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Edited Transcript of CVTI earnings conference call or presentation 23-Oct-19 3:00pm GMT

Q3 2019 Covenant Transportation Group Inc Earnings Call

Chattanooga Oct 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Covenant Transportation Group Inc earnings conference call or presentation Wednesday, October 23, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Ray Parker

Covenant Transportation Group, Inc. - Chairman of the Board & CEO

* Joey B. Hogan

Covenant Transportation Group, Inc. - President & COO

* Richard B. Cribbs

Covenant Transportation Group, Inc. - Executive VP & CFO

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Conference Call Participants

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* Adam Kramer

Cowen and Company, LLC, Research Division - Associate

* David Griffith Ross

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics

* Jack Lawrence Atkins

Stephens Inc., Research Division - MD & Analyst

* Kevin Wallace Sterling

Seaport Global Securities LLC, Research Division - MD & Senior Analyst

* Scott H. Group

Wolfe Research, LLC - MD & Senior Transportation Analyst

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Presentation

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Operator [1]

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Excuse me, everyone. We now have all of our speakers in conference. (Operator Instructions)

I would now like to turn today's conference over to Richard Cribbs. Sir, you may begin.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [2]

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All right. Thank you, Samantha. Good morning. Welcome to our third 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 our current year 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 covenanttransport.com, under our Investors tab. Our prepared comments will be brief and then we will open up the call for questions.

In summary, the key highlights for the quarter were that our Truckload segment's revenue, excluding fuel, decreased 9.7% to $152 million due primarily to a 9.5% decrease in average freight revenue per truck, along with a small 9 average truck decrease in the 2019 period as compared to the 2018 period.

Versus the year-ago period, average freight revenue per total mile was down $0.109 per mile or 5.5%, and our average miles per tractor were down 4.2%. The main factor impacting the decreased freight revenues per total mile was the much weaker freight environment in the current year quarter. The main factors impacting the decreased utilization was an approximate 160 basis point decrease in the percentage of our total fleet comprised of team-driven trucks and a lower freight demand in relation to industry-wide tracking capacity.

Versus the prior year quarter, freight revenue per tractor at our Covenant Transport subsidiary experienced a decrease of 8.9%, the SRT subsidiary experienced a decrease of 12.9%, our Star subsidiary experienced a decrease of 4.4%, and the Truckload division at Landair experienced a decrease of 1%.

The Truckload segment's operating cost per mile, net of surcharge revenue, were up approximately $0.10 per mile compared to the year ago period. This was mainly attributable to higher group health, workers' comp and casualty insurance claims cost, net fuel expense and capital costs, partially offset by reduced non-driver wages and operations and maintenance expense.

Our Managed Freight segment's revenue, excluding fuel, increased 3.4% versus the year ago quarter to $47.8 million from $46.3 million.

Our minority investment in Transport Enterprise Leasing contributed $2.1 million to pretax earnings or $0.08 per diluted share in the third quarter of 2019, which is equal to the prior year quarter.

The average age of our tractor fleet continues to be young at 2.0 years as of the end of the quarter, down from 2.3 years a year ago. During the third quarter, we took delivery of 485 new tractors and disposed of only 182 used tractors, with the large influx causing a temporary increase in excess tractor units that impacted our capital cost and total indebtedness; we expect to dispose of most of the excess tractor units in the fourth quarter of 2019.

Since December 31, 2018, total indebtedness, net of cash and including lease obligations, has increased by approximately $74.3 million to $328.8 million. At September 30, 2019, our stockholders' equity was $348.4 million, for a ratio of net indebtedness to total cap of 48.5%, compared to a 42.6% ratio as of the end of last year. In addition, our leverage ratio has increased to 2.3x as of September 30th from 1.5x as of December 31, 2018.

The main positives in the third quarter were: one, consistent demand and profitability from our Landair dedicated and Managed Freight businesses in a difficult freight economy; two, steady earnings contributed from our investment in Transport Enterprise Leasing; and three, increasing our percentage of operating trucks with automatic transmission to over 95%.

