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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to today's Covenant Logistics Group Q1 '23 Earnings Release Conference Call. Our host for today's call is Tripp Grant. [Operator Instructions].
I would now like to turn the call over to your host. Tripp, you may begin.
Yes. Thank you, Ross. Good morning, everyone, and welcome to the Covenant Logistics Group First Quarter 2023 Conference Call. As a reminder, 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 to review our SEC filings and most recent risk factors. We undertake no obligation to publicly update or revise any forward-looking statements. A copy of the prepared comments and additional financial information is available on our website at www.covenantlogistics.com/investors.
I'm joined on the call today by David Parker, Joey Hogan and Paul Bunn. First, I'd like to start by welcoming the Lew Thompson & Son Trucking team to the Covenant family. We pursued this acquisition because it aligns with our strategic plan of becoming a niche year, well-diversified service provider in a market that is less sensitive to typical freight cycles.
Lew Thompson & Son Trucking's reputation of providing first-class service to their customers in the poultry industry, combined with opportunities for future growth added to the attractiveness. Our goal is to maintain their service standard and to provide the financial support required to allow our combined team to grow in their home territory and in territories that they do not currently operate. Their results will be included in our Dedicated segment's operations.
Consistent with our focus on profits and returns on capital, through the first quarter, we had reduced the Dedicated fleet by 200 trucks since the first quarter of 2022 by exiting low-return contracts. With today's action, we are regrowing our fleet with Lew Thompson's approximately 225 trucks, which are expected to generate a double-digit return on invested capital and immediate accretion to our earnings per share.
Now focusing on the first quarter's results. Given the softness in the freight market, we are pleased with our results and how our team responded in a market that quickly transition. Compared to a year ago, consolidated freight revenue was down 9%. This decline was expected and related primarily to less overflow freight handled by our Managed Freight segment due to lower overall demand. The Dedicated segment also experienced reductions in freight revenue, primarily as a result of our efforts to carve out underperforming contractual business.
Adjusted operating income fell approximately $12 million or 48% compared to the prior year quarter, primarily as a result of our asset-light Managed Freight and Warehousing segments, which declined approximately $10 million and $1 million, respectively.
On the truckload side, we were pleased with the resiliency of our year-over-year margins, particularly in Dedicated, which improved its margin compared to any reportable period in the prior year. Adjusted net income decreased 43% to $12.9 million and adjusted earnings per share decreased 31% to $0.93 per share compared to the year-ago quarter. Weighted average diluted shares decreased as a result of our share repurchase program.
The primary adjustment to our reported results exclude approximately $7.6 million pretax gain on sale of the Tennessee-based terminal during the quarter. Proceeds on the transaction were approximately $12.4 million.
Key highlights for the quarter include, within our combined truckload operations, operations and maintenance related expense declined on a cents per total mile basis by $0.02 or 6%. Fixed equipment costs, including leased revenue equipment, depreciation and gain on sale decreased year-over-year by over $0.03 per total mile or 9% as a result of our equipment replacement plan. Gain on sale of revenue equipment was $1.1 million in the quarter compared to $0.2 million in the prior year. The average age of our fleet at March 31 was 26 months, flat sequentially compared to December 31, 2022.
For the remainder of 2023 based on our current equipment order, we anticipate sequential improvements to the average age of our fleet.
Our TEL leasing company investment produced $0.31 per diluted share compared to $0.30 per share versus the year-ago period. Our net indebtedness at March 31 was $65 million, yielding a leverage ratio of 40.4x and debt-to-equity ratio of 14.9%. Return on invested capital was 19.8% for the current quarter versus 15.7% in the prior year. We purchased approximately 610,000 shares in the quarter, representing approximately 4.5% of the outstanding shares as of December 31, 2022.
Giving effect to the Lew Thompson transaction, we expect net indebtedness of approximately $165 million, a leverage ratio measured by net indebtedness divided by run rate adjusted EBITDA of approximately 1.2x to 1.1x and $60 million of remaining liquidity, including cash and availability on our line of credit.
