Welcome to today's Covenant Logistics Group Fourth Quarter 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.

Thank you, Ross. Good morning, everyone, and welcome to the Covenant Logistics Group's fourth quarter 2022 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, Paul Bunn. Before jumping into the quarter, I'd like to first take a moment to reflect on 22 as a whole. As it's a remarkable year for us in many ways, it marked the second consecutive year of record earnings, record revenue, capital returns and safety results. We repurchased approximately 20% of the outstanding stock of the company and acquired a small but highly profitable specialized truckload carrier, all while maintaining moderately low debt leverage. We also made progress on our operating model through improved contracts in our Dedicated segment and grew the core business in our asset-light segments comprised of managed freight and warehousing. Although the tailwinds of a strong freight cycle may well be behind us, we believe the combination of our improved operating model and our strong balance sheet has us well positioned for the future. Our company today is much improved, and we are grateful to all of our team members whose dedication and commitment made this possible. Focusing now on the fourth quarter. On an adjusted basis, we believe our team performed well during a market of transition. Consolidated revenue was essentially flat compared with the fourth quarter of 2021, while improved revenue per tractor and…

Thanks, Tripp. Taking a moment to dive deeper into what drove the consolidated results for the quarter, our expedited operating our expedited segments freight revenue grew 26% compared to the prior year quarter as a result of the combination of a 16% rate improvement and operating 67 additional tractors. The increases are related to the AAT acquisition we had in the first quarter and the loosening driver market, allowing us to seek more tractors. We are pleased with expedited rate and utilization in the quarter, which was improved by FEMA freight in October that resulted from Hurricane Ian. Cost headwinds from increased salaries and wages, maintenance and insurance continue to play a major impact in the quarter and condensed our margins. We believe the combination of our work to resolve a significant number of prior period claims and the impact of the equipment replacement plan will help improve costs in this segment going forward. Driver pay remains stable at the present time. Our Dedicated segment had a 5% reduction in freight revenue compared to the '21 quarter as a result of 143 or 10% reduction in the average number of total trucks in the period, offset by a 5% increase in revenue per truck. Although we are pleased with both the year-over-year and sequential improvement to the margin, we fell short of our profitability target, primarily because of the same cost increases, which were impacting our expedited segment. The fleet reduction we've experienced in this segment is a product of 2 factors: intentionally exiting unprofitable business and reducing fleet counts with existing customers based on reduced volumes. We continue to work diligently to improve margins in this segment by improving our customer mix, contractual terms and operating a younger, more efficient fleet. Managed Freight experienced a 30% reduction of total…

[Operator Instructions] And our first question comes from Jason Seidl from Cowen.

Paul, I wanted to kick things off and talk a little bit about managed freight first and then jump in the truckload. On the managed freight side, you said that basically prepare for significant margin compression. I guess maybe can you give us a range of what you consider significant? And then maybe walk us through maybe some of the puts and takes to just how bad it is out there? Because it seems like all of this is coming from competitive pressures out in the marketplace.

Yes, Jason. Here's what I'd say on the managed freight side. The market is crazy competitive out there right now. As far as -- I would say it's going to return to historical truckload brokerage margins. I think not just us, but a number of our competitors have been running margins in these brokerage businesses that are multiple times more than the historic margins that truckload brokerages operate. And I've seen several others out there. Everybody is kind of returning back to pre-pandemic pre-supply chain issue, brokerage margins levels. And those are mid-single-digit kind of numbers. And so we're seeing it just like our peers return to those numbers. there's no doubt there are folks out there trying to buy volume in this space right now. And a lot of logistics departments, traffic departments are trying to go back and recoup costs from the last few years. That said, a lot of these rates we're seeing are just unsustainable where they're 10%, 20%, 30% below what a small carrier can run at. And it's just kind of a purge. I think the whole industry on the brokerage and the truckload side is going to have to go through. But some of these small carriers stacked up some money running the spot market the last couple of years, and they're making it. But you can't run 10% or 20% below what your cost are forever.

No, no, that's clear. And what's your percent of business between contract and transactional right now?

Probably 65%, 70% contract, about 30% spot in that business right now.

And is that just more from the spot the spot market drying up in terms of loads?

Yes. And contract rates to the brokerage -- those are folks keep doing many it, get a number and then they do another bid and that kind of stuff.

