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Covenant Transportation Group (NASDAQ:CVTI)

Q4 2013 Earnings Call

January 28, 2014 11:00 am ET

Executives

Richard B. Cribbs - Chief Financial Officer and Senior Vice President

Joey B. Hogan - Chief Operating Officer, Senior Executive Vice President and President of Covenant Transport Inc

David R. Parker - Chairman, Chief Executive Officer and President

Analysts

A. Brad Delco - Stephens Inc., Research Division

Reena E. Krishnan - Wolfe Research, LLC

Thomas S. Albrecht - BB&T Capital Markets, Research Division

Operator

Ladies and gentlemen, and welcome to the Covenant Transportation Group's fourth quarter conference call. [Operator Instructions] It is now my pleasure to introduce today's first presenter, Mr. Richard Cribbs.

Richard B. Cribbs

Thank you, David. Good morning, and welcome to our fourth quarter conference call. Joining me on the call this morning are David Parker and Joey Hogan along with various members of our management team.

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

As a reminder to everyone, a copy of our prepared comments and additional financial information is available on our website at ctgcompanies.com under the Investor Relations tab. 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 divisions' revenue, excluding fuel, decreased 2.4% due to a 5.7% decrease in average tractors, partially offset by a 2.2% increase in freight revenue per truck and an increase in our refrigerated intermodal freight revenues. Versus the year ago period, average freight revenue per total mile was up $0.039 per mile or 2.6%, while our miles per truck were down only 0.3%. Freight revenue per tractor at our Covenant Transport subsidiary was up 4.1% over the prior year quarter, while our Star Transportation subsidiary experienced an increase of 1.2%, and our refrigerated subsidiary, SRT, experienced a year-over-year decline of 1.8%. Compared to the year ago period, the asset-based division's operating cost per mile, net of surcharge revenue, were up approximately $0.021 mainly due to higher driver wages, revenue equipment rental expense, as well as operations and maintenance expense. These increases were partially offset by lower net fuel cost and reduced casualty insurance expense. The asset-based operating ratio improved 220 basis points to 93.6%.

Our Solutions logistics subsidiary increased revenue by 58.6% due to the combination of reduced purchased transportation expense percentage and improved fixed cost absorption with the added revenues. Its operating ratio improved 1,100 basis points to 94.0% from 105% in the year ago quarter.

Additionally, our minority investment in Transport Enterprise Leasing produced a $0.6 million contribution to pretax earnings or $0.02 per share.

Since December 31, 2012, total indebtedness, net of cash and including the present value of off-balance sheet lease obligations has increased by approximately $63 million to $305 million, primarily due to our decision to increase the number of tractors that we've purchased in 2013 due to their improved fuel economy, as well as building of a larger inventory of out-of-service tractors at the end of the year to be disposed during the 2014 fiscal year.

The average age of our tractor fleet continues to be very young at 1.9 years as of the end of the fourth quarter. With available borrowing capacity of $44.1 million under our revolving credit facility, we do not expect to be required to test our fixed charge covenant in the foreseeable future. Versus the prior year quarter, our consolidated operating ratio improved by 260 basis points to 93.7%, while net income improved to $3.3 million, compared to net income of $1.5 million last year.

As stated in our release dated January 14, 2014, the first 2 months of the quarter were solid, but not unusual. During December, we experienced a significant increase in demand, particularly in our expedited team-driver operations, which supported higher than expected freight revenue per mile and miles per tractor. We believe the December activity was uncommon and related at least in part to the compressed period of time between Thanksgiving and Christmas, holiday shopping trends toward delivery of gifts purchased over the Internet, the volume carried by less-than-truckload and parcel delivery companies, and our customer exposure to the line-haul freight of these other transportation companies.

The main positives in the fourth quarter were: One, the unusually strong December results; two, significant improvement in the operating profitability at our Covenant Transport and Solutions subsidiaries; three, a 2.6% increase in rates versus last year; and four, our safety efforts produced a 14% reduction in our quarterly DOT accident rate per million miles as compared to the prior year quarter.