Now Paul will provide a little more color on the items affecting the individual business segments.
Thanks, Tripp. Taking a moment to dive deeper into what drove the consolidated results for the quarter. Our Expedited segment's freight revenue grew 1% compared to the prior year despite a 2% reduction in the average fleet. The increase was largely driven by a 4% improvement in average total miles per truck offset with an approximate 1% decrease in average rate per total mile compared to the year-ago period. While we are pleased with the segment's utilization improvement, we recognize that year-over-year freight revenue per total mile comparisons will become increasingly challenging as we progress throughout the year.
While cost headwinds from salaries and wages and insurance condensed margins, these were somewhat offset with improvements to both fixed and variable based equipment cost for the quarter. Our aggressive equipment replacement plan, which was initiated in the second quarter of 2022 is beginning to pay off. We expect this trend to continue as we progress throughout 2023, and the average age of our fleet declined sequentially.
Our Dedicated segment experienced a 10% reduction in freight revenue compared to the 2022 quarter as a result of 194 or 14% reduction in the average number of total trucks offset by a 5% increase in revenue per truck. The fleet reduction in our Dedicated segment aligns with our strategy of replacing unprofitable or underperforming business with business that meets our profitability and return requirements. We were pleased with both year-over-year and sequential improvement to adjusted margin and expect to continue the improvement in this segment's profitability as the year progresses.
Managed Freight experienced a 29% reduction in total freight revenue and an 89% reduction in consolidated adjusting profit -- adjusted operating profit. The significant reduction in revenue and operating profit was primarily the product of a little to no high-margin overflow freight from our asset-based truckload segments. In addition, our results include an approximate $2 million cargo-related claim in the period.
The environment is highly competitive with numerous brokers aggressively competing for volumes at the expense of margin. We anticipate continued margin pressure in this environment.
Our Warehouse segment, although the smallest of all of our segments saw a 41% increase in freight revenue compared to the year-ago period, resulting from the start-up of 4 new customers during the previous 12 months. We are pleased with the top line growth we've achieved in this segment, and the team has done a phenomenal job executing these start-ups, which are both intense and time consuming. However, despite the top line growth in this segment, we've seen sequential deterioration in margins. Our focus for 2023 will be to continue to grow this segment and restore profitability to mid-single digits through improved labor utilization and rate increases with existing customers.
Our minority investment in TEL contributed pretax net income of $5.9 million for the quarter compared to $6.8 million for the prior year period. The decline was largely a result of reduced gains on sale of used equipment compared to the year-ago period. TEL's revenue in the quarter grew 25% and pretax net income decreased by 11% versus the first quarter of '22. TEL increased its truck fleet in the quarter versus the year-ago period by 128 trucks to 2,201, and grew its trailer fleet by 404 to 7,116.
As a reminder, TEL focuses on managing lease purchase programs, leasing trucks and trailers to small fleets or shippers and aiding clients in the procurement and disposition of their equipment.
Units business model gains and losses on the sale of equipment are the normal part of the business and can cause earnings to fluctuate from quarter-to-quarter. Our investment in TEL is included in other assets on our consolidated balance sheet, and has grown to $61 million as of March 31, 2023, from our original investment of $4.9 million. In 2022, we received $14.7 million in cash dividends from TEL, and we anticipate a similar amount during 2023, although we have no confirmation with dividend plans at this time.
Regarding our outlook for the future. There is no doubt that 2023 will be challenging. While we are pleased with our first quarter's results, we also see opportunities to improve from them and are working diligently to do so. In this environment, we are intensely focused on cost savings to improve our operating cost profile.
However, our primary focus is the long term -- is and remains on the long term by continuing to invest in the areas that provide opportunities for us to make forward progress on our strategic plan by investing in new revenue-generating equipment, people and technology.