Okay, that's good color. I want to jump over to the asset-based side now and maybe talk a little bit about some of the deterioration you're seeing. We held a call a bunch of private companies earlier this month, and they basically said that the market has deteriorated a lot in the last 60 days. What are your expectations for sort of the pricing gains that you're going to get out of the contracts that you signed here during this bid season?

Here's what I would say. A lot of ours just right now, quite frankly, is coming from volume reductions because a lot of our customers just don't have the freight they had, and our reduced margins are coming from having to take more broker freight to fill the trucks as opposed to straight up customer price reductions. I mean I will tell you, on the expedited -- I mean we're somewhere between low single digits to flat to up a little on customers. I mean it's -- on the expedited side, there's not a lot of margin pressure. But when customer XYZ is giving you 10% less loads than they were giving you 5 months ago. You're either -- your replacement or broker freight right now and the freights you're going and getting to refill the bucket is not as profitable as what you got out of. And so that's what's pushing on truckload margins.

Okay. Fair enough on that. I wanted to talk a little bit about the changes in the fleet, obviously, a far newer fleet than you had before, probably newer than you thought it was going to be. Talk a little bit about the savings that can maybe help offset some of the market pressures we're seeing.

Yes, I may be able to help with that. There's no doubt about it that new equipment is more costly than from a price perspective than some of the older equipment that we're taking out of the fleet. And we've been pretty vocal on the last couple of calls on really looking at our ops and maintenance spend, the cost of running that older equipment. Just to frame this up for you, if you look just on a cents per mile basis, our ops and maintenance costs in our Truckload division ran $0.21 a mile. -- in 2021. When we look at 2022, it ran up $0.29 a mile. And sequentially, it got worse and worse and worse. And so it was pretty early in the year where we decided we've got to get in front of this. And we got in front of it through being more aggressive on new acquisition or acquiring incremental tractors beyond our 2022 trade plan. And those incremental tractors, which were about 250 units landed in the quarter in the fourth quarter on top of what we were scheduled to already received. We've also bumped up our trade plan for 2023. I think our original order was somewhere in the neighborhood of 600 tractors and anticipating to get closer to 900 now. And so what this did in the short term and the compounded with the fact we went out and identified the most expensive tractors in the fleet, which were these leased units that we talked about in the earnings release, just call them 600 units. We went ahead and proactively park those units. And so all of that being said and done, it created a little bit of a logjam of excess equipment. We had newer equipment we had received and deployed that we're setting out that were being operated and then we had all of these leased assets that were generating costs, and we weren't able to turn them in. So, I don't want to get into specific numbers but I do think that you're going to see meaningful improvement in both ops and maintenance costs. And I think you'll also see even though the cost of equipment is going up -- if you think about the little gain on sale that we had this year, which was just over $2.2 million or about $3 million adjusted when you exclude out the terminal sale, you're going to see, I think, meaningful improvement because what we're going to be selling next year, we're not going to be trading in leased vehicles. We're going to be selling used vehicles that we own. And so you'll see some meaningful improvement in gain on sale next year. So we think the fixed cost of equipment could be flattish, even though the price for that equipment is going up, but we believe meaningful improvement in ops and maintenance and also meaningful improvement in fuel economy with that newer equipment.

Tripp, just 2 clarifications. One, when you say next year, are you referring to $24 million or $23 million?

I'm stuck in the past I'm a balsa. I've got to live in the past...

Sure.

I'm talking about 2020. Sorry -- I'm sorry. You're right, I was referring to 2023 and then.

So the other thing I wanted to say, so you went for $0.21 a mile to $0.29 a mile worsening as you went throughout the year. What is the maintenance cost on these new trucks that you're bringing in, so you can put it into perspective for us for mile?

Exponentially, better. I think that there have been cost and I don't know if it's realistic to get back to what we consider all in ops and maintenance costs of 2021 number of $0.21 per mile, the parts of the cost of tires, the parts of labor, the cost of parts all have had significant cost inflation. But I think that I think you could see that number lands somewhere between the $0.21 and $0.29 per mile. It's a little bit hard to say because the other key component to this is uptime and utilization. We had to keep -- throughout 2022, we had EPA considerable number of excess units, particularly in our dedicated fleet in the fleet just because we would have a customer that would require 15 trucks and we were putting 20 trucks in there because 5 of them were down. And it will help us with uptime and utilization, too. So it gets a little bit muddy when trying to do some sort of cost reconciliation by just looking at ops and maintenance. But I think you're going to see an overall improvement and efficiency of that -- in the truckload -- larger truckload segment, which both includes expedited and dedicated.

