Covenant Logistics Group, Inc. Class A

Welcome to today's Covenant Logistics Group Q421 Earnings Release Conference Call. Our host for today's call is Joey Hogan. At this time, all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session. I would now like to turn the call over to your host. Mr. Hogan, you may begin.

Thanks, Ross, and good morning, everyone. Welcome to our fourth quarter 2021 conference call. As a reminder for everyone, the conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risk and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. Please review our disclosures and our filings with the SEC, including without limitation the risk factor section and our most recent Form 10-K, and our current year Form 10Qs. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances. A copy of our prepared comments and additional financial information is available on our new website at www.covenantlogistics.com, the Investors tab. I'm joined on our call today by our Senior Executive Vice President and COO, Paul Bunn, and our Chief Accounting Officer Tripp Grant. David Parker is not able to join us this morning for the call. 2021 was a record year by Covenant in many ways. Revenue, our minority investment in tail, earnings per share, and return on invested capital all achieved record results. Our team battled through the continued effects of the pandemic, the most difficult driver market in history, Huge growth in our managed freight division and leadership changes early in the year. We pushed through some large pay adjustments across the enterprise in all areas. Warehouse teammates and our office staff. And over the last year, and we're excited to tackle 2000. The model transformation that we started five years ago is really starting to prove out with continued opportunities. And our results for 2021 are directly due to the Covenant community, its hard work and its commitment to each other and our customers. In summary, the key highlights of the quarter were freight revenue grew 27% to $267 million compared to the 2020 quarter. Our asset-based truckload group freight revenue grew 9% versus the fourth quarter of 20 with 186 less trucks. Our less asset intensive managed freight and warehouse segments grew a combined 56% compared to the fourth quarter of 2020. On the safety side, we produced another solid quarter with our DOT accidents rate per mile being 19% below the year ago period, the second lowest fourth quarter on record. And 2021 for the year finished the best year on record. Our tail leasing company investment produced a record quarter and year, contributing an additional 10 cents per share versus the year-ago period. We finished the year with an all-time low leverage ratio of 0.72, an all-time low net debt total capitalization ratio of 15.8%, and an all-time high return on invested capital of 13%. Additionally, we're very excited to announce the commencement of a quarterly cash dividend program. Work over the last few years to deleverage the company and improve our operating model to produce more consistent results led our board to this approval. Net indebtedness has decreased by almost $240 million over the last two years, with the potential to be close to debt free by the end of 2022. The goal is to yield 1% on an annualized basis, And at our current share count, we'll impact cash by about a million dollars per quarter. We continue to evaluate a full range of capital allocation alternatives to effectively deploy our cash. Now I'm going to turn it over to Paul to provide a little bit more color on the items affecting the business units.

Thanks, Joey. For the quarter, our managed freight division was our largest division, both in terms of revenue and operating profits. Its revenue for the quarter grew 67% and achieved record revenue of $321 million for 2021. Managed Freight's favorable results for the quarter were primarily attributable to the robust freight market executing on various spot rate opportunities and handling overflow freight from both expedited and dedicated truckload operations. This division remains a major strategic growth opportunity as we have invested more operations and sales resources into the division to continue its momentum into the future. We remain excited about this leadership team and the prospects going forward. The expedited division's revenue grew by 13% versus the year-ago quarter due to both strong rate and utilization improvements. We did invest in our driving workforce during the quarter with a significant pay increase, which after several quarters of sequential decline, we were able to hold the fleet size versus the third quarter and increase our seated truck camp. The driver pay investment was our third pay increase for the year and has given us momentum heading into 2022. We are very thankful that our customers value our service and supported our driving teams in this unprecedented time. The dedicated division had a good quarter and achieved nice sequential and year-over-year margin improvement despite some unusual corporate expenses that hit both expedited and dedicated in the quarter. Had it not been for the 250 basis points of unusual expenses in the quarter, dedicated would have hit the mid-90s OR target set at the beginning of the year. Revenue per truck continues to improve as we push through our improvement plan with further rationalization coming in the first half. The 21% revenue per truck improvement in the quarter was a significant contributor to the margin improvement. The pipeline for this division is very encouraging as we start 2022. The warehouse division grew 11% due to the impact of new business late in the third quarter and pricing to offset cost increases. Operating income was negatively impacted due to higher labor costs as it relates to a tight labor market and escalating real estate costs for newly leased facilities. We remain committed to our current asset-light model and continue to pursue opportunities to accelerate our growth. We're excited about this year as the operating model continues to be refined. We expect a good freight environment for the first half of the year with some moderation in the second half. Cost pressures will be meaningful in terms of wages, equipment, and over-the-road repairs for the year, but the market should allow us to pass the majority of those increases through to our customers in the form of rate increases. The first few weeks of the year were tough from a working truck percentage as many of our drivers the virus after the holidays, but the fleet working percentage has improved greatly in recent days, and we are especially pleased with where the team count is today. The dedicated improvement plan continues to make progress, and we are confident that we will continue to improve the margins to high single digits in 2022. Net indebtedness is already dropping in January. We will generate free cash in 2022, providing further opportunities to deploy cash for growth and or share repurchases. Thank you for your time and I'll open up the call for any questions.