For the remainder of the year, we expect market headwinds from a softer market as well as continued inflationary pressures. However, based on company-specific factors, we expect less earnings volatility than in prior periods of economic weakness.
We have worked hard to strategically shift our customer base to less cyclical industries through our full-service logistics offering. Even with a weak freight market, we expect our cash generation, moderate leverage and available liquidity to continue to provide for a full range of capital allocation opportunities to benefit our shareholders.
Thank you for your time. We'll now open up the call for questions.
[Operator Instructions]. And our first question comes from Jack Atkins from Stephens.
And congrats on both the acquisition and a really, I think, strong quarter despite all the challenges out there. So congratulations. So I guess maybe if we could start, David or Paul, I'd love to get your take on sort of what's going on out there. It's just -- it feels like there's just a lot of volatility depending on end market and customer and individual companies. So could you maybe talk a little bit about how you think both the next couple of months could shake out with the spring sort of peak and build up? And then are you expecting much of a second half build back? I know that was kind of the thought, not just from you guys, but from a lot of folks 3 months ago. Is that a view changing at all? If you could maybe kind of give us your market take first?
Yes. Jack, yes, the market is flat. I really think that what we saw in -- around Thanksgiving in November, the market dropped and it's just been there. That's where it has been. We have not seen a second downward spiral of economic activity from a business standpoint, freight standpoint, but we have just been on that same level since November. And we were anticipating that it would start getting better in the second half, but I think that we're going to continue in this sluggishness that we're in for the rest of this year is kind of where I am at in my thoughts.
There is no doubt that I was glad to see first quarter GDP number that inventory levels were reduced because that's why all of us on this call are waiting on is for inventory levels to be reduced because I don't care what the economy is doing, if they're going to have to refill some inventories eventually as that continues to go. So that was a bright spot.
And I think that as we all know, no matter what the economy is doing, as we start grilling out and going to the lake and open up Coca-Cola, there's going to be more freight available. And so that is going to help but again, it is a sluggish. I think capacity is in the process of being taken out. That will help.
I think that what we have seen so far this year is that anybody, the onesie, twosie, threesie, foursie that operated in the spot market, those folks are gone. Those onesie, twosies are gone. Now that said, that capacity is left. But all those drivers are now driving for us and Warner and Swift and everybody else that filled all of our fleet. So capacity as a whole has not left. It's just been -- they just shifted from one to the other.
So as we go forward and with some of the pricing that is out there today, carriers cannot stay in business. You cannot operate at $0.20 and $0.30 and $0.40 a mile under your cost, and that's what is happening in a lot of areas today. So capacity is going to be leaving. So we will fill that. But the background of all that is that I think it's going to remain sluggish for the remainder of this year.
Okay. Well, that -- David, I think that makes sense, and I hope things pick up, but I think that's a good base case to have.
I guess for my follow-up question, I'd love to dig in some more on the Lew Thompson acquisition. It seems like that's a business that kind of helps further insulate the company from sort of the volatility of the freight cycle. Do you see opportunities to grow that business more, either with existing customers or new customers as you can put some more capital in there? And would just love to kind of get you to talk a little bit more about Lew Thompson.
Yes, Jack, it's Paul. We're really excited. I mean if you think about it, it's a true dedicated business, multiyear contracts and with specialized equipment, one. And so those businesses are always attractive. The other is, okay, you got a dedicated business with specialized equipment, but then you start looking at the commodities and the protein, especially the poultry protein space is one that is -- I'm not going to say recession-proof, but I would say, recession-resistant. And so that -- and then you hit it on the potential for growth.
I mean we think there are, as Tripp said earlier, opportunities for growth, not only in the region they operate, but expanding that into other regions with the same customers and new customers because they've just got a stellar reputation and provide a really great product from a service perspective and just how that thing's wired up works really well. And so we do see the ability to start expanding that in the months to come.
