Prepared remarks
Welcome to today's Covenant Logistics Group Second Quarter Earnings Release and Investor Conference Call. Our host for today's call is Tripp Grant. Operator instructions were provided. I would now like to turn the call over to your host. Mr. Grant, you may begin.
Good morning, everyone, and welcome to the Covenant Logistics Group Second Quarter 2026 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 review our SEC filings and most recent risk factors. We undertake no obligation to publicly update or revise any forward-looking statements. Our prepared comments and additional financial information are available on our website at https://www.covenantlogistics.com/investors. Joining me today are CEO David Parker; President Paul Bunn; and COO Dustin Koehl. Before we dive into the quarterly numbers, I want to take a step back and connect a few dots regarding the freight recovery we are now seeing. Ten years ago, Covenant looked very different. We're almost entirely an irregular route carrier without multiple-year committed customer contracts. That meant our financial results were significantly linked to the ups and downs of the volatile freight cycle, making it difficult for investors to understand the long-term value proposition of our business. To fix that, we launched a strategy to deeply embed ourselves in our customers' supply chains. We began moving away from a highly volatile, commoditized business and intentionally invested in more specialized value-added businesses, such as dedicated and warehousing, which require multiyear committed relationships. These businesses have performed well and, crucially, lowered the volatility of our business. We aren't finished, but we are well on our way. Today, we have much less exposure to the extreme swings of the market. We saw the proof of this from 2023 through 2025. When the market bottomed, our margins held up much better than our peer group average and our own historical results. As a result, our stock outperformed. As we look ahead, we expect this strategy to keep delivering. Over the next few quarters, we are focused on three execution priorities. First, we are transitioning expiring contracts into new long-term commitments. Second, we are moving more of our uncommitted capacity into committed revenue. And third, over time, we expect managed freight gross margin to return to normal levels as contract rates catch up to capacity costs. Given our levels of contractual capacity, our operating margins won't spike as fast or as high as peers who have mostly uncommitted capacity. But the flip side is exactly why we built this model. When the market turns down again, our margins should be more stable because we have proven our long-term value to customers. During the last cycle, we proved we could raise the floor on our earnings. In this cycle, our goal is to raise the ceiling while establishing an even higher floor. Based on an extended cycle of tight industry driver capacity and strong execution, we believe we can significantly expand our operating margin. We expect steady improvements, not a hockey stick. This is where we have been heading for a decade, and we are confident in our path forward. With that background, I will move on to the quarter's statistical review. Highlights for the quarter include: while rates and revenue quality improved in the quarter, elevated costs more than offset any improvements to operating margin. Consolidated freight revenue increased by 6.6% or approximately $18.2 million to $294.7 million, primarily as a result of the brokerage assets acquired in the fourth quarter of 2025 that are now being operated as STAR Logistics Solutions within our Managed Freight segment, partially offset by approximately 3% less freight revenue from our combined truckload operations as a result of fleet reductions. Consolidated adjusted operating income shrank by 19% to $12.2 million. The largest contributor was lower gross margin in managed freight. Dedicated Truckload improved its results, and all others declined slightly. Adjusted net income declined by 9.8% as a result of the combination of higher pretax earnings from our minority investment in TEL, combined with a favorable tax rate as a result of infrequent discrete items impacting our income tax provision, partially overcoming lower operating income. Our net indebtedness as of June 30 decreased by approximately $6.6 million to $289.7 million compared to December 31, 2025, yielding an adjusted leverage ratio of approximately 2.2x and debt-to-capital ratio of 41.2%. The reduction in net indebtedness in the first half of the year was in line with our expectations. Cash proceeds from operations for the period were impacted by acquisition-related earn-out payments, insurance policy renewals, and large claim settlement payments. For the second half of the year, we anticipate our net capital equipment investment to range between $50 million and $60 million depending on the timing of deliveries and the prices for used equipment, operational cash flow to improve, and net indebtedness to reduce modestly. The average age of our tractors at June 30 was 26 months, up from 22 months compared to a year ago. This growth is in line with our