If you would like to ask a question, please press star one on your phone now and you will be placed in the queue in the order received. Please be prepared to ask your question when prompted. Once again, if you would like to ask a question, please press star one on your phone now. And our first question comes from Scott Group from Wolf Research. Please go ahead, Scott.

Hey, thanks. Good morning, guys. In the earnings release, you had some comment in the outlook section about operating results similar. And maybe just can you give a little bit more color? I wasn't sure if that was a first half comment, a full year comment. If that's you're talking about earnings, just any more color there would be great.

Yeah, I think, Scott, what we were trying to do, so if we were confusing, I apologize for that. But we feel, based on what we see today, we feel that the first half earnings will approximate first half of 2021 or higher. So we feel good between the combination of the commitments from the customers and kind of what we see in the market. And so that's what we're intended to do. Second half, from a modeling and or a planning purpose, we – If the Fed continues to do their job, we're anticipating some slowdown in the second half, but we were saying we felt we could do at least what we did in 21 from an earnings perspective in the first half of 22.

Okay, great. You gave some helpful color on dedicated margins. I'm curious how you're thinking about the expedited margins this year.

Yeah, thanks, Scott. This is Paul. You know, I think expedited margins will probably approximate 21 for 22. I think you could see margins, Q1 is starting off really strong. We've dedicated and expedited. We've done a good job getting out of the gate on rate increases early in the year. And so I think you see margins, you know, maybe a little stronger. And then as costs continue to pile up, they could dilute a little bit. But expedited specifically to your question, I think will be similar margins to what you saw in, uh, in 21 on a four year basis.

Right. So maybe if I just take those two things combined. So if expedited is similar and dedicated, it's got a lot of improvement. I would think there'd be some, you know, potential for more for earnings growth and better than flattish. So maybe just tie those two together.

Oh, I think, um, In warehousing, you should see some small improvement there too. The pipeline is pretty decent. It's all going to come down to managed trans in the overall freight market. If things stay really tight and managed trans has a year like it had this year, then we'll make more money in 22 than we made in 21. If things soften up a little bit in the second half of the year, you saw the large contribution that managed trends had, especially in the third and fourth quarters. I think that's where we don't have the full visibility. And so that's what could determine are we a little bit under this year's earnings or a little bit over this year's earnings is where managed trends end up the second half of the year.

Makes sense. And just lastly, just from a pricing standpoint, what you guys are seeing to start the year?

Yeah, low single – high single digits to low double digits. Okay. From a rate standpoint.

Okay. Thank you, guys. Appreciate it.

Our next question comes from Jason Seidel from Cohen. Please go ahead, Jason.

Thank you, operator. Good morning, gentlemen, and my best to David who's not on the call. I wanted to talk a little bit about the pricing in your script that you have out there online. You talked about how the contracts are elongating, excluding dedicated. Can you give us a sense of sort of what percentage of your contracts now are over a year?

Yes, I'll speak. As you know, managed trans, there's not a lot of stuff that's over a year. It's pretty – short-term opportunities, and as we've said before, that's where we play in the spot market. On the expedited, we're probably somewhere in that 40% to 50% of contracts that are multi-year in nature right now.

Okay. That's helpful. I wanted to switch back to the dedicated side. Now, you said if you exclude some of those unusual costs, which I'm assuming aren't going to happen again and reoccur in 2022, You're about 95 for the end of the year. You know, what set of market do we need to get this business down to that low 90 level?

Yeah, I mean, I think some of it's market and some of it's time. But if you look at the, you know, on an adjusted basis, Jason, with the, you know, you're at a 95 and the thing had been running 100 or 101. So, you know, we've improvement through there. We continue the weed and feed process. You'll remember we entered some contracts right on the heels of COVID and had some contracts that were longer term in nature that we've gotten the increases we could get, but they're still sub-part of market. As we roll out of those in the first half and second half of the year and either replace those with business that is I would say more market rate business and has more of a fixed variable type pricing margin or renegotiate those contracts to be more, I'll call it true DCC with fixed variable. You're going to continue to see that improvement. So I agree, you know, you're on about a 95 run rate for Q4. And I think you're going to continue to see that, you know, eat down, you know, a little bit each quarter for the balance of this year. And so are we going to be at a, 92 OR at the end of Q1? No. Do we hope to be there by the end of the year or the first part of 23? Yes.