The main negatives in the quarter were: one, the operating margin declines of our expedited and solo refrigerated service offerings; two, an approximate 9.5% year-over-year decrease in average freight revenue per truck for our Truckload segment; three, increased Truckload operating cost on a per mile basis, most notably from the unfavorable group health, workers' comp and casualty insurance expense, net fuel costs and capital costs; and four, the $34.3 million quarterly increase in our total net indebtedness primarily related to the delay of proceeds from disposals of used revenue equipment to adequately offset the expenditures for a large portion of our annual new tractor deliveries during the quarter.

Our operational fleet size experienced a decrease to 3,008 by the end of September, a 93-truck decrease from our reported fleet size of 3,101 trucks at the end of June. This decrease was primarily driven by a reduction of trucks from our solo-driven one-way fleets. This was partially offset by an increase to our dedicated fleet.

For the fourth quarter of 2019, we expect to remain an important provider in our customers' peak season supply chains. However, given the current imbalance of capacity and demand, we expect pricing and volume levels to remain subdued compared with the last several holiday peak seasons. Our focus will be on identifying opportunities to improve the performance of our one-way truckload service offerings and adding more predictable long-term contracts in our dedicated truckload, transportation management and warehousing service offering.

Barring unforeseen circumstances, we expect our combined insurance and capital costs to decrease sequentially as compared to the third quarter of 2019 and anticipate our consolidated adjusted net income to improve sequentially to a profitable level in the fourth quarter of 2019.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from Scott Group with Wolfe Research.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [2]

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So what can you tell us about October and what you're seeing out there? And then as we think about the fourth quarter, utilization was down 6, in the third week per mile down 5. What do you think we should be modeling for fourth quarter utilization and rate?

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [3]

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Let me talk a bit about the market itself, Scott. We kind of felt like we hit the bottom and part of the that, the middle of August. And since that time, it is basically just dragging along the bottom. All spring and all summer long, it's been going down, down, down. Then it kind of flatlined in the middle of August. And it's about between flat -- that time from flat to up, say, 5%. And that's kind of what is happening as we speak. One week is up 5%, the next week it's back down to that bottom, but it's not falling any further. And so I can't say that the song has changed any over the last 2 months. And so from a freight environment, I expect it to still continue to be muted, very similar to the third quarter kind of numbers. From a freight environment, I think that peak is going to get better, but it's not going to be the peak that we have seen in past years although there's going to be a gigantic surprise and -- while all the customers are going to be shocked about their ability to be able to get it because they have just not came to the table this year. First time in, I don't know, probably 10 years that I've gone through what we've gone through this up and coming peak season that our customers are still not going to have -- they have got it under control. And that they are not going to have any issues.

We got a lot of peak, but it's probably only about 60% kind of numbers before as we've been out in the past and the rest of it is going to be on an ad hoc basis. And so instead of firming up peak capacity and saying, "Here, let's take it." They're saying, "Hey, let's do about 60% of what we've done in the past and we'll call you when we need you." And so that's going to be an interesting peak. So that said, we will have those out. We'll have the sequential increase over third quarter in terms of the business environment and utilization, all those things. It's definitely going to be down from last year.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [4]

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Yes. Scott, on a sequential basis from Q3 to Q4, I think that the rates will be up anywhere between 3.5% and 4%. That's not what we would have gotten in the past on a sequential basis, but it will be. And then on the utilization standpoint, I think sequentially, it will be up another 1% to 2%.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [5]

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Okay. And with that, so you're saying profitable. But any more color you want to give us, Richard, in terms of how profitable you think you might be?

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [6]

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Well, I think only from a standpoint, peak is always strange for us and hot or -- it's even more difficult to forecast, so it's hard to put a number on it. But I do feel comfortable that a lot of the costs that we saw, increases we saw in Q3 should be reduced from where they were and most of those significantly reduced from where they were on a cost per mile basis related to the -- especially related to the insurance cost. But also the capital cost if we can get this equipment out and -- into the OEMs, into the buyers, then we should see a reduction of depreciation expense, maybe in the leased revenue equipment and some decent gains again in the fourth quarter. Gains in the third quarter were approximately $800,000, and I would expect something similar, maybe a little better in Q4.