That's a great explanation. And last, and I'll turn it over to somebody else. Expectations for share repurchases. Obviously, you guys were very aggressive last year, repurchasing your own shares and supporting them. This year is going to be a down year by anybody's estimates in terms of just your overall financials. Are we going to see you still be the same aggressive way as you did in '21?

I don't want to comment on what we're going to do in the future, but it is public information on what we have out there and what we've repurchased today. And we still have about $20 million of availability on what we -- on the plans that have been approved and are in the market today. We'll evaluate that. Obviously, we have the strength in our balance sheet to do that if we so choose, but there's a number of different options that we may choose not to do that. So it's certainly in the arsenal of things that we could act on, but there's been no decision or no public disclosure of us committing to something additional beyond what's out there today.

Okay. Sounds good. gentlemen. I really appreciate the time as always.

Thanks, Jason.

And our next question comes from Jack Atkins from Stephens.

Okay, great. So, I guess maybe I'd like to ask you about sort of the trends into the first quarter here, but maybe we could take a step back and kind of think about, Paul, going back to the last couple of quarters, you guys have sort of commented on the cyclicality in the business and sort of how you think you've been able to mute that a bit, given all the work you've done in the last few years, but you do sound a bit more bearish about the trends in the business that you're seeing over the last few months. So I guess, as you sort of think about the run rate for the business today based on sort of your outlook for the managed transportation managed freight business in mid-single-digit margins. Do you think down 25% to 30% peak to trough earnings is still how to think about it? Or has that changed any over the last few months?

Jack, I would say it's probably -- that's still our goal. That's still what we're shooting for each and every day is down in that 25% to 30% range. We haven't given up on that goal internally for 2023. And so we had a big meeting on that yesterday, and we talk about it frequently. To your point, you're taking a step back. I'll take a long step back. I mean historically, peak to trough, we might have been down 50% or 60%, 70% some years. If you go back to the years we've made 2.86 and the next year made 61 or something. And so 75% type reductions. Is it going to be 25%? Is it going to be 30%? Is it going to be 35%? I don't know. A lot of that's just going to be what is the market deal up for us, but it's not going to be anywhere like you saw in the team 10 years ago. So we're still very confident in the changes in the model, reducing volatility compared to, I'm going to call it, the last 10 or 15 years. We're still shooting every day for that 25% to 30% reduction. And I think it's -- how achievable that is, probably is a function of how much further the market in general falls? And does it bounce off the bottom? Or does it stay on the bottom for a little while. But we're still in that whole kind of big vein of becoming less volatile, there's no doubt compared to the prior years were materially less volatile.

Yes. about that -- no doubt about that. And I think that's helpful and I appreciate the way you've kind of framed that up. I guess as you think about the first quarter, I know that a lot of people are kind of looking at this 4Q to 1Q trend and should we see better or worse to normal seasonality given all the factors that are at play out there. You guys -- it sounds like you guys had a really strong October, which may have been kind of boosting the fourth quarter, but you didn't have much peak season in November and December. So as you think about the way the business is trending into the first quarter, consensus is about $0.90 or so. Do you feel like that -- I mean do you feel like that's in the right ballpark based on the trends that you're seeing in the business today, the run rate there? I know January is a tough one too.

Yes, it's tough to peg it off January but that's in the range of reasonableness. I mean here's what we did. You said October was a stout month, no peak, November, December, definitely pulled back. But I mean, Tripp talked about the interest we had $0.23 a mile insurance. We're hopeful we don't run $0.23 a mile insurance. And so I would tell you that, again, no doubt things are soft out there, but we are -- our cost structure for the first quarter is going to look better than our cost structure in the fourth quarter. So revenue won't be as robust, but our cost structure will be better.

Okay. Okay, that's helpful. And I guess maybe kind of I'd be curious to get your take on what your customers are telling you about maybe the -- the trends within their business and sort of how they're thinking about their inventory levels. I mean, do you think that we can get back to maybe normal levels of replenishment, normal ordering levels in the second quarter? Or do you think that's maybe something that we'll need to see in the second half of the year? Just sort of what are your customers telling you about the direction of their business?