All right. Well, the progress is definitely there. I didn't want to insinuate it wasn't. You talked a little bit about the contracts that weren't really to DCC. What percentage of the contracts that you have right now would you consider problematic?

Yeah. 30%, 40% of the contracts, and there's a, you know, half of those come up between now and August.

Okay. That's a good sign for sure. Well, fantastic, gentlemen. Those are my few, and I'll turn it over to a colleague. Thank you for the time, as always.

Thanks, Jason. Our next question comes from Jack Atkins from Stevens. Please go ahead, Jack.

Great. Good morning, everybody. Thanks for taking my questions.

Good morning.

So I guess maybe to start, I'd like to ask maybe a two-part question. First, just, you know, Joey, Paul, Tripp, whoever wants to take it, what are you seeing in the equipment market both for trucks and trailers? And if you could maybe help us think through how that's going to progress. change if it changes at all over the course of 2022? And then I guess kind of as it relates to Covenant specifically, you know, within your equipment leasing investment tell, you know, it's obviously a very strong contributor to the bottom line. You know, can you help us think through how that should maybe trend as we look forward?

Yeah, we did have some trucks pushed from 21 into 22. It was a small amount. about 50 trucks that pushed into first part 22. We'll have those by March, so they're satisfying the commitment from 21. Our 22 initial order, as well as everybody's, what you wanted, you didn't get, you got a percentage of that for 22. We've worked around that from various means, so we've got about... 70% of our requested order for 22. Now, for us, I don't want to say, quote, that's okay, but we were trying to pull some equipment forward that we were having problems with that we wanted to kind of transition to another manufacturer inside of our suppliers. So for us, it's okay. Trailer market, the pricing's up pretty meaningfully on the truck side. But I would say it's – I would call it manageable. The trailer side is a different ballgame. If you go look at our trailer capacity, it's pretty concentrated in a few years. And so our big years to start trading trailers will start in 2023 and will go on five or six years. So we tried to get an order placed for 22 and got zero to try to start moving that schedule forward to smooth out that concentrated purchase cycle. We got zero. I mean, not even a quote of pricing. I mean, we're not a huge fleet, but we're not a small fleet. And so, you know, basically from all the suppliers, look, we can't. We can't commit anything, and we'll talk to you late in 22 for 23 and beyond. We've even tried to float a five-year commitment, five-year committed capacity. So, again, no biters, but folks want to talk in the end of 22. Pricing in that market, from what I understand, is significant, just significant. And so there's various theories and reasons why. But it's up significantly. Tail, on the other hand, our investment is Tail. It's in this business. It's in the truck trailer sale, resale, leasing business. And obviously, it had a good record, actually. And I believe strongly we'll have another record 22. They were able to get some trailer capacity. That's their business. They're paying about 25%-ish more, and they will pay more for that in 22. Reefer pricing, I can't even say the number, and I won't say the number because it's almost ridiculous what I'm hearing, what he's having to pay for Reefer. On the other hand, the pricing he's been able to get out in the market to lease that equipment is unbelievable also. So, Dale's doing really well. I mean, the $5 million-ish number in the fourth quarter that they contributed to our results, some of that was gained on sale. They're a very opportunistic buyer also in the marketplace, and they do a great job. But it's definitely going to be higher than what we've seen over the last year or so in 22. So, they're going to have a really good year. So, we buy trucks. and trailers together. Between the two of us, we have a pretty good-sized fleet between trucks and trailers. We chose to let them have the trailer capacity because they had opportunities this year, and between the two of us, we'll sort it out in 23 for going forward. But the equipment market is real tight. We did get a little, just one other note, our trucks that were pushed into the first quarter are being delivered slightly early, which is a blessing, versus over the last year or so, and the schedule that's been committed to on schedule, and no further delays that we know of.

Just to add on to Joey's point about kind of the size, give you some context, and 2021 was a very, very light year from a CapEx perspective, obviously. We've talked about it throughout the quarters and had a little bit of a bump up with some deliveries in Q4 of 2021. But over the course of the year, we had, I think, net proceeds of $10 million or such rounded. As we think back to 2022, just to give you kind of an idea of the scale of what, you know, how it'll look. you know, with the equipment purchases, even though it wasn't as much as we had ordered with the cutbacks and assuming things, well, you know, we're looking at a range of about $50 to $70 million of net CapEx for the year. So there's quite a big swing as we try to normalize our CapEx flow in terms of maintaining CapEx and get it back to a normal course, a lot of which stems back to what we did in 2020 with the downsizing of the shrink and or downsizing of the fleet and shrinking it and selling a bunch of older equipment, it naturally made 2021 a light capex year. So you're going to see a little bit of a rebound in 2022 and probably even a bigger rebound in 2023 as trailers come into the equation.