It will be a slow growth. I mean that's not a business that you just -- that can take off, but it's -- as we've talked about, it's sticky, it's nichey and good return on capital business. And so we couldn't be more excited, as Tripp said, to welcome them to the family.
Okay. Last question, I'll hand it over. But when you kind of think about the acquisition and the incremental accretion from that, maybe a little bit of seasonality in May and June. We'll see combined with continued actions to improve profitability and Dedicated and some things like that. Do you feel like you can improve earnings quarter-over-quarter, 1Q to 2Q? Or just given the freight backdrop, that's just too tough of a hill to climb this year?
Yes. I think we will improve earnings quarter-over-quarter. And I would tell you, we're kind of -- if you go back to the previous calls, compared to the prior year, we're still in that with the Lew Thompson acquisition, we're still standing by the -- we think that we'll be down 25% to 30% from last year's EPS.
And our next question comes from Bert Subin from Stifel.
Paul, maybe just a follow-up to that last answer there. So the Lew Thompson & Son acquisition looks like we could add sort of north of 15% to annualized EBITDA and then your net interest rises as something in the ballpark of $5 million, and this is all on a full year basis. So just some simple math gets you roughly $0.30 of EPS for a full year. Do you think that is -- like relative to where we were 90 days ago and sort of the outlook you gave, do you think that offsets the incremental weakness in the market? Or do you think that offsets the weakness and then there's some top-up as that business grows? Just trying to think about sort of how things have sequentially changed maybe in the last 3 months and layering the deal -- layering in the deal to that equation?
Well, a couple of things. If you think about it, and we talked about it in the release and in the script, we're replacing some, I'll call it, unprofitable to marginally profitable business with the Lew Thompson. And so I think Lew Thompson combined with exiting some marginally profitable business, and to your point, Bert, some other things going backwards, I think it's kind of what I just said to Jack, it's all a big offset. And the combination of all of that still kind of puts us on the same path we were thinking Q2, Q3 and Q4 last year, where we said, hey, our goal is 25% to 30% reduction in year-over-year EPS because that's a lot better than places we've been in the past. So I think when it all comes out in the wash and you're still within that kind of same range.
Okay. That's super helpful, Paul. And maybe to follow-up to Jack's other question there and David's response. I think there's been this consensus view that's forming that '23 now will be weak. And maybe there's a little bit of improvement later in the year, but that's getting discounted and David sort of noted that. As we think beyond '23, is it your view that '24 is the inflection point and then '25 is better than that? And if that is your view on how things unfold, does that make you want to bolster your Expedited and Managed Freight businesses just as you think about an impending multiyear upcycle?
Yes. This is David, Bert. Yes, I do. I think that we're here for '23. I think that '24 election year, we'll start getting some better things going on the economy. And I think it does set it up for a good '25. So what you said is what I agree with. And -- so the cycle, I think, is going to be good over the next couple of years for all of us, but we will continue to show growth or continue to attempt to grow in all these verticals that we've worked.
We're going on 5 years. July 3 is when we purchase land there of '18. So we're going on 5 years here in a couple of months of truly becoming a logistics. I don't think of us as a trucking company. I don't think -- we're not an OTR carrier. You call, we haul and I hope that I get enough phone calls today. We are into the niches that we want to be in of bringing value to our customers, customers that need what we are giving out there today.
And so that said, our goal is to grow all four of these areas in the next couple of years. And I do think that as we come off whatever sluggishness we're in, in '23 and it starts turning around in '24 and sets up for '25, I think it presents a lot of great opportunities in all four of those segments.
Let me add on Bert on what David said, getting big volumes of new business right now is tough just because a lot of folks don't have it to give. But we're still doing really well on adding new badges in Expedited, in Brokerage, Managed trans, in Warehousing and in Dedicated and it's exactly what you said. We may not be getting the exact volumes we want out of these folks right now. But when it turns, we're going to have a contract set up and a salesperson in there, and we're going to have already been working with them. And so yes, we're focusing on what you talked about.