life cycle management plan for our asset-based fleet and consistent with year-over-year reductions to our high-mileage expedited fleet. On an adjusted basis, return on invested capital was 5.2% for the trailing four quarters versus 7% for the same period in the prior year. Now providing a little more color on the performance of the individual business segments. The Expedited segment reported an adjusted operating ratio of 94.6%, approximately 70 basis points above the prior year quarter. The segment's profitability improved sequentially from the first quarter by 450 basis points, but still fell short of our expectations for the quarter. Over the past 12 months, this segment has undertaken a considerable amount of transition. While the fleet was reduced by 17%, freight revenue per average tractor has improved by 6.8%. Our focus on growing our customer base with high-value cargo through multiyear committed capacity agreements has resulted in improved freight revenue per total mile but has been partially offset by a reduction in miles per average tractor for the period. Elevated insurance-related claims costs also impacted this segment unfavorably in the quarter. As we work to convert the segment to serving more committed capacity freight under multiyear agreements, we are confident that profitability will improve to a level that meets our expectations. Going forward, we have line of sight to steady sequential improvement in this segment's profitability throughout the year. Over time, our goal is to average a double-digit adjusted operating margin across the freight cycle to generate an acceptable return on capital. Dedicated's adjusted operating ratio of 95% was in line with the prior year quarter. Freight revenue per average tractor for the period improved by 8.6%. Cost headwinds in the quarter, including maintenance and insurance-related claims, offset improved freight revenue in this segment. Going forward, our goal is to steadily restore adjusted operating margin to double digits, grow the fleet serving high-service niches, improve profitability with certain legacy customers as contracts renew and, if applicable, reduce any part of the fleet that is not adequately returning capital in line with our expectations. Managed Freight grew freight revenue 28.4% compared to the prior year, primarily as a result of the brokerage assets acquired in the fourth quarter of 2025. However, the segment's operating margin in the quarter lagged our longer-term expectations as a result of rising costs to secure quality brokerage capacity outpacing our ability to secure contractual rate increases from customers. This type of margin compression is normal for an early up cycle. As we look ahead, our goal is to improve upon these results with the understanding that cost pressure may remain elevated as carrier capacity may be constrained for some time and higher insurance and claims expense has become a greater risk after the Supreme Court's recent Montgomery decision. The Warehouse segment performed in line with our revenue expectations, but disappointed us by failing to improve margins sequentially as a result of a continuation of labor inefficiencies with a new customer. Looking ahead, we remain committed to driving organic growth within this segment and are focused on enhancing our adjusted operating margin with a target of reaching high single digits. Our minority investment in TEL contributed pretax net income of $5.3 million for the quarter compared to $4.3 million in the prior year period. While pleased with these improved results, much of it is attributable to higher equipment sale gains, which we do not anticipate benefiting from in the third quarter. Regarding our outlook for the future: the second quarter marked a positive inflection point for the freight economy following a prolonged downturn, reinforcing our view that 2026 is a transition year for the industry. While elevated costs pressured our profitability in the quarter, we were encouraged by the pace of revenue improvements this early into the up cycle. Through the remainder of the year, we intend to build on this progress by improving the quality and durability of our customer relationships and maintaining disciplined cost controls, resulting in improved operating margin and earnings over time. Although the pace of improvement may be more measured than that of certain peers, we believe the durability of our model and the continued execution of our strategy position us well for long-term performance that meets or exceeds our shareholder expectations. Thank you for your time, and we will now open the call for any questions.
Questions and answers
Operator instructions were provided. And our first question comes from Reed Sah from Stephens Inc.
I wanted to start by following up on some of the maintenance and insurance costs that you called out. It seems like mostly one-time in nature. If you could give us a little more color on how much was in Expedited versus how much was in Dedicated. And the insurance does seem to be a pretty prolific problem in the industry. But I was wondering if you could give a little more color on what's behind some of the increased maintenance costs here in the second quarter.