The main negatives in the quarter were: One, the increase in our total indebtedness; two, the deterioration of operating profitability from our SRT subsidiary; and three, a year-over-year increase in average open trucks from 3.2% during the 2012 quarter to 5% during the 2013 quarter.

Among asset-based service offerings since the end of the third quarter, we reduced capacity allocated to our refrigerated and dedicated service offerings, while maintaining capacity levels in our expedited and regional offerings.

Freight results for the first 3 weeks of January 2014 were a little ahead of expectations for the first 2 weeks, but slowed in the past week due to difficult weather -- winter weather conditions across the United States. We continue to utilize improved systems and processes to challenge our employees to improve profitability through improved yields, cost control, better driver retention, and appropriate allocation of valuable capital resources.

SRT will be the final one of our subsidiaries to implement use of our standard freight operating system when they go live on February 1, 2014. While any large conversion project is expected to be a lag on short-term results, we are excited about the additional synergies, implementation of best practices and other long-term benefits that should be realized with having all subsidiaries on the same system. We believe that our disciplined approach to continuous improvement and strategic execution is driving positive results.

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

Operator

[Operator Instructions] Our first question comes from Tom Albrecht with BBT.

I'm sorry his lined dropped. Our next question comes from Brad Delco with Stephens.

A. Brad Delco - Stephens Inc., Research Division

Richard, I was hoping you can provide a little detail -- I guess, it ties into CapEx and gains on sale. First, what was the number in the fourth quarter and then, kind of what do you expect for 2014, I guess, relative to what you saw in 2013?

Richard B. Cribbs

CapEx in the fourth quarter ended up being $41 million. Net CapEx, as we mentioned, there was several good amount of equipment that was parked or held for disposal by the end of the year. Number was approximately 250 trucks and some trailers this year versus last year about 60 trucks and some trailers. So probably about $15 million of assets that are to be disposed of in the first quarter, at least the first 4 or 5 months of the year versus last year, that number was about $4 million. So that made a big difference to the fourth quarter numbers alone as it's not really a hot selling time when people are running their trucks heavy in the November, December timeframe. And so we will be disposing of those again in the first 4 or 5 months of the year. Looking at the -- and then, another question you had was on gain or loss on disposal. The loss on disposal in the fourth quarter was about $430,000 versus a gain last year of $130,000. So it's about almost half -- a little over $0.5 million swing in that line item alone. Going forward into this year, we haven't set our absolute numbers on what we expect CapEx to be, but I would, at this point, assume that it will be a little greater than depreciation next year as we continue to invest in the newer, better fuel economy trucks that we're investing in this year. And then on gain loss, I expect the gains not to be as great as they were for the full year this year. We've made about $800,000 this year in gains, and that number will probably be a little south of that this year.

A. Brad Delco - Stephens Inc., Research Division

Got you. I appreciate that, that's good color. And then, I guess, to hit on rates a little bit, I mean, we're hearing some good commentaries from your peers as well about the environment orient in January, and I'm wondering if you guys can just kind of give your expectations or what your targets are for rate improvements this year given sort of the tightness we've seen over the last 2 months.

Joey B. Hogan

Hi, Brad. This is Joey. We finished 2013, about 2% up over a year ago. The industry as a whole needs it frankly to be more than that. We've set our targets higher than that. There's no question. A lot of what we did also throughout 2013 was a lot of yield management, freight selection, product selection. For example, we made the conscious decision to shrink our regional offering kind of in the Southeast, East Coast and grow our dedicated more rapidly within our solo operation. Well, that affected rates pretty meaningfully but it helped utilization quite a bit. The net effect, it helped the bottom line profitability of that particular subsidiary, so -- and that store in particular. So we did quite a bit of that. Did the same thing on the Transport side, even though Transport's capacity shrunk throughout the year. Really, its expedited group grew, which is the bread and butter of the core of the Transport product offering. So we're actually able to grow that, actually grew it about 3% in the fourth quarter, so again, that's a yield mix profit management throughout that. So all of that being said, we -- our targets are higher than 2%. I don't want to say publicly what that is, but we need it, the industry needs it, and we're going to continue to work with our customers and hopefully provide the service to warrant at least market average and hopefully better for 2014.