Great. No, great response. Just my final question. A couple of quarters ago, Joey had highlighted that he thought Expedited could run at 92 OR sort of in the worst of years and you run in the 80s and good years. As we've seen -- as you've seen the bid season start to unfold and gotten a little bit of a greater appraisal of the freight recession, do you still think that's the case?
I think we're still in that range. I mean we've got a couple of contracts left that have been signed, but the effect of them needs to roll in. But yes, I think we're still in that range of reasonableness.
Our next question comes from Scott Group from Wolfe Research.
Just want to follow up on the sequential earnings growth from Q1 to Q2. Can you just maybe go through the different businesses and walk through that and where you expect not...
Here's what I would tell you. I think Expedited, Scott, will be flattish, just based on what we're seeing today. I think Dedicated would get a little better. I think Warehousing, albeit small, probably [indiscernible] better. And Managed Freight, that's the wildcard. I mean that's -- as you said, that's where we backed up the most, and we did have the cargo claim in Q2 that negatively affected earnings. I would say that it's softer in April than it was in Q1. And so I could argue, Managed Freight is flat, Warehousing's flat, Dedicated's better and Expedited is better to flat.
Okay. And then Expedited rate per mile only down 1% What -- how does that look like for the year?
Here's what I think. I think you're going to see the Expedited rate probably go down a little bit in Q2. But I think you'll see it come back up a little bit in Q3 and Q4. We don't have hardly any spot market freight, but there's a little bit of broker freight in there and the minute ago when I started talking about the team adding new badges and stuff, there's some really good stuff in the pipeline. It's just how quick do we get it started up. And -- because we've got a few contractual reductions they're going to -- we'll see the full quarter effect of in Q2. So I think the rate will go down in Q2. But then we'll be working to get that new business on board and replace broker freight, and I think it could come back up a little bit in Q3 or Q4.
And I'd say another thing, Scott, that -- on that Expedited side, over 50% of our business is in long-term agreements. And those that we've got long-term agreements with , they're really holding, and they have been a very good partner with us. And we entered those agreements there in '22, and they couldn't find any trucks, and we made great relationships and partnership. And now they're showing that they really do need our teams, and they have not came back to the, saying, do this and do that. They've been an extraordinary partner.
And so the other 45% of the volume is where it's gone up and down to only have a 1% negative, but we do have a couple -- as Paul said, a couple more that are rolling through as we speak. There are going to be a negative hit to that -- to the rate. But that said, our -- to give you how bad the -- as you know this, but to give you how bad the brokerage side of the business out there in today's environment is, is that our brokerage are dependent upon brokerage freight has gone from 1% to 4%. So we're only doing 4%, but the 4% rates are so bad that it is bringing our total rate down by $0.04 a mile.
So as we replace that 4% and get it back down to 1% kind of number, it's almost going to be like taking a 2.5%, 3% rate increase. And so there's some great things of possibilities that we're working on to offset negative rates.
And then how many -- you seem to -- you guys seem to be able to have found now two small nichey, but really profitable trucking companies. How many are there? How many of these can you do? Is 1 a year the right kind of number? Do you want to keep doing them? .
Here is like, I think we're going to launch leverage but we're hunting for them every day.
Scott, I can add on to this. I think we've been really, really disciplined in our approach to how we've looked at M&A over the last few years. And just in my position, I get dozens of [indiscernible] every week, it seems like and we're turning down things and turning down things just consistently. And for about every 100 I get, we'll get 3 or 4 that will kind of pass to the next level, we'll talk about and generally, we'll turn those down pretty quickly.
But over the last 2 years, as we've worked harder in identifying some things in our strategic plan and where we want to look for, it's helped us really identify kind of where we want to play and where we want to expand. And these two -- out of the hundreds that have showed up, these two transactions have really just popped up. And we knew pretty quickly after some diligence, it was done that we wanted to pursue these things, and we did all of the leg work and they've been really positive and especially AAT, and I think Lew Thompson & Son is just going to be just as good.
