Covenant Transportation Group, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited. Amounts are in millions of dollars unless noted. The filing registrant is Covenant Transportation Group, Inc.; the request metadata uses Covenant Logistics Group, Inc.
Business context and financial performance
The company operates Truckload and Managed Freight segments, including brokerage and logistics services. Q2 results improved substantially year over year amid strong freight demand, higher rates, and better Truckload profitability.
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Total revenue | $196.3 | $164.3 | $369.9 | $323.1 |
| Freight revenue, excluding fuel surcharges | $170.6 | $145.6 | $321.1 | $285.7 |
| Operating income | $14.1 | $4.0 | $20.5 | $4.3 |
| GAAP operating ratio | 92.8% | 97.6% | 94.5% | 98.7% |
| Adjusted operating ratio | 91.8% | 97.3% | 93.6% | 98.5% |
| Net income | $10.0 | $1.5 | $14.4 | $1.5 |
| Diluted EPS | $0.54 | $0.08 | $0.78 | $0.08 |
Q2 Truckload revenue was $170.7 million and operating income was $11.7 million, versus $147.6 million and $2.4 million a year earlier. Managed Freight revenue rose 53.4% to $25.6 million; operating income increased to $2.3 million from $1.6 million. Income from the TEL equity-method investment was $1.8 million for the quarter and $3.3 million for the half year.
Cash flow, balance sheet, debt, and liquidity
- First-half operating cash flow was $62.6 million, compared with $46.3 million in 2017. Investing activities provided $6.4 million, versus $24.1 million used; financing activities provided $37.8 million, versus $11.3 million used.
- Cash was $122.1 million at June 30, versus $15.4 million at December 31, 2017. Working capital was $172.5 million, compared with $81.1 million at year-end.
- Debt was $228.5 million, comprising $32.5 million current and $196.0 million long-term; capital lease obligations totaled $40.0 million. Debt plus capital leases was approximately $268.5 million. The company reported no revolver borrowings and $56.4 million of available borrowing capacity, after $36.8 million of undrawn letters of credit.
- First-half property and equipment acquisitions were $31.8 million and disposal proceeds were $38.1 million. Management reported lease-adjusted indebtedness, net of cash, of $163.9 million at June 30, down $56.3 million from December 31.
Material changes and unusual items
- Q2 revenue increased 19.5%; freight revenue rose 17.2%. Management attributed Truckload growth largely to a 14.2% increase in average freight revenue per tractor per week. Higher rates and customer growth also lifted Managed Freight revenue.
- Operating performance improved as revenue growth and lower net fuel expense and depreciation more than offset cost pressures. Net fuel expense was $6.8 million, down from $8.0 million; insurance and claims expense rose to $9.9 million from $7.9 million, with cost per mile increasing to 12.6 cents from 10.1 cents.
- General supplies and expenses included $1.5 million of Landair acquisition-related legal and professional costs and a $0.3 million write-off of software costs. The filing also cites higher driver compensation, casualty costs, and third-party capacity costs.
- The company adopted revenue recognition standard Topic 606 using the modified retrospective method. Adoption added $0.6 million, net of tax, to opening retained earnings; the first-half reported net income impact was a $0.3 million reduction. Revenue is recognized as transportation service is performed.
Outlook, risks, and contingencies
- Management expected favorable business conditions through the second half of 2018 and into 2019, citing exceptionally strong freight demand and robust customer expectations for the holiday peak. It expected Q3 operating ratio to be similar to Q2, with Landair revenue added, and Q4 operating ratio and diluted EPS to improve versus Q4 2017. No more specific earnings guidance was provided; prior comments on second-half percentage rate improvements were superseded.
- Landair was acquired July 3, 2018, after quarter-end, for approximately $83 million cash; the company also refinanced about $15.5 million of Landair debt. Funding included approximately $45.5 million of cash and $53 million of financing against previously unencumbered equipment. Landair reported about $121 million of 2017 revenue. Purchase accounting was incomplete, and pro forma financial information was to be filed later. Management expected year-end leverage to approximate December 2017 levels.
- Driver recruitment and retention, wage inflation, rising healthcare costs, tight third-party capacity, fuel prices and incomplete fuel-surcharge recovery, and accident severity are key operating risks. Management noted that higher Landair-related debt could increase second-half interest expense.
- The company had a $6.5 million reserve for a 2008 cargo claim and was appealing the damages decision. A separate California wage-and-hour case against SRT sought class certification. Management considered pending claims adequately provided for and did not expect their resolution, net of reserves, to materially harm the financial statements.
- The company cited self-insured claims exposure and potential used-equipment value changes. Fuel hedges covered approximately 16.9% of projected remaining 2018 fuel needs; no hedges were in place beyond 2018. Management estimated a $1-per-gallon diesel price change would affect net income by about $0.4 million, considering surcharge recovery and hedges.
Important facts for investors to verify
- Track whether the strong rate and freight demand environment persists and whether Q3/Q4 results meet management’s qualitative outlook.
- Assess Landair integration, completed purchase accounting, acquisition financing, and subsequent leverage and interest expense.
- Monitor driver availability and compensation, purchased transportation costs, insurance claims severity, and fuel-surcharge recovery relative to fuel prices.
- Follow the 2008 cargo-claim appeal, the California wage-and-hour litigation, and any resulting changes to reserves or expenses.
- Compare reported and adjusted operating ratios, noting that adjusted operating ratio is a non-GAAP measure and is not directly comparable if other companies define it differently.