Welcome to the Covenant Logistics Group Q1 '23 Earnings Release Conference Call. Our host for today is Tripp Grant. I will now hand the call over to Tripp to start.

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 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 for 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 transitioned. 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 excludes approximately $7.6 million pretax gain on the 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 expenses 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 a 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 costs 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 a 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 of 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 adjusted operating profit. The significant reduction in revenue and operating profit was primarily the product of 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 four 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 the 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 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 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.

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 just 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 three months ago. Is that a view changing at all? If you could maybe kind of give us your market take first?

Yes, the market is flat. Since the downturn around Thanksgiving in November, the market has not changed significantly and we have not seen a further decline in economic activity or freight demand. We expected improvements in the second half of the year, but I believe we will continue experiencing this sluggish environment for the remainder of the year. I was pleased to see the first quarter GDP numbers showing a reduction in inventory levels, as that is what many of us are waiting for. Regardless of overall economic conditions, there will be increased freight demand as we move into the grilling and outdoor season. However, the market remains sluggish. Capacity is being reduced, which will help. This year, we have seen the smaller operators in the spot market exit, and now those drivers are working for larger companies like us, Warner, and Swift. Overall capacity has not diminished; it has simply shifted. With current pricing levels, many carriers cannot sustain their businesses, operating at rates significantly under their costs. Consequently, more capacity will exit the market. However, I believe the sluggish trend will persist for the rest of this year.

Okay. Well, David, I think that makes sense, and I hope things pick up, but I think that's a good base case to have. For my follow-up question, I'd love to explore the Lew Thompson acquisition further. It appears that this business helps strengthen the company against the volatility of the freight cycle. Do you see opportunities to grow that business more, either with existing customers or new customers as you invest more capital? I would appreciate it if you could discuss Lew Thompson in more detail.

Yes, Jack, it's Paul. We're really excited. If you consider it, this is a dedicated business with multiyear contracts and specialized equipment. Such businesses are always appealing. Additionally, while it's a dedicated business with specialized equipment, the commodities, particularly in the poultry protein space, show resilience, especially during economic downturns. There's great potential for growth here. As Tripp mentioned earlier, we see opportunities not only within their operating region but also in expanding into new regions with the same and new customers, given their excellent reputation and the quality of their service. We believe there is a pathway to start expanding this in the coming months. While growth may be gradual—it’s not a business that can rapidly scale—it is stable, niche-focused, and offers a good return on capital. We are truly excited, as Tripp noted, 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 believe we will enhance our earnings from one quarter to the next. Looking back at previous calls, due to the Lew Thompson acquisition, we still anticipate being down 25% to 30% compared to last year's EPS.

And our next question comes from Bert Subin from Stifel.

Paul, following up on that last answer, the acquisition of Lew Thompson & Son seems poised to contribute over 15% to annualized EBITDA, while net interest expenses might increase by around $5 million on a full-year basis. Basic calculations suggest this could result in approximately $0.30 of EPS for the year. Considering where we found ourselves 90 days ago and the outlook you provided, do you believe this compensates for the additional market weakness? Or does it not only offset the weakness but also allow for further growth as that business expands? I'm trying to understand how things might have changed sequentially over the last three months and how the deal fits into that picture.

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 a 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, 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. I agree with you. I believe we are set for 2023, and I anticipate that as we enter the election year in 2024, we will start to see improvements in the economy. This will position us well for a strong 2025. I share your sentiments, and I think the upcoming cycle will be favorable for all of us. We will continue to strive for growth across the various sectors we have been focusing on. We are approaching five years since we acquired the land in July 2018, marking our transition into logistics. I don’t consider us a traditional trucking company or an OTR carrier; we are focused on niche markets, providing value to our customers who need our services. Our objective is to expand in all four areas over the next couple of years. I believe as we move past the current sluggishness of 2023 and into a turnaround in 2024, we will uncover significant opportunities across those segments in 2025.

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 response. Just my final question. A couple of quarters ago, Joey mentioned that he believed Expedited could operate at a 92 operational ratio during tough years and in the 80s during good years. Now that the bid season is starting to unfold and we have a better understanding of the freight recession, do you still hold that view?

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...

I think Expedited will remain about the same based on current observations. Dedicated should see some improvement. Warehousing, although small, may also improve slightly. Managed Freight is the uncertain factor, as it experienced the most setbacks, especially due to the cargo claim in Q2 that impacted earnings negatively. It's performing softer in April compared to Q1. So, to summarize, Managed Freight is flat, Warehousing is flat, Dedicated is better, and Expedited is better to flat.

Okay. And then Expedited rate per mile is only down 1%. How does that look for the year?

I believe the Expedited rate is likely to decrease slightly in Q2. However, I expect it to recover a bit in Q3 and Q4. We have very little spot market freight at the moment, but there is some broker freight included. Earlier, I mentioned that our team is adding new capabilities, and there are promising opportunities coming up. It’s just a matter of how quickly we can start these initiatives. Additionally, due to some contractual reductions, we will see the full impact of that in Q2, which is why I think the rate will decline then. Nevertheless, we will be working to bring in new business to replace the broker freight, which could allow rates to rebound a bit in Q3 or Q4.

Another thing to note, Scott, is that over 50% of our business in the Expedited segment is secured through long-term agreements. The partners we've established these agreements with are proving to be reliable and great collaborators. We formed these partnerships in 2022, particularly when they were struggling to find trucks, and as a result, we built strong relationships. Now, they clearly need our teams and haven’t been dictating terms to us, which has been refreshing. Meanwhile, the remaining 45% of the volume has fluctuated but only saw a 1% decline. As Paul mentioned, we are experiencing a few more changes currently, which will impact rates negatively. To illustrate the challenging conditions within the brokerage side of the business, our reliance on brokerage freight has increased from 1% to 4%. Despite this increase, the rates for that 4% are so low that they are dragging our overall rate down by $0.04 per mile. As we work to reduce that percentage back to 1%, it will feel almost like implementing a 2.5% to 3% rate increase. We are actively seeking opportunities to counteract these negative rates.

How many of these small, niche but profitable trucking companies have you found now? How many more can you pursue? Is acquiring one each year a realistic goal? Do you plan to continue doing this?

Here is like, I think we're going to launch leverage but we're hunting for them every day.

I can add to this. We've maintained a disciplined approach to mergers and acquisitions over the past few years. In my role, I receive numerous inquiries each week, and we consistently turn down a lot of opportunities. Out of every hundred inquiries, maybe three or four advance to the next stage, but we usually decide against those quickly. However, in the past two years, as we've focused on our strategic plan and targets for growth, we've become better at identifying areas where we want to operate and expand. Out of the hundreds of opportunities that have come up, these two transactions have really stood out. After some preliminary research, it became clear that we wanted to pursue them. We’ve put in the necessary groundwork, and the results have been very positive, particularly with AAT, and we believe Lew Thompson & Son will prove to be just as beneficial. We're excited about both acquisitions. We plan to remain disciplined moving forward. As Paul mentioned, we will be mindful of leverage, but our balance sheet is still moderately leveraged, allowing for further opportunities if needed. Yet, we will keep our focus on sticking to our acquisition plan and will not pursue growth for its own sake.

And gentlemen, at this time, there appear 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.