A. Brad Delco - Stephens Inc., Research Division

And then David, maybe one for you. It seems as if a lot of truckers were talking about if they had the ability to move more freight in the fourth quarter, they certainly could have. But I think there are a lot of guys that are in a similar position with you seeing unseated truck counts going higher, and the commentary is "We'd be moving more freight, and it's not like I need to go out and buy more trucks to do it, I just need to find a driver." How does that sort of play out this year in your view in terms of balancing what rates you need to get to customers as well as more likely than not, it seems increasing driver wages in order to fill trucks up. I mean, how -- what comes first, I guess, and how does that play out this year in your opinion?

David R. Parker

Brad, it's the same story that we've all have had for years and years and years but definitely the last couple of years. And that is driver pay is going to go up 8% to 10% kind of numbers, and it has for the last couple of years. And you make very little headway on adding equipment. I don't know what the reflection point is of what a driver pay's got to make, whether it's just a onetime, we all used to say it's $60,000, but my goodness, inflation itself has taken that to a higher number. So it is some number that we got to get the driver pay up to, and it's going to be a multiyear problem because no one is going to take and do it in a 1-year basis because if it didn't work, it would kill their company. So they're going to -- we're all going to keep going up $0.02 and $0.03 a mile and those kind of things and hope that we can find some drivers. That said, the $0.02 and $0.03 a mile has basically just kept you in the same position that you're in out there. So I don't see any great hope. I mean, we -- as I think about CTG, we have worked intensely on driver turnover. And we had a good year last year on driver turnover. I was talking to Star yesterday in the fourth quarter, their driver turnover was 60%, which is an excellent, excellent number. And -- but that all said, what you can do is to continue to work on the driver turnover because you could, one day, if in fact what we all believe and what we're starting to hear from anywhere from analysts to economic folks that 2014's going to be a good year from an economy standpoint based upon the last few years anyway. If that's the case, there's going to be a lot of freight out there, and I'm here to tell you in the fourth quarter, especially in particular in the month of December, there was freight that did not pick up and deliver when they're supposed to as we all know out there. And it's not just the parcel guys. I mean, it was our shippers and our customers that had the same issue, and freight sat on docks. And that is what's going to -- getting ready to happen one day. We all make believe, and it may be 2014 that, that's going to happen, and it gives me a lot of hope that rates will be able to increase very nicely, and part of that's going to be increasing driver pay. But there's no good answer to it except keep doing what you're doing.

Operator

Our next question comes from Reena Krishnan with Wolfe Research.

Reena E. Krishnan - Wolfe Research, LLC

I was wondering if you guys could first give us some guidance or some expectation in terms of profitability for first quarter as we look at the year ago period.

Richard B. Cribbs

Well, as -- we lost $0.13 a share last year, and as we've discussed many times, our team expedited business does not lend well to improving profitability greatly each -- in the first quarter as freight is really slow, and we're doing everything we can to make sure that those team drivers are getting the miles that they need, and sometimes that means they're taking shorter length of hauls than normal and those type of things just to make sure they have the miles. And then the cost structure for that, when you're not running heavy utilization, isn't as good as it is maybe in the solo operation. Over the last year, one of the things that Joey mentioned is we have decreased our regional operations. And right now, our team operations and our team revenue is probably the largest percentage that it's been in about 3 or 4 years. And when you look at that model and it's got heavier fixed cost, it doesn't lend as well to, again, profitability. So even though we would -- we believe we can improve on last year's results, getting back to breakeven is going to be something that we're going to be pushing for and just don't know that we can get there just yet.