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Joey B. Hogan, Covenant Transportation Group, Inc. - President & COO [7]

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Okay. I'm just...

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [8]

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Scott, the major issue there also, just FYI, as I think about the third quarter on that equipment, when you see those numbers and dealt with us, got some gain on sale of that, et cetera, it is not any particular Class 8 manufacturer. They all were in the same boat. But they just could not deliver their trucks. They just could not get them here. Then all of a sudden, like in the month of July, they decided to bring us 250 or -- in about a 2-week period of time, they just slammed us because their used trucks are out running in the marketplace. Then all of a sudden, you got to get the used trucks back into where you're going to prep them for trade. And that is the issue that just slammed us in the third quarter that we're in the process of getting out from under.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [9]

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Okay. That makes sense. And just last question. So if I take that rate per mile up 3%, 4% in the fourth quarter sequentially, and it ties it down around 10% year-over-year? So I guess 2 questions. One, what do you think that means for 2020 rate on a reported basis? And then if you're doing contracts today, what sort of -- how much are they going down if you're repricing your contract today that you repriced this time a year ago?

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [10]

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Scott, let me answer one thing in relation to the rates not being up as much as they have been in the past. Driver pay also will not be up as much than it has been in the past. In the past or last year, I think we saw it up about $0.07 a mile compared to Q3. This year, we're looking probably more 1% to 2% -- sorry, $0.01 to $0.02 a mile higher in Q4 for the driver pay per mile. So there's pretty big offsets there to the benefit side as well.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [11]

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Now that makes sense. Any thoughts on the pricing pieces here?

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [12]

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Yes. I would say, at dinner, Scott, because we just saw you out in San Diego and we had a conversation on that, and as I have looked at Class 8 truck orders in the last few months from a standpoint of orders, order going up, order going in, which have been reduced 70%, 80% kind of numbers, and as I look at capacity that is leading the industry, I've been saying for a few months that I really thought that probably some time in the fall that we would start sensing a capacity -- not a problem, but the tightening of capacity. And we all had an interesting discussion out in San Diego that we're -- some people believed, including yourself, that it's probably the second half of next year before you start sensing that.

And there's probably nothing wrong with that. That's probably where very well could be. I think it comes before them, but it's a flip of the coin of when it does, there is a day that it is coming. There is no doubt that you can have capacity leading in the future, leading in it, not start tightening. And so what -- but I can't tell you that it's now -- definitely not in October. So is it March? Or is it July or August? And I think those are kind of the prevalent months that people are kind of looking out there. So hey, it's next year. It's next year. There's probably more middle of next year than it is early of next year. We are negotiating a couple of customers as we speak, and we're not there yet. But I don't think the rates are going to be going down.

So now -- and the thing is because you're asking about contracts because you've got 2 things happening: one is contracts of existing business and then the second thing is in order to win new business. And so that's 2 different questions that go into this rate per mile that Richard has ended up giving everybody, up or down. And so those are 2 things. There's no doubt that customer business that you're -- you've got, you've got relationships and you're doing a great job, those customers are willing to work with you somewhat because of the relationships and the experience that you got with them. But if you, the carrier, are wanting to win new business, you have to win it with -- at cheaper rates.

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Scott H. Group, Wolfe Research, LLC - MD & Senior Transportation Analyst [13]

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Okay. That all makes sense. And we agree, it's when not if.

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Operator [14]

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Our next question will come from Jack Atkins with Stephens Inc.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [15]

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So I guess, David, just to kind of go back to your last comments there in terms of some negotiations that are going on right now. Are you seeing increased bid activity for this time of year, maybe folks pulling their bids forward or opening up their bids may be earlier than normal? Can you kind of talk about what's happening there? And I mean does that maybe provide an opportunity for you guys to struggle with better utilization as you sort of look out over the next couple of quarters?