Jack, this is David. Yes, there are 4 bullet points that I would say is that I really believe that first second quarter from an economic standpoint are going to be negative GDP. That's what I believe. I believe that as it relates to transportation, I think that we hit the bottom around Thanksgiving, and I think that we have just been there. That's where it's been. We've not seen a second downward trough going down below kind of Thanksgiving. And we have since that all in the month of January as well. So I'm optimistic that the industry and us are down on the bottom level there. And as I think look at it in the second quarter, even the first and second quarter or negative GDP -- when they start buying more Coca-Colas and it gets warm in May and it gets warm in the end of April and hot dogs and all those kind of things, freight is going to pick up even if it's a negative GDP growth. And so I believe that that will be a tailwind for the industry. I also believe that it will be about a second quarter event when the inventory levels are corrected. And as soon as that happens, that in itself will be a tailwind for the industry because right now, that's what a lot of our customers are doing and are correcting their inventory levels. And so we're just having to muddle through it. And -- but I'm optimistic that the pipeline is good. I mean better than you would think it would be in the month of January, I'm optimistic about that. I think that we've got -- I'm optimistic about what I've seen from the rate levels thus far, the pressure of reduction that it's only…

I'm going to add one thing to what David said is that -- you asked early in your questions about the changes and volatility and peak the trough and all that. Here's what I would say. I used the word niche on last quarter's call. And I would tell you, everywhere we're we are niche and people really need our teams or they really need hazmat heavy haul dedicated? Or they really need -- where we're providing value, things are holding in there just incredibly well in this market. We do have -- there's still a little bit of business that's commoditized here and there. But every day, we're trying to find where we can be more value-add and itchy -- and the commoditized people are going to do what the commoditized people are going to do. I feel like we're probably down that path, but we're going to keep working on that path every day. Good market or a bad market. And eventually, that saves going to become 80 or 90. And that niche stuff where we add value for our customer, and they add value to us, we want to get that to 100%. And so that's part of what to David's point is protecting us thus far in this market. And it's really -- it's the pressure points are in 2 places where we still have a little bit of commoditized business. And then where we don't have enough freight in certain geographies, and we're having to haul broker freight. So we keep working on those 2 things, it will be good.

Okay. No, all that makes sense, and I really appreciate all the commentary, David, thank you for that, too. I guess maybe just last question, David, and I'll hand it over. I'd love to get your take on this. because you've seen a lot of cycles over your career for such a young man. But I guess you sort of think about just capacity attrition in the market. You talked about rates being at 1990 levels in certain markets. But it doesn't really feel like we've really seen a lot of capacity come out yet, at least from what we can tell. I guess how do you see the capacity situation playing out over the next 6 months or so? What do you think needs to happen to really trigger that sort of attrition that we would normally expect to see with rates at these levels?

Yes. I think going forward, that we will see the reduction in capacity because I think that what has happened thus far, I mean if you look at new DOT numbers, it's negative. And so there is not new trucking entries coming into the marketplace. That's number one. But I do think what's happened, Jack, is that the folks that just grew -- I mean, not good, but came into the market in the spot and Holland $450 a mile, those were onesie, Tuesday trucks. Those are -- somebody has got 3 trucks and not many. Those trucks have left that you and I have not felt it yet because they've been to drivers for me or truck drivers for Warner truck drivers for you, they just started driving company trucks. And so we still got the same amount of capacity. And so I think that's where the market is today. but 2 plus 2 does equal 4, you can't haul 1990 rates with cost in 2022, 2023 cost and think you're going to stay in business. So I think in the next couple of months, we will see a rush of capacity that is going because all of us truckload guys, our trucks are full virtually. They're virtually full. And so that's what I think you'll start seeing capacity leaving in the next couple of quarters.

Yes, Jack. It's going to -- the ones that made a lot of money had some capital to hold on for a little while. But again, you can't run at some of these rates forever, and I won't mention the vendors, but I've talked to a couple of vendors in the last few weeks that deal with big truckers and small truckers. And they're small trucker delinquency rates or people hitting their credit limits is it's getting there to a spot where eventually -- I don't think we're going to wake up one day and say, well, capacity left yesterday. But over a 6- to 9-month period, you're going to see it trend down. And again, that's some of that's just talking from vendors that deal with big truckers and little truckers and their credit departments are pretty worried right now.

Really appreciate it.

And our next question comes from Bert Subin from Stifel.

Thank you for the time. David, maybe just a follow-up to some of the comments there. I think if I go back a few quarters, you've been communicating a more bearish position toward future freight market fundamentals. So your comments, I think there maybe indicate you're starting to become more optimistic at least about where things are trending even if we go through a little bit of a dip here in the first half. Does that make you from the covenant perspective, want to be more aggressive during the downturn? And in terms of trying to put your finger to the wind in terms of when the market is starting to turn, is it as simple as you as what your customers are saying or looking at the spot market? When do you think it really becomes more risk on in the trucking side?