Joey B. Hogan

I think one of the things to consider in the first quarter -- Richard already touched on the high inventory that we've got of equipment to get sold and get pulled completely out of fleet, i.e., receive cash for that. And that's going to put a stress on the first quarter as far as -- there's a lot of those that are already here, but utilization, getting the equipment ready, getting them out of the fleet, in the meantime you have cost that you're bearing on that, that's not producing revenue. So that's a bigger drag on the business this year than we had last year. We've got to go to grow profits this year, higher than we did last year. We haven't said externally what our goal is. There's a street estimate out there, and we're going to work hard to improve our earnings each and every quarter. The one quarter I just caution everybody just to really, really look at it is that fourth quarter of '14, and Richard's done everything he can to be as candid as possible about -- that was a -- it was an incredible quarter from a profit standpoint. So our goal, if we could move some of that into the first 3 quarters and still have a plus earnings goal for the year would be great. And so that's what kind of what we're working diligently on, but it's that equipment drag will -- could potentially -- it's going to be a hurdle to get over trying to improve our profits for the first quarter.

Reena E. Krishnan - Wolfe Research, LLC

Okay. That's helpful. Just a follow-up on some of the questions earlier, especially around, I guess, just your expectations for the fleet. I mean, the fleet, it looks like you guys cut the fleet further in fourth quarter. There wasn't a meaningful improvement in terms of unseated tractors, I mean, some improvement relative to the 3Q. But just wanted to get your thoughts on how you're thinking about the fleet overall in 2014 relative to challenges in the driver market.

Joey B. Hogan

I think the thing is, as Richard said, we expect the fleet -- right now, our goal is to hold the fleet size. I think if we look across our fleet, our different products, the 2 areas that we did reduce this year and meaningfully in '13 that we won't be doing in '14, Covenant's Transport's dedicated division. Again, at the end of the day, it's about making money, and this dedicated division was -- has been a large drag on profits. It's primarily solo. We weren't able to get it to a point of margins that we wanted. And so we consciously made the decision to reduce the size of that fleet and meaningfully. So expedited did grow inside of Transport for the quarter and the year, but it wasn't able to grow enough to offset that difference. There still could be some shrinkage in that dedicated piece, but I don't think it will be as much as it was in '13. The other side of Star, we already mentioned, we took its regional business down dramatically and had been growing its dedicated business, believe it or not. So that dedicated model is really, really good margins. And so we're trying to do a lot of collaborative things between Star and Transport on the dedicated business. I don't see that going down any more. Late in the year, we did adjust SRT's fleet size a little bit, just because utilization and margins. I think we're in a pretty good spot right now. I feel that as we move into '14, that there's a good chance to hold it. We've got a lot of hard work to do. I don't expect it will shrink. Our goal is not to shrink anywhere near what we did in '13, and then the big key to that is, again, margins and are we able to get to keep -- get and keep the drivers that David already mentioned. So I would say, like I said, our goal is to hold it. Am I going to say we got a chance to grow it right now? Too many unanswered questions. Difficult marketplace. We're starting out the year pretty strong from a fleet size standpoint, so we're encouraged about that, but I don't think it will shrink near what it did in '13. And I think we got a good shot of holding it where it is.

Reena E. Krishnan - Wolfe Research, LLC

Okay. And then just the last question then. Can you provide some guidance or expectations around debt repayment this year?

Richard B. Cribbs

Reena, with the CapEx, one of the things I commented earlier to Brad was I still expect CapEx to be a little higher than depreciation this year with operating cash flows making up the difference. It could be a little more of a breakeven to slight amount of debt repayment this year is the way I'm looking at it, Reena.

Joey B. Hogan

Reena, one thing to add -- just to everybody, I'd like everybody to kind of keep in mind is that we had a swing of CapEx of almost $100 million from '12 to '13. We had a net credit, if you will, in '13 of CapEx to over $80 million in '13. So a swing of about $100 million year-to-year and our total indebtedness went up about $60 million. So there's other things that helped us close that gap between making more money, reducing days outstanding, some of the things that Richard's already talked about. In the release, we're going to have more dispositions than purchases in '14. And so I think we've got a good shot of repaying some debt in '14. But I just want everybody to focus on just the huge swing and investment we've made in balance sheet to hopefully help our margins, help our drivers, help our service in '13, and I think that will continue out through '14. But I do believe there's a good shot for us to reduce our debt in '14.