Yes, Reed, this is Paul. Let me start with the insurance. From an operating ratio perspective, Dedicated and Expedited both had probably 1.5 to 2 OR points of excess insurance over our run rate for the last 24 months. A couple of things: we had a number of mediations pop up in the second quarter. As you know, in this litigious environment, if you can get a mediation and get it settled and get it off the books, that's what you do. We probably had more mediations in the second quarter than we've had in a number of quarters, and several mediations on some claims. None of them were monster claims, but it doesn't take much for a claim to be a seven-figure claim anymore. So I would just say a heightened number of mediations that happened to get scheduled in the second quarter, and we had the opportunity to close a lot of those out at numbers we were comfortable with. That volume drove an increase. The other point is when you take those higher costs in a period when truck counts come down a little, it just exacerbates the impact. Again, it's about 1.5 to 2 OR points on Dedicated and Expedited as the negative impact over what we view as a normalized run rate. I would say on the Dedicated side, and to a lesser degree Expedited, we just had some maintenance costs in getting some equipment ready for sales and maintenance costs in some of the protein-based businesses that were higher than our normal run rate. Some of those could have been deferred and perhaps were Q4 or Q1 items. That's probably at least one OR point on the Dedicated side of increased expenses. So if you normalize for those, we feel a lot better about the results, and we don't expect those to be fully recurring.
It does feel like those are one-time in nature, which seems like they are. Looking to 3Q, we should have some pretty solid improvement in margins. How should we think about that as we look at modeling 3Q? And then you all are, as you talked about in your prepared comments, relatively latercycle compared to some of your truckload peers just based off your end markets and the type of business that you serve. How should we think about margin expansion next year when we see a lot of this benefit actually flow through your bottom line?
A couple of things I would say. We feel really comfortable about sequentially and year-over-year improving earnings from Q2 to Q3 and from Q3 last year to Q3 this year. Some of what brokerage margins do, just like a lot of our peers, is going to really affect that number. So I think there are two or three buckets. Fuel was a help for the quarter for the whole peer group and us. So what does fuel do? Brokerage margins—what do they do? Across the whole peer group, brokerage margins were compressed for the second quarter. We do expect insurance and maintenance to normalize a little bit. So you take those three or four puts and takes; we feel like there are going to be more puts than takes in the short term. We think we'll make more in Q3 than we did in Q2 and more in Q4 than we made in Q3. If you keep doing that every quarter, the numbers keep stacking; that's how we'll get the numbers everybody is excited about.
Reed, I'd add just a couple of points about insurance. With the amount of self-insurance that we carry, there's no doubt that it can be volatile from quarter to quarter, and forecasting it is difficult. I'll paint some color around the number we reported this quarter. While we didn't have a large claim breach insurance limits, we had a high volume of claims. When that happens, we have a development factor for incurred but not reported claims, or development on self-insurance, that also gets reported. That increased pretty dramatically in the quarter as well. This was the highest quarter historically, looking back on it. Going forward, it's an industry issue and there is a lot of volatility, and the trend is not good when you're looking at it. But I would say Q3 is a bit of an anomaly based on past performance. The other thing to add to Paul's comments about the pace of improvement is I think you'll see a little better pace of improvement in Expedited. It's a bit more fluid. Dedicated will slowly get there, and we need to make the right strategic decisions not just with rate but customer mix, making sure we're working with customers that really need our dedicated specialized business and that are going to be with us cycle in and cycle out. These are strategic decisions that have multiyear sticky contracts and they take time. If you went back and looked at how our Dedicated improved historically, we were on a path of improvement well after the cycle ended. Part of that was acquisition, but part was consistent with our strategy of getting more specialized and focusing on areas that don't follow the typical freight cycle. So we're focused on the longer term and on slow, steady, intentional improvement to both Expedited and Dedicated.
One quick one left for me, and then I'll pass it on. On the transition that you all talked about, it started late last year and carried on into this year. How much do we have left to churn out of this business that you're trying to get rid of? Or have we already gotten rid of it all, and we should return back to truck growth here soon?
