Covenant Transportation Group, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; amounts are unaudited and in U.S. dollars. The company provides truckload transportation and related services. Its primary reportable segment is Truckload.
Financial results and liquidity
| Metric | Q1 2017 | Q1 2016 or prior date |
|---|---|---|
| Total revenue | $158.7 million | $156.3 million; up 1.5% |
| Freight revenue, excluding fuel surcharges | $140.1 million | $144.7 million; down 3.1% |
| Operating income | $0.3 million | $7.4 million |
| GAAP operating ratio | 99.8% | 95.3% |
| Adjusted operating ratio, excluding fuel surcharges | 99.8% | 94.9% |
| Net income (loss) | $(0.04) million; reported EPS rounded to $(0.00) | $4.4 million; EPS $0.24 |
| Operating cash flow | $30.7 million | $51.5 million |
| Cash and cash equivalents | $7.3 million | $7.8 million at Dec. 31, 2016 |
| Working capital | $36.5 million | $47.9 million at Dec. 31, 2016 |
| Total debt, excluding capital leases | $182.6 million | $193.6 million at Dec. 31, 2016 |
| Capital lease obligations | $22.6 million | $22.2 million at Dec. 31, 2016 |
Capital expenditures were $22.5 million and proceeds from equipment disposals were $6.6 million; investing cash flow was a $15.9 million outflow. The company reported aggregate debt and capital lease obligations of $205.2 million and said these obligations declined $10.1 million since year-end. The $95 million revolving credit facility had $14.0 million drawn, $26.6 million in undrawn letters of credit, and $48.9 million of available capacity at quarter-end. It matures in September 2018. Management said liquidity was adequate and it did not expect to test the fixed-charge coverage covenant in the foreseeable future.
Material changes and operating drivers
- Total revenue rose because fuel surcharge revenue increased $7.0 million to $18.6 million, while freight revenue fell $4.6 million. Truckload revenue increased overall, but Truckload operating income fell to $3.9 million from $8.4 million.
- Operating expenses increased $9.5 million. Higher driver and employee costs, insurance and claims, maintenance, and depreciation more than offset lower net fuel expense and interest expense. Depreciation and amortization rose $2.2 million, partly reflecting lower tractor salvage-value assumptions adopted in 2016.
- Insurance and claims expense increased 26.4% to $8.7 million; expense per mile rose to 11.2 cents from 8.6 cents, despite the company’s lowest first-quarter chargeable-accident rate in ten years.
- Operating cash flow declined $20.8 million year over year. Management cited receivables and advances, including delayed collections on 2015 receivables from a large customer, the quarterly loss, and timing differences in payables and incentive compensation.
- Net fuel expense fell to $8.5 million from $13.5 million, mainly because fuel-hedge losses reclassified to expense were $1.2 million versus $5.0 million in Q1 2016. Fuel expense itself rose as average diesel prices were about $0.49 per gallon higher year over year.
Outlook, risks, and unusual items
Management described the 2017 outlook as mixed. It expected Q2 to face difficult comparisons in freight revenue per tractor, higher depreciation and maintenance, and higher professional-driver wages. The company hoped for improved earnings in the second half versus the second half of 2016, if ELD implementation, fewer industry trucks, and economic growth tighten capacity and improve freight markets; timing and magnitude were uncertain. It expected operating cash flow to exceed net capital expenditures and planned to continue paying down debt. No specific earnings or revenue guidance was provided.
- A May 8, 2017 court decision concerning a 2008 cargo claim led the company to add $0.9 million to its Q1 reserve, bringing it to $7.2 million; the company is considering further appeals. This is a material subsequent event recorded in the quarter. A separate California driver wage-and-hour class action had a $0.5 million settlement pending final court approval, and another SRT wage-and-hour class action was pending.
- Used tractor values and residual-value estimates remain important risks: further market declines could increase depreciation or losses on equipment sales. Management cited extended tractor trade cycles as a contributor to higher maintenance.
- Fuel-price changes, incomplete surcharge recovery, driver availability and wage inflation, accident severity, and freight capacity and rates may affect results. Fuel hedges covered about 24.6% of projected remaining 2017 fuel needs and 15.4% of projected 2018 needs; approximately $2.5 million of net-of-tax fuel-hedge losses were expected to be reclassified into earnings over the next 12 months.
- The company had operating leases with $15.6 million of remaining payments and $4.0 million of undiscounted residual guarantees. Its balance sheet also includes insurance and claims accruals and an $86.0 million deferred tax liability.
- Management said the new revenue-recognition standard was expected to have no material prospective effect on equity or earnings, though it anticipated changes to reported revenue and certain variable expenses. It was still evaluating the standard; the new lease standard’s impact was also under review.
Investor verification points
- Track whether freight revenue, operating ratio, and Truckload profitability improve after the weak first quarter, and whether the expected second-half recovery materializes.
- Verify the final outcome and any additional financial effect of the $7.2 million cargo-claim reserve and the pending wage-and-hour cases.
- Monitor cash conversion, receivable collections, capital spending, debt paydown, and available revolver capacity ahead of the September 2018 facility maturity.
- Assess whether used-equipment values, depreciation, maintenance costs, and insurance claims require further reserve or estimate changes.
- Review realized fuel-hedge and surcharge effects, and confirm the company’s assumptions about ELD-driven capacity tightening and driver costs.