And so we're excited about both of them. And I think we're going to continue to be disciplined. Like Paul said, we're going to kind of watch leverage, but I also think that we've still got a moderately leveraged balance sheet, and we have the opportunity to do more if we need to. But again, we're not going to lose that discipline of really sticking to our plan on acquisitions. We're not just going to grow to grow.
Makes sense. I try and never say congrats on these earnings calls, but if you were to ask me, heading into a pretty nasty trucking downturn, if we'd be talking about $4 of earnings for you guys, I would have said no shot. So well done, guys. Kudos.
And our next question comes from Elliot Alper from TD Cowen.
So in Dedicated decreased 13.5% in the quarter. I know you talked about some existing business or underperforming business -- Can you talk about kind of how far along you are in that process? And if there are any other factors at play? I guess how much of that is customers just needing kind of less trucks given the volume environment?
It's a mix, Elliot, of just underperforming business and customers that -- I had 20, 19, 17. I had 35. Now I need 31. Here's what I'd tell you, I think we would -- I think we've already absorbed most of the people that were doing reductions. They kind of know where they are from the demand standpoint. And so -- and I think we'll probably by the end of Q2, we'll be 90%, 95% through this weed and feed effort.
So as Tripp talked about, truck count came down, truck kind of go back up by the end of Q2 back up to that 1,400 and some-odd number, a couple of hundred trucks more than we ran this quarter. And so we probably about -- to answer both of your questions, about 90% through the weed and feed process. And it's a mix of us weeding and feeding because it just didn't meet profitability requirements and customers that those just changes in their demand profile and they've downsized.
Okay. Great. So you bought back a lot less in the quarter kind of compared to 2022. How are you thinking about capital allocation going forward? Maybe what should we assume for buybacks? And I guess kind of dovetailing on the last question in terms of M&A, kind of is your focus primarily going to be in Dedicated?
Well, to answer your first question, we bought back about 610,000 shares during the 2023 quarter, and we don't consider that a small amount. It was actually about 4.5% of the shares outstanding from December 31, 2022. We still have an open 10b5 plan, but we generally don't comment about any forward kind of plans. The plan itself has certain non-disclosed purchasing criteria associated with it, so we don't comment on that. But what is public is that there is an open 10b5 plan out there, and we like what it does for us, but we're going to stick with what we've got out there today.
In terms of M&A going forward, I think that we'll continue to look, and it would have to be a perfect fit. I think we want to, first of all, make sure that -- we are working with Lew Thompson & Son in that new business in a way that will help them understand us and help us understand them. So there'll be a lot of attention on that just over the next few months. And working with them on some integration stuff. They're going to continue to operate out of their headquartered operations.
And so no kind of integration plans beyond just trying to work together and understand each other. So you'll probably -- we're not actively kind of hungry and looking for immediate M&A opportunities, but like Paul had mentioned, they're always crossing our desk and we're always analyzing them for the right deal. So if the right thing came along, it could be possible, whether it's in Dedicated or one of the other segments.
Before, we've been pretty vocal about not growing Expedited fleet until we came along AAT, and AAT met the criteria that we were looking for was an opportunity to do something different in Expedited that we weren't doing. And it checked all of the boxes of what we look for strategically. And so there could be something else that comes along like that, that we would love to look at. But it'd be hard to really tell you.
Yes. We're absolutely, we're all in on Dedicated, but -- and Dedicated is something that we really love and we plan on growing. But you just never know what comes up.
[Operator Instructions]. And gentlemen, at this time, there appears to be no further questions.
All right. Well, thank you, everybody, for joining us today, and we look forward to speaking with you next quarter. Have a good weekend.
This concludes today's conference call. Thank you for attending.