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [16]

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Yes, we are seeing that. We are seeing an increase in bid activity of which we find that good. We find that helpful. We're kind of winning. Some of those opportunities are out there. And Joey may have these numbers on top of his head, but I mean, it's like double the amount of bid activities. Do you agree with that statement?

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Joey B. Hogan, Covenant Transportation Group, Inc. - President & COO [17]

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Yes. We could see -- I don't know, the numbers plus or minus, but 80 is kind of room to move forward.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [18]

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Yes, versus 40, to give you an idea at this time of the year. So it's almost -- we're seeing a double activity. And the opportunity of bids not just with our existing customers, but more of the side of customers that we don't do business with.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [19]

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Okay. Got you. Yes, that makes sense. I mean that's good news and maybe some bad moves, but I think maybe it nets out for you guys to be positive.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [20]

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That's right. It's going to help somebody and hurt somebody.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [21]

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Sure. Sure. And you referenced in the press release, you're seeing some of these nonasset-based brokers getting more aggressive. Could you maybe talk about what you're seeing on that front? And I guess as you kind of think about next year with capacity maybe tightening up, I mean, do you think maybe that could be a catalyst for a turn in their freight cycle if those brokers get too aggressive going after freight that they may have trouble filling next year?

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [22]

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Yes. And we are seeing that because on the brokers' side, you are seeing more of the customers that are attempting and so far being successful in treating the brokerage business as they are to ask that. And that is, hey, we want your rates and we want them to be for 1 year and trying to tie you into more contract rates on the brokerage side. And of course, there's no doubt that the brokerage side wants to kind of have a 50-50 situation that half of your business is under the contract and then half of it is bearable that you can go up and down, depending upon what the market is and try to make a margin in good and bad environments. And so you're definitely seeing the customers are attempting to make the contract more so that they are trying to protect themselves from what they perceive as, as Scott said, "not if but when" opportunity. And that is what we are seeing out there. And I think that you're seeing the margins on the brokerage side that are getting reduced. And there is some vulnerability there that, on the broker side, when capacity that's tightening.

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Jack Lawrence Atkins, Stephens Inc., Research Division - MD & Analyst [23]

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Okay. Got you. Got you. Just a couple of other things and I'll hand it over to somebody else. But there's just been a lot of talk over the last 3 to 6 months about rising insurance rates, obviously with some of these verdicts we've been seeing in the marketplace over the last, really, last year. Richard, could you talk about how you guys are thinking about your insurance premiums next year just given what we've been hearing in the market?

And then I guess more broadly, David, a question for you. Is this something just given what insurance rates are going up so dramatically, is this something they could just accelerate this capacity attrition that may be just beginning to happen?

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [24]

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Yes. Jack, I think -- so looking into next year, our renewals come up on April 1 for casualty excess coverage. And one thing that we're thankful for is that our 9x of one coverage, which is our primary layer of excess coverage, is actually not due until March of '21. So we've got another year left under that primary arrangement, so there should be no premium increase there. Two, the coverage we do have, excess of $10 million layers, we do expect to increase somewhat. We are seeing all the nuclear verdicts. The 10 to 20 range tends to be more based on company history and past performance related to claims and claims management. And there, we stand pretty strong -- very strong. And so I'm hopeful that our carriers will be fair to that end. And because of the way that we handle claims with an empathic approach, et cetera, that they won't raise it as much as maybe we're seeing others. On the 20-and-up layers, that's basically just whatever the industry is doing and nuclear verdicts affect all of us kind of equally, and so there will be some increase there. But as long as we can keep that, we know our 0 to 10 isn't going up. Our 10 to 20, I don't -- I would hope wouldn't go up very much. And that's where most of the insurance premium dollars are, not for above 20. So I'm not expecting -- and maybe as large an increase as what I think maybe some of our peers are getting and what I'm hearing in the market that are having to renew on their lower level of coverage as well. So I'm kind of hopeful we'll get through that fairly unscathed and continue to try to perform just better on the safety side to get our claims down in those type there.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [25]

