks, 50 trucks just thinking about it, getting it ready, getting trailers in place, getting the drivers, recruiting the drivers because they got to be at certain origins in certain destinations. By getting the trailers at origin and destination, there is a lot of money. And that's what you're seeing in there. And once we get to say, 75%, I'd say right now, we're at 60%. Probably 60% today, and we'll get the fourth quarter up to 75% in then you'll start seeing that smooth out from the extra cost there. But anyway, the long-term minimum contracts. It's what we've got, and they cannot get out of them. If service gets pinnacle, they can get out of it, documented of which we have, I think, 90 days to correct the service. To give you an idea, it's a period of time to correct the service, and if we don't, then they can get out of it and to be honest with you, if we can't get the service, we ought to be fired. So that's really the only out that is there over the next few years. So it's better than I got in my OTR. What I got, I got a contract and they said, we'll give you 20 loads a week, and I may get it and I may not. So it's much more tighter than that. I hope that helps you.

No, that's helpful. And David, with that comments on dwell and lower utilization, all this downside protection, do those -- are these deals once you get them up and running in the network kind of stable -- are they going to run at full profitability quickly and not have a lot of variability? Or is there some upside to volume as well in the way these deals are structured?

Yes. Some of them have got upside, for instance, if you got some that a customer, a shipper, not just somebody you're thinking about, but from a high security but -- again, we've got regular shippers, but some of them that may be running 3,000 miles a week, Keep in mind, I'm used to running 4,000 and 5, 000 and 6,000 miles a week and some of them are running 3,000 miles a week. And as they get their system up and running better and tighter then they'll take that up to 4,000 miles a week. And so there is going to be some increased utilization. What you're seeing today is the low side utilization on these and there'll be opportunities there. So therefore, when they run extra miles, we'll get paid extra money but we got the minimums predominantly it's what you are seeing today. But I'm going to tell you also that you're only seeing probably Paul 40% or 50% of the minimum as we see

Think of it like this, is Bascome. It's a big dedicated start-up right now because this really didn't pick up a lot of legs until May, June. And so we've been in a major team, dedicated start-up, May, June through Thanksgiving. And as David said, there's a lot of inefficiencies in dedicated start-ups. You can study any of the solo dedicated guys on an account-by-account level, and we're just experiencing that with kind of the whole business unit right now. So is upside in the margin, both on how these contracts are structured and as we work with our customers to get these started up and optimize how they're running.

Yes. There's definitely Beto just adding on to what they have said, some learning curves -- just -- I think there's a lot of operational efficiencies to be had to capture more minimums. I think there's been some learning curves on what the drivers like and what the drivers don't like. David mentioned additional dwell time, and we know drivers like to drive. And so we're having to create different pay packages for that dwell so that the driver is still getting compensated for having to sit there. And so this is a very -- this is really -- it's complicated stuff that we're working through. And the good news is in tandem with our customers hand-in-hand, our drivers and our operators, and I think it's coming together. And I think the fourth quarter will be a transition point, I think, for expedited and we'll continue to see improvement after that.

Just last one to maybe put a period on this thing because it does sound like a very exciting opportunity, especially as we get into next year. Do you have any of these new deals that you think are representative where you can share the kind of mature margin this business operates at compared to what it's replacing and expedited?

Yes. I'll tell you, these are going is dedicated. It's going to operate in that. And to me, I mean, internally, I don't care to tell you because I'll tell my customers, it's going to be at 85% or better kind of ORs or you don't need to be on the team side. I mean it's 1 or the other. You can't pay for what I'm paying for trucks and trailers and all this stuff on the cost standpoint. So yes, it's going to operate in those kind of numbers.

And that 85% or better, are you talking about this can take the entire segment to that level? Are you at this point of the segment should not .

Probably not the whole segment of that, but there'll be portfolio pieces of business that operate there. Remember, you're still going to have some OTR business that probably won't operate that good. And so the blend of the totals probably won't be that low. But either way you look at it, it will be better than it's running today.

From TD Cowen, we have Jason Seidl.

This is Elliot Alper on for Jason Seidl. Can you talk about some of the dedicated contracts you signed earlier this year? And if you guys honor those contracts or going back to customers to renegotiate, we've heard some carriers talk about that through earnings, given how significantly the cost picture has changed through the year? And then maybe looking forward on that same vein, I guess, like I assume the big step back in refracturing the quarter was due to that poultry headwind you talked about. I just want to make sure that's all that was, and that should kind of rebound back in the fourth quarter?

