Welcome to the Covenant Logistics Group's First Quarter Earnings Release Conference Call. Our host today is Tripp Grant. I will now pass the call to him. Mr. Grant, you can start.

Yes. Thank you. Good morning, everyone, and welcome to the Covenant Logistics Group First Quarter 2024 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.covenentlogistics.com/investors. I'm joined on the call today by David Parker and Paul Bunn. We were pleased with our first quarter's operational results despite the lingering weakness in the overall freight environment and the severe weather challenges early in the quarter. Compared to a year ago, consolidated freight revenue increased by approximately $14.3 million or 6.1%. While each of our business segments grew freight revenue, the asset-based segments consisting of expedited and dedicated were the primary contributors with growth in the average tractor fleet and improved utilization compared to a year ago. Adjusted operating income increased approximately $2.2 million or 17.3% compared to the prior year quarter. Our asset-light segments consisting of managed freight and warehousing grew adjusted operating income by a combined $3.3 million, partially offset by $1.1 million of reduced adjusted operating income from our asset-based segments. Compared to the prior period, increased interest expense of $2.6 million and reduced pretax income from our equipment leasing company investment TEL of $2.3 million, resulted in a decline in adjusted net income of approximately $9.7 million to $11.6 million. Key highlights include all four of our reportable operating segments were successful in growing freight revenue compared to the prior year quarter. Our combined truckload segments navigated difficult weather conditions and improved utilization by 5.4% compared to a year ago, partially offsetting the impact of rate reductions of approximately 1.7%. We successfully executed two new start-ups in our dedicated fleet during the quarter and added to the pipeline of new customers in our expedited fleet. Our net capital investment for revenue-producing equipment was approximately $12 million for the quarter, consisting primarily of specialized equipment CapEx for poultry-related growth. The average age of our fleet at March 31 improved to 21 months compared to 26 months a year ago. Within our combined truckload segments compared to the prior year, operations and maintenance-related expenses declined by $0.07 per total mile or 27%. Fixed equipment-related costs, including lease revenue equipment expenses, depreciations, and gains on sale increased $0.09 per total mile or 25% as a result of operating newer, more costly equipment and a soft used equipment market. The sale of revenue equipment resulted in a $0.7 million loss in the quarter compared to a $1.1 million gain in the prior year. TEL produced $0.20 per diluted share compared to $0.31 per diluted share versus the year ago period. TEL's contribution to pretax net earnings declined primarily as a result of the year-over-year softening in the used equipment market, suppressing gains on sale. Our net indebtedness as of March 31 was $252.1 million, yielding an adjusted leverage ratio of approximately 2.1x and a debt-to-capital ratio of 38.2%. On an adjusted basis, return on average invested capital was 8.3% for the current quarter versus 14.8% in the prior year. The decline is attributable to reduced year-over-year trailing 12-month operating income, particularly from our asset-light Managed Freight segment and the increase in the average invested capital base associated with acquisitions growth CapEx and reducing the average age of our fleet. And now Paul will provide a little more color on the items affecting the individual business segments.

Thanks, Tripp. Expedited performed well in a seasonally soft quarter, compounded by severe inclement weather, yielding a 93.9% adjusted operating ratio. In this segment, rates have declined by approximately 5% as a result of the rate reset in the second quarter of 2023. The utilization has improved approximately 7%. The improvement in utilization was principally attributable to more engineered routes and newer equipment in the fleet with less downtime. Dedicated reflected another success story, yielding a 93.5% adjusted OR and successfully executing on two key customer start-ups during the quarter. Over the past three years, we have worked hard to improve the profitability in this segment by exiting unprofitable business and adding profitable business. This weed and feed approach has been uneven, but over time has served us well in deploying capital towards opportunities that meet our profitability and return requirements. We are pleased with the year-over-year improvement to adjusted margin and expect to continue to improve upon this segment's size and profitability over the longer term. Managed Freight experienced a 3% increase in freight revenue and a 102% increase in adjusted operating profit. The significant improvement in adjusted operating profit was primarily the result of a large cargo-related claim in 2023. The brokerage environment remains 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 saw a 4% increase in revenue and a 795% increase in adjusted operating profit compared to the prior year as a result of a stabilizing labor market where employee retention has improved, and the cost of labor is no longer outpacing the rate at which we can capture rate increases from our customers. Our minority investment in TEL contributed pretax income of $3.7 million for the quarter compared to $5.9 million in the prior period. The decrease was largely due to continued deterioration in the equipment market, suppressing gains on sale of used equipment. TEL's revenue in the quarter declined 14% and pretax net income decreased by approximately 35% versus the first quarter of 2023. TEL decreased its truck fleet in the quarter versus a year ago by 119 trucks to 2,082 and introduced its trailer fleet by 292,000 to 6,824. Regarding our outlook for the future. Despite the continuation of a soft freight market, we remain optimistic about our model as a result of the durability of our earnings for the past six quarters and the positive momentum we have taken with us into the second quarter in the form of a strong pipeline of new customers in our expedited segment, fleet growth in our Dedicated segment, operational efficiencies that come with a young fleet, and improved margins in our warehousing segment. We anticipate adjusted operating income growth from our core operations to sequentially improve each quarter as we execute throughout the year, although much of this growth will be offset by higher interest costs and reduced earnings contributions from TEL. We are excited about the direction the company is headed. Thank you for your time, and we will now open up the call for questions.