Operator

Our next question comes from Tom Albrecht with BB&T.

Thomas S. Albrecht - BB&T Capital Markets, Research Division

So on February 1, refresh my memory, on the IT system, which is the last company being switched over to the common platform?

Richard B. Cribbs

That's SRT, the refrigerated subsidiary in Texarkana. [indiscernible] truck operation.

Joey B. Hogan

Remember, Tom, our first one was Star in the first quarter of 2010, so we're on a 4-year journey. For all of these -- to get all these companies on one platform. So we're excited and very excited to get through this. It takes a lot of hard work. Our SRT operation's done a fabulous job, all the corporate support staff to get ready and go. The results will be in the pudding, if you will, relative to how we do throughout February. And fortunate that's on a weekend, which is good. February was good. So we believe we'll -- we're working hard to minimize as much disruption as possible.

Thomas S. Albrecht - BB&T Capital Markets, Research Division

I know on Star you had some disruptions that you talked about publicly, but in the other companies since then, I don't recall any discussion of problems. Is that an accurate reflection?

Joey B. Hogan

No, Tom. We -- Star went the first quarter of '10. I agree, there was some disruptions there. I think we came through that pretty quickly, I would say, it's a good 5 or 6 months. The summer of '10, our Solutions group transitioned from its platform to TMW. Covenant changed in the summer of '11, and that was pretty major. And more on it was -- each company is Covenant's totally different from Star. Many more driver jobs, the teams. You've got trainers, you've got 2 and 3 people on the truck. So there was some visibility issues that we just didn't do a good job of having our hands around as quick as we should have. Coming back to SRT, now over 2.5 years later, we've intentionally kept SRT last and until we've felt much more comfortable. SRT's -- the main difference between SRT and Star, if you will, one, it's primarily a solo fleet; two, you do have a difference in the reefer, so we've been very focused of making sure that we've got good visibility on monitoring of the reefers. And -- but as far as driver tops, driver jobs, it's much closer to Star than it is Covenant. So we're going to have a good size of team there for 2, 3, 4 weeks from the other subsidiaries. They can do their jobs from Texarkana just as well as helping their counterparts in Texarkana get their jobs done. So we feel we won't be near as traumatic as the other ones.

Thomas S. Albrecht - BB&T Capital Markets, Research Division

Okay. And then last question, I know you talked a lot about rates, but a lot of those were average discussions. If you look at your different business units from regional to refrigerated to team, can you kind of talk about the different rate conversations within those different services because they're not all created equally?

Richard B. Cribbs

That's right. If you kind of -- if you go and look at kind of the fourth quarter in particular, the expedited group did well. It was the highest increase relative to the overall average and rightly so, tremendous amount of stress on the whole system. David's already talked about across our whole network. And I think in times of tight capacity, our team franchise sees it out a shoot, and so managing through that is a challenge. But also it's going to be an opportunity, I believe, going forward. So expedited group was much higher than the average. Our SRT subsidiary, reefer product, it was up a little bit less than average. So it was up also. And then, the other ones were down, and some of that was by design. The regional product was by design. We already talked about that, moving from regional to dedicated. So it put a lot of stress on the rate side of the equation but helped utilization. For example, Star's rates were down 5% to 10%, but it's utilization was up 10% to 15%. So again, the swap in that mix of product was significant for the regional business. And then on Covenant's dedicated business as well, had a change with one of its larger customers on how they manage their fuel. It went basically to a 0-fuel program, 0-base fuel program. So that all came out of the rates and went into fuel. And so again, just purely focusing on the rate side, its rates dropped. So all that in the hopper, expedited was up much greater than the average, SRT was up a little less than average, and the other ones were down to get to the 2.6%.

Operator

At this time, we have no other questioners in the queue.

Richard B. Cribbs

All right. Well, thank you, everyone, for calling in, and we will talk to you next quarter. Thank you.

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