I mean, Ali, you're on top of it. I mean dedicated, as we know, most especially solo dedicated has got very similar annual escalators. And we did sign on some new business earlier in the year. And just like a lot of our peers have reported, the costs have gone up more than the escalators and a good bit more than annual escalators. And so I would say we are working customer by customer through that. And that's going to take -- we went through this in the COVID deal back in '21. And folks can go study us and our peer group and look at what dedicated -- a lot of the dedicated performance, most of it was better in '22 and '23 than it was in '21 when things got really tight because it took a little. The cost came first and the rates came second. And I think that's what you're going to see in this. The costs have come first. And now we've just got to work customer by customer to get the rights to justify the cost increases. And the customers are asking the questions -- are these costs permanently increased or temporary. And I think what we're all believing today is truck prices, David, I don't think our truck prices, insurance prices are drivers going down.

No.

Well, he is answer to question. So it's you're not going to upset long-term dedicated deals and long-term customer agreements over three or six months. But over the long term, you've got to get revenues got to be more on the cost. So we're working on it.

Okay. Great. And then you had really nice growth in the managed freight business. Can you talk about maybe what's driving that strength? Do you expect that to continue going forward? And then I think in the release, you talked about the insurance and claims becoming a bigger risk. I assume that's related to Montgomery. Can you talk about the insurance front? We've seen a few companies through earnings this quarter take charges specifically to Montgomery. So just curious thoughts around managed freight growth and the cost side going forward?

Here's what I'd say, a couple of things. Sequential growth, every broker in the world got killed in Q2. And so the sequential growth is just a function of going from really bad to pretty good out there. The year-over-year growth, it has to do -- we did a tuck-in acquisition in the fourth quarter of last year. And those guys that really came on in the third quarter. And what I'd say is brokerage margins were really good for the third quarter. We don't expect them to stay that good forever. I mean these things bounce around. It's always been a little volatile. And so it may not be as good as it was in Q3, but it isn't going to be as bad as it was in Q2. take a blended average of those. That's not what these brokerages will probably run long term. You're right. The related to Montgomery, it is a riskier world out there. we've always done a lot of things from a compliance standpoint. We continue to double down on those and refine what we're doing. But we'll just kind of keep going down that same pie.

Yes. We hit on it a little bit, and I look at it as a kind of a three-legged stool. It's rates captured in the first half of the year with all the tightness for the last previous three quarters, you've got basically carrier capacity loosening up in the quarter that kind of helped us procure capacity a little bit of a cheaper rate. And then you've got kind of just your -- quite honestly, your overflow stuff that's come over with projects and different asset-based overflow freight that's come up that's helped grow this segment from a top line perspective in addition to the acquisition that Paul mentioned.

And I'll tell you another way to look at it is that you should think about it is that second quarter as it relates to the managed freight the brokerage side, second quarter, we saw an explosion in market rates, not contract with spot rates exploded as we all know. And it came on at about a 3-month period of time. And that's the reason why it's hard to make a margin because the spot rates were going so much higher than you could go to the customer and get your rates changed. And One of the things I think we ended in June, and I think on our second quarter call, I said that the freight environment in the second quarter was basically two loads for every truck. So I mean it was unbelievable, good. Now what happened in the third quarter? I would tell you that freight is 1.3 loads for every truck, it's still good. We're loading all our trucks, and we're getting broker freight and the customer is still needing service and is needing capacity. It's not too low, just 1.3 loads for every truck. But then there's been 5%, 6%, 7%, 8% of freight has gone to intermodal. And you have seen the spot rates that came down a little bit. Since the second quarter, which is healthy because the freight is now moving there's freight that's not sitting at docs for days and days and days and the freight is being able to move and there's still a lack of capacity, but because the spot rates have come down because of the lack of the freight going to intermodal, it's allowed the brokers to start making a margin again. And so that in the third quarter. So that's the way I see it.

And Elliot, to your last question on Insurance, it's definitely something we're keeping an eye on. There's no doubt in this post Montgomery era, the risk. There's just a lot of eyes on risk and insurance. And when we go through our renewal process, I'm sure we'll learn a little bit more, but I saw a couple of notifications earlier this week where people got hit in this segment with some development of some past period claims and it kind of deteriorated margins pretty materially. So we've been living with that on the truckload side for a while, and now it seems to be creeping over. And everybody, it's an industry thing, not just us and into the brokerage world, and we're just kind of keeping an eye on it and trying to control what we can control and do the best that we can.

Next, we have Jeff Kauffman of Citizens Bank.

Congratulations, everybody. So I wanted to go back to one of the answers that you gave Bascome and just make sure that I understand what you were talking about when you were saying we're at 60%, we're going to be at 75%. Are you talking about the percent of expedited trucks on long-term contracts?