On the Dedicated side, I think for the most part you're there. On the Expedited side, I think the truck count probably is what it is. What we're in the process of doing right now, Reed, is trying to convert as much of the Expedited fleet as makes sense to Dedicated teams as opposed to more over-the-road teams. So that's in process and we'll see how that shakes out. But on the legacy Dedicated side and the protein side, I think we're at the numbers. I could see those growing over time. For Expedited, we're trying to convert as much of that as we can to Dedicated teams, and we'll see how that continues.
Operator instructions were provided. And our next question comes from Jason Seidl from TD Cowen.
This is Elliot Alper on for Jason. In your release, you talked about having all your asset-based businesses under long-term Dedicated contracts by the end of the cycle. I would be curious to hear your thoughts on maybe the length of this cycle and how pricing is trending and how the market continues to evolve from here. It's been a couple of years since you guys have been in the low 90s for OR. Is this going to be a slow and steady, like you suggested, trip? Is this a multi-year effort? Or could this be something sooner since you're rolling some of these contracts into the books quicker?
Elliot, I'd tell you I would much rather be in the industry we're in, in the position we are, because I think the world is going to change. I really do. From what I've read in analyst commentary about a long-term industry change, I believe it is happening. As I look at the backdrop, I don't think the industry, including us, is at first base. I see a lot of things happening within DOT and FMCSA that will continue to allow this industry to get back to returns we all want. I'm excited about where we are. We have challenges, and insurance is the top one—ours doesn't expire until next year, so we're good for another eight to ten months before the market renewals hit. High deductibles remain a problem, and it frustrates me how much you pay for insurance relative to what you actually receive on claims. But rates have to go up, and they're going up because capacity has left and will continue to leave. Eight months ago—late last year—there was a lot of question about whether the market was turning. We went to the market in the middle of December and got increases of about 3.4% for January and early February. By April, market increases were around 7% to 8%. You can't repeatedly go back to customers who just gave you 3.4% and raise them again two months later—you have to let six to ten months pass. By June and July, market increases were in the double digits—10%, 11%, 12%, even higher on certain pieces of business. So the market has moved quickly. I'm happy with where our rate increases are. Over the last four years in this industry, there's been a difficult period, but I think we're only halfway through the improvement. The costs from claims drove some of our Q2 results, and those tails are long, but that hasn't changed the broader trend. The driver situation is getting harder, which is a negative for growth because it increases driver pay and makes it harder to grow Dedicated quickly, but it's also a structural benefit for rates because it constrains capacity. Electronic logging devices and regulatory impacts have also removed capacity. So while I can't say exactly when growth will accelerate, I do know we'll be a lot more profitable; we'll recapture earnings we lost over the last four years. My focus is not on how big we get; it's on how profitable we can get and how we can recapture earnings. This is 53 years in the making for many of us, and I couldn't be more excited about the opportunity. Is it going to happen in Q2? It didn't. Q3? Probably not. Q4? I expect to see progress. Some write-ups say 2027 will be a blowout year—there will be obstacles in 2027, but I think it will be a very good year. I believe we're entering a three- to four-year super cycle, and I expect to see continued improvement through 2027 and 2028.
You talked about adding some new ag protein business and exiting some nonspecialized contracts. Can you talk about the pipeline for Dedicated? How are customers thinking about the Dedicated offering in light of the Montgomery ruling? It should improve your product offering as more shippers look to high-quality asset-based carriers. Are you starting to see that pipeline expand?
The pipeline is the best it's ever been, period. Paul and I agree—it's the best pipeline we've ever had for Dedicated and the best opportunities we've seen. We have customers right now that want to grow Dedicated. Yes, it's exciting. We all need to make sure we have drivers, but there's going to be a lot of opportunities in Dedicated.
Elliot, this is Paul. The demand is even bleeding over into some of our Expedited fleet as we lock up multiyear committed capacity with high-value freight serving industrial and heavy industrial, and data center work. Those trucks are running very well, and there's a good pipeline there too.
Operator instructions were provided. And our next question comes from Jeff Kauffman from Citizens Bank.