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And then on the -- there's no doubt that it's going to continue to put pressure on carriers to leave. It's one of the reasons why carriers are leaving today out there and it's going to keep -- I mean, in San Diego at ATA, we met with that, whatever, Joey, 5 or 6 of our insurance companies? So we met with them and -- hey, we've got great relationships and our numbers -- internal numbers are very good on those. But you're right, the wildcard is the nuclear verdicts that have come down. And so anyway, meeting with all of them. On the small carriers, I don't know how they're going to pay it. I mean I was hearing numbers out there that didn't affect us. But I was hearing numbers on the small people and the small carriers that today, as we speak, that insurance is costing them $25,000 a truck. And I remember -- let me think, this is '19, so in '16, I guess, it's about 3 years ago, that number was $5,000 a truck that was going to $7,000 a truck, that went to $12,000 a truck. And in San Diego, I was hearing $25,000 a truck. And there is just no way that any of them are going to be able to stay in business and pay $25,000 for a truck.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [26]

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But they raise their rates a lot.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [27]

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Yes. So...

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Joey B. Hogan, Covenant Transportation Group, Inc. - President & COO [28]

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The market's not giving them that.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [29]

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So it's going to continue to put pressure on the small guys, and they're not going to be able to stay in business with it.

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Operator [30]

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Our next question will come from David Ross with Stifel.

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David Griffith Ross, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics [31]

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Yes. On your comments around the various trucking segments, you've mentioned that SRT was hit the hardest. I guess their utilization or revenue per truck per week was down double digits. Why was that? What's different at SRT versus some of the other places like Star and the legacy Covenant?

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Joey B. Hogan, Covenant Transportation Group, Inc. - President & COO [32]

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Hey, Dave. This is Joey. I think the main thing is freight. Why is it? We had -- we've been working on a realignment of the enterprise. And this year -- we came into this year on the highway side of SRT. Remember, there's 2 pieces. There's OTR side, as we call now highway, and then there's the dedicated side. And on the highway side, we had very -- based on what we saw the last 2 years, we had a very tight plan to diversify SRTs, what we'd used to call SRT but our Texarkana highway office, our location, around some very large customers. And we did that. And so we did that into the teeth of a quickly slowing freight market and that's just a pretty big void on the highway side there.

So that's -- I would keep it simple. The biggest piece of what that is was a strategy to help us long term, hoping that we have more opportunities to continue to diversify our customer base as it happens. So the hole got pretty big and we've been fighting to replace that hole this year on those trucks. There's about 440 trucks in that office -- or in that location on the highway side. You're seeing -- and I agree with David's comments, it's not on the utilization and rate side. It has been flattish, which is more a little up sequentially than it was in the spring. The spring was free fall, but it has bottomed, mostly on the highway side at Chattanooga and Texarkana. But it feels like it's kind of bouncing along the bottom. And -- but we're trying to be strategic and long term as we think about it. The growth of freight had grown crazy. It's just so much that we'll pull a load for. And so I'm proud of that. It takes some discipline but especially when you need freight through your trucks, so what I would call really participate in the spot market. It hasn't happened, so we're relatively speaking in this marketplace kind of discipline on what we say and try to stay focused on the long-term outlook.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [33]

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Dave, I'll add. On a comparison basis, SRT and Covenant both have a lot more of a one-way business and compared to Star and Landair as a percentage of their business. So you're seeing that hit to the one-way business a lot harder than to the dedicated side. Star is basically 100% dedicated and if they had not had the GM strike hit them in the last 2 weeks of the quarter, they probably would have been brought on with last year. And so that took a pretty good shot at that company or that subsidiary. And then Landair is primarily dedicated with a little piece of OTR. They're dedicated -- actually got a little better on a revenue per truck basis, and their OTR was backwards more similar to the -- which is about 80 trucks more similar to what we saw at Covenant and SRT. This plan -- they really do play in the spot market more than just the contract market. So that's really the reason behind the differences there.