Okay. Got it. Got it. That's helpful. I guess maybe thinking bigger picture, you know, Joey, going back to your comments, you know, in your prepared remarks, you know, around the market, and sort of the outlook for the market and how it could unfold this year, it doesn't seem like there's going to be an influx of capacity coming just because of the items you just talked about on the equipment side. When you kind of think about the idea of the second half maybe being a little bit more of a moderation in terms of the marketplace versus the first half, is that because of your outlook for the economy, just concerned about the Fed, or is it something that your customers are maybe telling you about about their business in the second half of the year?

Just the economy. I mean, when the Fed starts raising rates, it's intending to slow the economy down. And so if they do, and there's a lot of rhetoric around that, is it four, is it eight, is it three? But history shows that it's impactful. Now, the question is how big and when do we start seeing it? But We certainly know it's within six months or so. That's what history shows. Now, if this is different because of drug and alcohol clearinghouse, because of infrastructure spending, which is a natural competitor to our drivers, the construction market in general is hot and low inventories. Inventories to sales is still very low. Is there some things that overcome that? to delay that impact into the economy that pushes it out, or the freight side is minimal impact because of that. I find that hard to believe, but we'll see. So that's just that. No, there's no indication from customers regarding any anticipated slowdown. Now, nobody's talking about peak either, but it's way too early to be talking about peak.

Got it. No, that sounds good. I guess the question is, have we even stopped with peak yet? Maybe not. That's right. I guess last question, and I'll turn it over, but it's on capital allocation. Obviously, there have been some just significant improvements to the balance sheet over the course of the last couple of years because of the actions that you guys have taken. Business is hopefully more profitable through cycle, but I think folks are looking forward to that. The stock is kind of back down to the levels where you guys sort of initiated the Dutch tender last year. You initiated the quarterly dividend. Help us think through ways that you're kind of contemplating returning capital to shareholders today. you know, outside of the quarterly dividend, you know, would you look to maybe get more aggressive on open market purchases of the stock, just given that the Dutch tender really didn't yield the type of, you know, reduction in share count that maybe you were initially intending? Could you maybe kind of walk us through some of the capital allocation strategies, just given the strength of the balance sheet here?

I think, A, let's go back to the you know, the expectations for cash generation for the year. So it depends on whatever modeling that everybody has as far as what they expect, you know, even not to contribute for 22. Uh, we feel that even with 50 to 70 million of net capex, we will still generate cash, uh, for 2022. Um, the dividend, relatively speaking, the cash impact of that is small. It's around a million dollars a quarter. Um, And we felt it was not only a commitment but a signal to the market and our shareholders that, you know, it's time just because of where we are. Number two, you know, what are we going to do with the cash generated this year and what we see into the future? I would say, Jack, it's all of that. We firmly and fully intended to execute the Dutch auction in full, you know, Some people would say that we executed it without having to use the cash. Our intent was to use the cash. People that ran away from us because I think we kind of woke the market up and the government's going to buy this too cheap and I'm not going to sell it at this price. Because it ran much higher than what our generous at the time of announcement offer. Sure. Based on history. So it ran away from us. And our intention was to, was to execute that. So as we move forward, obviously, Jack, I can't, I mean, we're looking at M&A, you know, our last one of size was 2018. And so we feel the models at a place that our team can focus and execute, you know, another acquisition size. I don't know. I mean, I'm, uh, there's some things, there's some strategic, smaller ones that make sense that are good compliments. And there's some larger ones that, uh, you know, are larger, you know, similar to what the land air acquisition was back in 18. So we're in the market looking, uh, we're in the market looking at further, you know, whether it's normal share repurchases, Dutch's, whatever. Uh, so we're, we're going to move and the dividend was a start if you will. And, uh, We'll see how it plays out, but we're excited about it. It's neat to be in a cash generation mode because it gives you a lot of opportunities, and we're going to try to be diligent about deploying that cash in the right means.

Okay, that's great. Thanks so much.

Thanks, Jack.

Our next question comes from Bert Subin from Stifo. Please go ahead, Bert. Hey, good morning, everyone. Good morning, Bert. Good morning, Bert.