David, thank you for that terrific answer to the previous question. I've got a more boring question. There was guidance in the release on $50 million to $60 million in net CapEx spend in the second half. You talked in the release about not shrinking the fleet anymore at this point. But with what is starting to happen in the industry and the prospect of free cash beginning to build, as we think beyond 2026 and into 2027 and beyond, is there CapEx that needs to occur as free cash comes along? Do you want to get debt down to a certain level? I know the average fleet age is up, and Tripp mentioned that was part of the plan. How are you thinking about free cash and capital deployment as we see the super cycle that David referenced?
Jeff, I can take that. In the past few years, our net CapEx has been a bit clunky for a couple of reasons. We were in a post-COVID recovery replacing very old equipment, and we acquired Lew Thompson, which required certain specialized trailers and spec tractors that we couldn't substitute from existing inventory. So we've had some growth in CapEx for specialized assets and some offsets from reductions in nonspecialized equipment. This year in total, I think net CapEx will be a bit below our normal capital replacement cycle for a couple of reasons. One, we entered the year in very good shape. Two, the mix of our freight is changing toward more low-mile Dedicated business that has a longer replacement cycle and fewer expedited tractors that put 180,000 miles per year on a tractor. Even within the expedited fleet, utilization is coming down with some specialized Dedicated-like business we're doing. Net-net, it's a clunky year because we sold a bunch of equipment in Q1 and bought equipment in Q2, so net we're about even on net capital investment in the first half of the year. For Q3 and Q4, we expect that $50 million to $60 million range. I don't anticipate a large ramp in CapEx without justifying the cost of capital. While I don't expect fleets to be reduced further, I still feel we're in good shape on average age given the mix change. Our goal is to minimize disruption from large capital purchases in any single quarter and spread purchases evenly throughout the year. Going into next year, you'll likely see a bit more net CapEx, mostly replacement, with potential for modest growth, but it's too early to finalize that number.
A follow-up: terrific contribution from TEL this quarter. It looks like equipment values are beginning to rise. I don't want to take this quarter and assume it's a run rate, but how should I think about what's going on at TEL and that contribution moving forward?
Jeff, it's Paul. Related to TEL, yes, they had a great quarter. I wouldn't use Q2 as a run rate—Q2 was a bit higher than we expect. But I do think their performance will be between Q1 and Q2 on a go-forward basis. TEL's customer base has been hit hard by the freight recession because many of their customers are small to midsized carriers who struggled. There were bad debts, and they struggled to keep lease counts flat. What we've seen is that the customers who have made it through the rough years are set to thrive for the next three to four years of this cycle. David and I met with the TEL management team a couple of weeks ago, and I think you'll see slow, steady progress for TEL over the next couple of years. We're excited about where they're at and where they're going. They should continue to build quarter after quarter, though Q2 was a little hotter due to some large equipment sales they pushed through.
I'd add that what we're seeing in July is a pretty steep pickup. We've spoken to many folks and are seeing some strengthening. In the first half of the year, there was appetite for volumes, which is step one. Now we're seeing appetite for volumes plus a bit of a step-up in price that should impact us positively in Q3.
Tripp, finally, in the release you said cost per mile was up about 16-and-change percent, and you explained that a fair amount was due to settlements you saw on insurance and claims. Did you quantify how much of that was an unusual lump in the quarter and, as that recedes toward normal levels, what kind of cost-per-mile change should we be thinking about in aggregate?
I'd be cautious when we talk about insurance—it's so volatile. There was no doubt it shocked all of us the way it developed this quarter; historically, this was a spike. I would say the combination of items could be worth anywhere from roughly $0.05 to $0.08 a share from that spike, but I'm hesitant to model that from Q2 to Q3 to Q4 because of the volatility. It was unusual historically, that's a fact, but I'm cautious in making forward-looking statements on exact amounts.
Operator instructions were provided. At this time, there appears to be no further questions. I'll turn the call back over to our speakers to close out the call.
All right. Thank you, Ross. We just want to thank everybody for your interest in Covenant, and we look forward to speaking with you next quarter.
Thank you. This concludes today's conference call. Thank you for attending.