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David Griffith Ross, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics [34]

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Hey Richard, how much do you think the GM strike cost the company in the quarter? [$0.01 or $0.02] or is this more than that?

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [35]

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I think it was $0.01 or $0.02 a share because it was just the last 2 weeks. So it was probably $250,000 to $400,000. It matters how you look at it. We had the fixed cost anyway, so just variable contribution phase and we try to recover some of that with the broker freight that was maybe at cost or even below cost. So I'd give it somewhere in that range, $0.01 to $0.02 per share in the third quarter.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [36]

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So that continues -- I mean, we have no thoughts of it yet and we're continuing because the thing about that is that we have about, say, 250 truckloads -- drivers that are loaded with vendor freight that's for General Motors that's loaded before the strike happened. So not only are we not able to get our -- to our trailers, to even the business that we're having with them, run around trying to get trailers into the system to try to run that couple of hundred trucks that get something on those trucks, doing something. But the thing is, is that the day that the contract is settled, we got to take 250 loads and start delivering them for the next day. So when you start -- as we all know, when you started these walkouts and strikes, you don't know if it's 1 day, 1 month. And so it feels like we've been living on a 1-day basis for a month now and hopefully, they'll vote on price as the thing gets settled. But that means the whole month of October had the same experience that those 2 weeks of September had.

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Joey B. Hogan, Covenant Transportation Group, Inc. - President & COO [37]

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Yes. We had hoped that after the negotiated settlement was reached that they would go back to work. Instead, the UAW declined to do that until they have ratified the agreement, and that vote is Friday. But to David's point, when they do ratify it, there's a lot of pent-up business to get back to and get moved. And the expectation is and some commentary we've received is that they would be working weekends through the end of the year in order to try to make up for some of their lost demand. So hopefully that will make up a little bit of it as we finish out the quarter.

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David Griffith Ross, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Global Transportation and Logistics [38]

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And talking about discipline and filling trucks with the right freight at the right price, how do you think about 2020? Should you be running more trucks on the road next year than this year? Or do you think that the fleet is going to downsize a little bit to better match supply/demand?

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Joey B. Hogan, Covenant Transportation Group, Inc. - President & COO [39]

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I think that we haven't completely finished our plan. But the long-term plan is with the highway side between, let's call it, team and solo might reduce slightly over the next few years. So let's call it flat. So I don't expect any growth there at all, could be some shrinkage, to your point, to kind of match the market. Dedicated will continue to grow slightly on the truck side depending on the opportunities that are there. So more around the growth of dedicated than the highway side. While the revenue growth for the future is planned around our brokerage and plan around warehousing and freight management operations.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [40]

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And on that dedicated side, part of the reason there wouldn't be more growth is that there's probably some of that dedicated that's not as profitable as we would like, so we could see culling out some of that and then replacing it, plus growing a little bit. So overall, the net worth that we might have to add 350 or 400 trucks on dedicated business while reducing about 250 or 300 that's just not performing at the levels we would like.

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Operator [41]

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Our next question will come from Jason Seidl with the Cowen and Company.

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Adam Kramer, Cowen and Company, LLC, Research Division - Associate [42]

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Hey, guys. This is Adam on for Jason. I wanted to ask a little bit on your expectations here for 4Q. You wrote in the release that you expect sequential improvement in results in 4Q. And so I wanted to just ask what your baseline expectation here. Is it that we kind of stay at this bottom that you've been talking about? Or built into the sequential improvement that you expect in 4Q, are you expecting that we're going to kind of move off of this bottom? I mean underlying trends are going to improve?

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [43]

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I think underlying trends are kind of similar to what they've been. I think we used the term muted and subdued and words like that. We haven't seen or reason to believe they're going to come off that. We normally have our peak. We participate pretty heavily in peak. A lot of that is on our broker side but also on the expedited side. And so we talked earlier about expecting sequential rate improvement versus Q3 and a little bit of utilization improvement versus Q3, but not to the same level of rate improvement we've seen in the past. But we're also expecting our cost on the driver pay not to go up near as much as it has in the past couple of years either. And so there's a somewhat offsetting -- not enough offsetting but somewhat offsetting compared to last year.