Hey, Joey, just to follow up to your comments there, what is your view on inventory restocking? It seems like there's been some concerns that perhaps retail sales start to moderate through the year. You know, inventory sales ratio is still at all-time lows. Are you noting any actions to rebuild inventories? And do you think that could be an offsetting tailwind if the economy does moderate from high levels in upcoming quarters?

You know, this is Paul. We met with a large customer yesterday that said, carries a lot of inventory, and yes, I think that restocking and carrying more inventories, building more warehouses, I mean, this company basically said everybody knows what they need to do post-COVID, which is keep more inventory domestically. They've just got to get there, and it's just been a firefight ever since COVID, and so And, again, that's a poll of one. But if it's a really large company that carries a lot of inventory, and their comment was that that has not happened yet.

Oh, yeah.

But they are making plans every day to try to do that, to increase inventory levels domestically.

You've got to close – it'll be in two phases. I think, you know, whichever your favorite stores are, as we walk through the stores, as we see the empty shelves start filling – You know, whenever it gets to fill, I think it'll be moving into the next phase, which is how do I fill the warehouse or do I add warehouses? And I think that's a general, whether you read it or hear it directly, I think people are saying, okay, we got too skinny, obviously. Now, you know, pandemics once every 100 years, we hope. We've got one that's lasting a while. But even besides that, I think the market – in general, feels that we were too skinny. And then I think to your point, Bert, is depending on that view, it could delay, you know, as I was saying earlier, it could delay that impact to the freight side of the economy as people are trying to push through that. It just depends on rates. Some CFOs doing the plus and minus on cost of capital and when does it make sense. I'd rather have more inventory than empty shelves. and the cost of capital is still pretty cheap. They can move a lot, and it's still cheap, relatively speaking.

That makes sense. Thanks for the commentary there. Paul, my fellow national champion, my follow-up question is for you. How good do you think the improvement in dedicated would have to be to more than offset what you're expecting to be? It sounds like some normalization in managed freight. Can you just give us a rough order of magnitude perhaps on OR improvements?

But, yeah, to offset it, dedicated would have to be in the 80s to get anywhere close. Once, you know, on a longer-term basis. So I don't think dedicated will get there this year, but I don't think managed trans will drop that much. I mean, it's going to drop probably in the second half of the year. So to fully offset it, it has to be in the 80s probably. Okay. Thanks.

And just a final question for me.

Go ahead. Our next question comes from Bruce Elephant from Oppenheimer. Please go ahead, Bruce.

Thank you. Congratulations on an excellent year. The one thing that I know was just covered, but I have to mention it. The one thing that's a little bit disturbing is that back in August, the company realized their stock was extremely undervalued, and you decided to have a Dutch auction to commit $40 million to purchase roughly 1.7 million shares, which represented about 12% of the outstanding shares. And that sort of sent a signal to Wall Street and investors that you thought your stock was extremely undervalued. And now, with the stock where it is today, and selling at less than seven times earnings, it's sort of disappointing that what we got was a small dividend for shareholders rather than management realizing some kind of buyback. It's almost like the only 80,000 shares got tended on the Dutch auction. We never really raised the price, which we could have done. And it's sort of disappointing that there's no action taken right now.

Yeah, it's a fair question, Bruce. as I said earlier, we fully intended to, to, to do that, to spend that cash. Uh, arguably we still have that cash and there's several things that go into the decision and the actions and the timing. And, uh, we're still very interested and feel that whether it's seven times earnings or 1.3 times tangible book value, uh, we're, we, we agree with you. And, uh, We're working diligently to, as I said earlier, to deploy our CAS in the best means that we can.

Okay, thank you. I hope something is done.

And we have a follow-up question from Bert Subin. Please go ahead, Bert.

Hey, sorry, I got sort of cut off there at the end. I just had a quick follow-up to an earlier question. You guys said high single to low double-digit rate increases. Can you break that out amongst dedicated and expedited? Thank you.

Yeah, it's probably – I would say they're pretty similar, Bert. I mean, there's not a ton of differentiation between the two. Yeah, you've probably got expedited is probably a little higher on the right side. They're probably in the low double digits, and dedicated is probably in the high single digits and expedited. Most business units are about the same size, you know, from a revenue perspective. And so, you know, if one's 11 or 12, you know, or 13, the other one's eight or nine.

Okay, that's helpful. Thanks, Paul.

And gentlemen, at this time, there are no further questions.

Okay, well, thanks, everybody, for being on the call. Thank you for your questions. Bruce, again, fair question, and we agree with you behind that. So look forward to meeting with you all and visiting with you after the first quarter. Thanks a lot.

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