And our first question today comes from Daniel Imbro with Stephens Inc.

Firstly, rate per mile was better sequentially than some of your peers reported. Can you walk us through the factors influencing that result and what you would primarily attribute it to compared to others in the industry?

This is Paul. I would attribute it to our expedited business, which has a lot of long-term contracts in it. So we really have a very limited amount of exposure in the spot market. And then, of course, dedicated is dedicated in nature. So I think it's probably due to less spot market exposure than most and a lot more contractual business with multiyear terms. One of the things I would share with you, we made a strategic decision in '21 and '22, not to take full advantage of the market as we could and really try to partner with accounts that had been good to us and that we thought would help stabilize our earnings going forward. And so there's probably some trade-offs in lost opportunity, especially in the '22 market for more stable results in what we saw in '23 and '24, and that's really kind of how we're shaping the business model in the company to try to get out of the peaks and valleys and work with folks we can produce value and make a profit in both good and bad market conditions.

And kind of along the same vein, we have heard talk of some shippers pulling forward some contract renewals to earlier in the year. Have you seen some of that? Or maybe just some insights around how contract repricing is progressing would be helpful.

Yes. I would say we're pretty much through all of our contracts. I think we've got one of any significance left. So a lot of those went into effect in April and May, with some in March and some in January. So we're pretty much through that process. As I mentioned, we have one or two more left, but nothing really pulling forward from the end of the year. It should be a relatively steady selling from here on out.

And our next question will come from Scott Group with Wolfe Research.

I know just last exposure, obviously, to the spot market, but just curious about your views on cycle and demand trends so far in Q2 and where we are? Are we at the bottom? Is it getting any better yet? Any thoughts?

Yes, Scott, I'll start it out, and then David might want to add to it. I mean, I think we continue to bounce along the bottom. I think if you think back to '17, '18, '19, the pandemic, everybody had gotten used to the spikes up and the spikes down. It's kind of gotten spiky and not really U-shaped; this reminds me of kind of coming out of '08 and '09. It's kind of one of those longer recoveries that is probably a little more historically accurate, more U-shaped longer-term recovery. I really don’t see much more movement down with where costs are. There are still some companies out there really testing the market. But not much more can go down with where costs are. People will start parking trucks or downsizing fleets or whatever because it doesn’t make sense to take the risks we take in this business to lose money. I think we’re at the bottom, bouncing along it. The million-dollar question is when enough capacity exits to kind of start heading the other direction.

You mentioned multiyear contracts. Can you share what percentage of those were dedicated comments or were they expedited comments as well?

Both, both. I would say probably roughly half of expedited business, 50% to 60%, is under multiyear agreements. We've renewed a couple of those thus far this year for additional multiyear agreements, which shows the partnership, again, that we've created with some of these accounts. As I said earlier, we could have made really a lot more money in '22 and '21 than we did. But we treated some partner customers well, and they're treating us right through this. I think some of our niche value-added service offerings have been appreciated, as we create value beyond just hauling their freight. So yes, we've renewed multiyear contracts in the first quarter that will protect some of that business for years to come in the expedited space. And then, of course, dedicated is like most other dedicated lines, except for the poultry business, which is mostly on longer-than-normal term dedicated contracts.

And so as you're repricing these multiyear contracts, would you call them above market right now or below? Like meaning when you're pricing, are you getting rate increases or are rates coming down on those?

I would say flattish. On those multiyear deals, we are not going backwards. With our costs, it just doesn’t make sense. But there’s not a lot of ability to get a significant amount of rate in this market. A number of those have escalators in out years and ways we can go back and retrade with the customers, with some incremental ups and downs based on what indices or costs do. If you have a good customer that's been with you for a long time and you are making a fair margin, as long as you can adjust that if your costs go up or down, you should keep making your margin.

And then just last question. I think last quarter, you talked about earnings this year being flat to positive. I don't know, just any thoughts, any updates?

I'd say that's what we're still targeting. We're still pushing hard every day to make that happen. I think Tripp mentioned in his comments that we think we'll see sequential improvement every quarter from where we were this quarter. It's going to be a push to get back to where we were last year or maybe grow them incrementally. But I think the market will dictate whether or not we can grow them, but we're working really hard to get something with a four in front of it.

Yes. I would agree with that. But Scott, just to add on to that, the thing I'm most proud about is the fact that the base business is growing. Year-over-year, I think we can grow operating income. Some of the things that have hindered the P&L this year, whether it's our operations or interest expenses, will pose a bigger headwind, year-over-year. So those factors will offset earnings a little bit but not significantly.

And we'll move to our next question from Elliot Alper with TD Cowen.

This is Elliot on for Jason Seidl. I wanted to ask about dedicated tractor count going forward, which stepped up sequentially in the first quarter. How should we think about that going forward? I mean, similar to some other questions we've been hearing about new shippers stepping into dedicated to lock in some rates given the current environment. I guess are you seeing this at all and expect any pricing pressure there from new business?