And then those costs, Adam, that we called out in the preannouncement, we still expect those to improve pretty nicely. In fact, they're more normal kind of numbers barring anything unusual again. So that should help in the Q4 versus Q3. And then capital cost reduction that we've talked about already as well should help versus Q3. So we have those things going for us. So I think you put that in your model and you'll come out with a decent number.

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Adam Kramer, Cowen and Company, LLC, Research Division - Associate [44]

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Got it. Appreciated the color there. I think kind of switching a little bit to your brokerage business. Last year in 3Q and then in 4Q, you had pretty large sequential jumps in gross revenue there for nonasset revenue. This year it's kind of been more steady at least 2Q into 3Q. I was wondering what the -- kind of the forecast is there for 4Q? I mean, you mentioned in your answers now that your brokerage may see some higher revenue from peak, so just wondering what the expectations is here for modeling out gross revenue here for brokerage.

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Operator [45]

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It seems we have lost the speaker line. Give me just one moment.

(technical difficulty)

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [46]

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Hello. We're back. Sorry about that. We had a technical difficulty call, my finger pushing the wrong button. So Adam, I think we got your question on brokerage related to expectations on Q4 versus Q3. So I think David is going to answer that.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [47]

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Yes. It is definitely going to be up over quarter 3 and the fourth quarter, but it's not going to be -- it's probably going to be in that 10% kind of number up, Adam, because they are going to participate in the peak. But there hasn't been an issue in that, that side is that their peak is not going to be as great as it was last year.

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Operator [48]

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(Operator Instructions) Our next question will come from Kevin Sterling with Seaport Global Securities.

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Kevin Wallace Sterling, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [49]

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Richard, I was beginning to think you hadn't paid the phone bill.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [50]

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We're trying to save money wherever we can, man.

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Kevin Wallace Sterling, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [51]

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And I know you guys have addressed SRT and some of the changes you're making there. But if you don't mind, can I ask a bigger picture about refrigerated and the reefer market? It seems that out of the Food Safety Modernization Act, there are some kind of tailwinds, I would think, kind of with that sector with that vertical. And along with those tailwinds, has it caused maybe some challenges, if you will, for SRT, but as we think, look out maybe the next couple of years with the Food Safety Modernization Act, how should we think about the reefer business? Can it be a growth opportunity for you guys in the future? If you don't mind just sharing some big-picture thoughts?

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [52]

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Kevin, I do believe you're exactly right that there's no doubt that the Food Safety Act has definitely put more pressure. And I believe that as capacity toughens, that a lot of the folks will continue to benefit from that because there is definitely a lot more requirement there. And I think the customers are really just the kind of second base, using a baseball analogy, on making sure that they are living up to the food safety act. And it is definitely not in the process -- your bigger -- your better customers there, they've been doing it for over a year, 1.5 years. So they've really been doing it. But a lot of your smaller customers that are not in the food side of the business or in the smaller side of it -- anyway, excuse me, they are not on top of it as what I would think that they should be. And I think that it continues to tighten on that.

And so I do believe that it could present some opportunities in the future. Because right now, you still got a lot of small carriers that are hauling their freight, and I believe that there are some opportunities that it needs to be more tightened than it is today. So I do think that it's going to present some opportunities for all the refrigerated side of the business in the future out there. But we look at it just as our highway services that -- that's saying you're going to be hearing more and more about is the highway services and away from Landair, SRT, Star, Covenant as we continue to -- the segmentation of dedicated highway services. And I think we'll be there in the course of next year. And I think that there are some opportunities that's going to be there, but we have taken about half of that fleet and put it on the dedicated side of the business. And we think that we're at a right number of where it should be at that will allow us to take opportunities as freight and capacity gets a little bit tighter because we really have a lot of it there last year. They actually had a very good year last year then follow this year, this had some difficulties. And I think that we got to continue to measure exactly where that fleet needs to be at. We think that we are there today currently. But only the future would tell where that fleet needs to be at. But as we continue to grow the dedicated side, there might be still continuation of freight -- of truck mixture split between dedicated and highway services going from highway services to dedicated.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [53]