Yes. Number one, I am more bullish than reporting some of the freight management being down and TEL the equipment and those kind of things from a business, from a freight standpoint, during a time that we hit the bottom, so things are not great, but I am becoming more and more bullish. There are more opportunities that are presenting their sales. And I do think it's -- some of that is because of what Paul talked about is that we've worked hard since 2018 and then 2020, we have worked hard on 2 things. getting deep in the supply chain, whatever that means, getting deeper in the supply chain; and number two, bringing value to our customer for that customer bringing value to us. And we have those kind of conversations with our customer because I don't care if it's 2 20 or 21 or 23 when you need some freight. If I'm not bringing value to that customer and if they're not bringing value to me, one or the other is going to leave because we are going to get to the point where when we started down the road of being you call, we're not going to be a UCO-hall carrier and just hope we get enough phone calls. We're going to have commitments from our customers, not that dedicated is running 20 trucks and they need to go to 15 because they have no freight. I understand that. That's just business. But not, okay, we're going to do a ban because at the end of the day, we used in abuse '21, and we don't like your pricing. Let them go do that. I don't care. We will go do other things. It means reduce our trucks, whether it means go do acquisitions, whether it means…

Thank you. This is Joey Hogan. We're a different company that's worked very hard the last 4 or 5 years to bring value. And the reason why our rates have not dropped like the market has dropped is because our customers recognize it. And I mean this is -- they're verbalizing this to us, and that is our business is down, but you do such a great job, and you've given us the teams when we needed it, you give it the dedicated trucks when we needed it. And we're not asking for a rate reduction. We were really fair for the last 24…

We have been -- we have I think, Bert, that's another piece of it. We didn't -- we were pretty far with a lot of these folks over the last 24 months when we could have taken advantage of some situations and we didn't. And in turn, what we're finding is our customers are being really fair to us back right now -- and the 30% that aren't -- well, as Dave said, we'll figure that out.

Yes, that's obviously great color. Maybe just all the things you guys talked about on the reduction of volatility. I think a lot of that has been some things you've done on the expedited side, and then obviously, improvement in dedicated. If we think about the 2 things that likely going to determine whether you end up at 25% down or plus 35% down in '23, it's going to be, I think, your ability to maintain that 92% or better or/and expedited. And I think it's going to be your ability to keep managed freight at least the sales side of that in a reasonable range, not going back to where it was pre-pandemic. Can you just provide some color on those 2 items and maybe why you have confidence that both of those segments are going to hold up better because expedited historically a lot more cyclical and managed freight obviously very cyclical in a backdrop like this?

Yes. I would say managed freight from a confidence standpoint, remember, other cycles Bart, we didn't have a lot of these long-term agreements. And we're 60%-ish of expedited freights tied up in long-term agreements. And so plus the addition of AAT, which rolls up into expedited, I mean that's just not our -- it's not your average expedited carrier and what they do and just the structure. And so we have a lot of confidence in how expedited is going to hold up in 2023. On the Managed Freight side, I mean, we said it, margins are going to be compressed but we're still feeling really good about top line revenue. Our team there has got -- as David said, they've still got a really robust pipeline, and expedite has a robust pipeline. And I think on the dedicated side, you're going to continue to see -- over the last 24 months, you've seen incremental improvement in dedicated, and I think you're going to see incremental improvement in Dedicated this next year. Not going to be -- it's going to be a little harder, but dedicated is going to continue to incrementally improve. You've got long-term agreements in AAT and expedited. Managed Trans margins are going to go way down, but they've been way high. But I think the revenue base will be there. And then on the warehousing side, I think we'll -- I think margins will start to rightsize as we continue to grow that business. And that pipeline is the best we've had since we entered that business in 2018.

So Paul, maybe as a follow-up to that, you only saw a modest quarter-over-quarter impact on the sales side in managed freight. Are we getting closer to the bottom? Do you think you can remain that elevated? Or does that step down in the first quarter and also sort of increase off of the new base?

Yes. I think managed freight will step down in the first quarter, and that will kind of be your new base going forward versus Q4 margin same.

And gentlemen, at this time, there appears to be no further questions.

All right, everyone. Thank you for joining us, and we look forward to talking to you next quarter.

Thank you. This concludes today's conference call. Thank you for attending.