Yes. I mean, there's definitely a lot of one-way guys trying to get in and do dedicated business given the market. Let me answer your first question: Truck count. I think you'll see the truck count probably go up a little bit in Q2, but I don't have a lot of visibility past that. After Q2, I could see it flatlining for a while because it's a tough market out there to add new business. We will keep working on the pipeline. As far as new entrants, it's competitive out there, but we're still winning as much as we're losing.

And then, given the softness in the brokerage environment, how are you able to hold up managed freight margin so well? We've seen losses at other carriers. I’m curious about your outperformance there. You spoke to some margin pressure going forward. Should we think about that similar to margins of the second quarter of 2023?

Yes, probably similar to the second, third, and fourth quarters of last year. What we're focusing on is making sure we’re not out chasing this business. We’re not trying to buy freight with our brokerage to make ourselves feel good about top-line revenue and lose money. If we can help a customer and make some money on it, we'll do it, but revenue for revenue's sake doesn't make sense for us. We’re managing our overhead and trying to guarantee we can make a profit on what we're doing and not chase loss-leader opportunities.

Next question will come from Jeff Kauffman with Vertical Research Partners.

And congratulations on a terrific quarter in a very challenging freight environment. I want to follow up on the last question and maybe look beyond the next quarter or two. I know we tend to manage the business in the short term, sometimes. But you mentioned the two new dedicated start-ups and the changing face of dedicated. As we look out two years, three years, can you talk about what this means for the dedicated franchise? And is the tractor count the right way to think about growth since some of this new business is shorter haul? Should we really be thinking about mileage, and then what could that growth curve look like in a normal environment for, let's say, 24 months, 36 months out?

Yes. Jeff, this is Tripp. One, we're very pleased with the way that Lew Thompson has performed over the last 12 months. In fact, Friday will be the 12-month anniversary of the acquisition, and it has been nothing short of a blessing for them and for us to be partners in this kind of work together. The teams have worked well together. The strategy is working, and we've experienced a lot of tailwinds with immediate growth that we didn't even model when we were pursuing the acquisition prior to signing the documents. Here's what I would say: I think the future is bright, but I'd be hesitant to put some numbers out there 2 years, 3 years out. That said, I'm excited with what I've seen. Our focus is on the shorter term because this is such a high service-oriented business, and it's something that we're new to. Lou and Josh are guiding us. We want to ensure we maintain the same level of customer satisfaction for all our existing customers while executing well on new start-up businesses. It may not sound great to say that we're focused on the short term, but it's critical for our team. I have confidence more growth will come, but we're excited about the momentum that we're taking into 2024 and 2025.

And just a follow-up, if I can. The tractor fleet down to, I think you said, 21 months—that's fantastic, and that's showing up in maintenance cost savings. But given the operating environment, you said fleet count is up a little bit dedicated, then kind of leveling out. Is there any thought about shifting capital in this environment? You mentioned the pressure from interest expense in future quarters. Where is your debt relative to your goals and your targets? Does it make sense to shift some capital and maybe reduce that interest expense, or no?

No, not in my opinion. We've seen a lot of optimization in fuel economy and operational expenses tied to a newer fleet. Service, driver satisfaction, and driver retention have improved with younger fleets. We’ve strategized to lower our fleet count and reduce the average age of it, which gives us the lowest total cost of ownership over the asset's life. If we face a disruption from obtaining new equipment, it provides us additional time before experiencing service decline or higher maintenance costs. I understand your point, and we don't just keep every truck for an arbitrary timeframe. We actively look at each vehicle to optimize the pull from it and manage each truck's lifecycle effectively. In terms of our debt situation, $250 million feels a bit high currently. However, with new business growth, I think you will see a nice uptick in our EBITDA run rate. We should start generating more cash flow in the future as this new growth unfolds, aiding in reducing our leverage profile. We’re not uncomfortable with a 2x leverage level. If we were at 3x, we might be concerned. We've never stated a desire to be debt-free, but based on our current plan, I believe you'll see some reduction in debt in the latter half of the year. However, it isn't something that causes significant discomfort, since we're poised to leverage this younger fleet and take advantage of new growth opportunities, not just in Lew Thompson but across the group.

Jeff, let me add two points to what Tripp said. A lot of the business we're adding is shorter length, which is adding capital expenditures to fund growth. Therefore, you're going to see a better free cash flow profile going forward, maybe incrementally better than where we’ve been because in a higher-mileage environment, you have to replace trucks sooner, whereas we’re able to hold onto trucks longer in a shorter-haul environment. Another point worth noting is that we're only a couple of years away from new EPA engine technology being required. The regulations regarding this are coming from several places, not just the EPA. The new engine technology is expected to lead to a significant price increase on trucks. Thus, there’s a strong incentive to purchase trucks now while prices are still lower.

No, I appreciate that. We're hearing about $25,000 more for trucks. My recollection when you're trying to fix NOx and particulates is that new vehicles don’t always outperform the older models. These are credible points. Thank you for the detailed response.

And there are no further questions at this time, and this will conclude today's conference call. Thank you for attending.