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Kevin, just keep in mind, we have noted it many times that our growth is really towards the dedicated and other contracts to logistics businesses weighted to managed transportation and warehousing primarily in order to really improve the stability of our earnings, which are still obviously extremely volatile, more volatile than we would like and more volatile than our shareholders would like. So we're working towards that goal, and part of that would be maybe continuing to increase in size in those areas and at least maintain flat in the other areas.

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Kevin Wallace Sterling, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [54]

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Got you. Okay. David, if I can follow up on Jack's question about some of the unsustainable pricing you guys are seeing within the brokerage market. We've heard about that and you mentioned new and incumbent freight brokers. Historically, how long do you think that can go on? But then, if you don't mind me asking that question in another way, we do have some new entrants into this market who really just want to show growth and are probably using price to get market share. Has that market structurally changed with some of these new brokers in the market who are just looking to grow? And along those lines, could some of these smaller incumbent freight brokers just cry uncle and get out of the business? So I'd love to hear your thoughts from a historical perspective. But also looking forward, with particularly to some of the rapid changes we've seen in some of the start-ups that appear to be using price to get market share.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [55]

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Yes. I think you had 2 to 3 questions there, and I think the answer is yes to everyone of them and that is some of the smaller ones are not going to continue to be able to stay in business. There is no doubt because of some of the large ones that are growing dramatically on the technology side of the business and actually growing it without any profit. And I had a major customer in my office just a couple -- 3 weeks ago that was literally looking at one of the companies that's technology-driven. And the thing is out there and we have many discussions today on this call about insurance. But one of the things that they're -- -that a lot of the technology companies are not offering to the customers is that the customer has to take the liability exposure. And it's interesting because we just had a discussion. We actually brought our insurance folks into the meeting with us and we talked about the verdicts -- some of the nuclear verdicts that all of us on this phone are aware of, that our customer was not aware of. And we went over the nuclear verdicts and said, "Here's where we're at. Here's what's going on in the industry," and the customer immediately left here and said, "I'll tell you one thing, there's no way I would ever sign this contract that this technology company broker is wanting me. It is not worth it." They -- there's definitely savings in rate, but I would never put my company exposed to what is the possibility of a nuclear verdict trying to save $50 on a load. And so I think that as that gets out, whether -- or the wisdom or the understanding to the customer base, something will change. Either they'll get into the game with the rest of it, they got to have, whatever, $100 million, $200 million, $300 million of liability exposure to take care of their self or the customer is not going to go own it for the long-term future. I mean, they may do it for right now as they're just learning. So I think all of us will get to the technology side. I mean, it's good, it's wonderful, it's zesty, it's great, but it's not something that nobody can get to. And to think that the only people that are smart are in Silicon Valley is Billy. I mean the rest of the people will adapt and offer the same type of technology that everybody else is offering, but we're not going to do it for growth and losing the kind of money they're losing. So there might be a little bump in the road that is happening out there today, but if I was the -- we're a fly on the shoulders, say, of a C.H. Robinson, but I'm not. If I'm C.H. Robinson, I'm not sitting there worried to death about what's happening in the technology. C.H. Robinson will be there but not there already. He'll be there in a very short period of time.

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Operator [56]

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And at this time, there are no further questions in the queue.

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Richard B. Cribbs, Covenant Transportation Group, Inc. - Executive VP & CFO [57]

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All right. Thank you, Samantha. Thank you, everyone, for calling in and asking good questions today and listening to us. We appreciate your support and we'll look forward to talking to you next quarter. Bye.

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David Ray Parker, Covenant Transportation Group, Inc. - Chairman of the Board & CEO [58]

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Thank you.

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Operator [59]

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Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.