Covenant Transportation Group, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; financial statements are unaudited. The filing entity is Covenant Transportation Group, Inc., which later used the Covenant Logistics Group name.
Business context
The company operates asset-based truckload fleets—Covenant Transport, Southern Refrigerated Transport (SRT), and Star—and ancillary freight brokerage, less-than-truckload, and receivables-factoring services through Solutions. Amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $177.6 | $170.8 | $512.2 | $508.1 |
| Freight revenue, excluding fuel surcharge | $142.0 | $134.4 | $406.0 | $398.5 |
| Operating income | $5.6 | $5.9 | $15.0 | $11.5 |
| Net income | $1.9 | $2.0 | $4.3 | $1.9 |
| Diluted earnings per share | $0.12 | $0.13 | $0.28 | $0.13 |
- Q3 operating ratio was 96.1%, versus 95.6% a year earlier. Management reported stronger underlying asset-based fleet profitability, but the adverse cargo-claim reserve materially weighed on reported results.
- For the first nine months, operating income increased despite nearly flat revenue. Lower fuel and maintenance costs and improved rates and utilization helped; higher depreciation, wages, and claims costs offset some of the gains.
- Q3 freight revenue rose 5.7%. Average rate per total mile increased 6.7%, and average miles per unit increased 5.7%. The average tractor fleet declined 6.7% year over year.
- Net fuel expense was $9.9 million in Q3, down from $13.3 million; as a share of freight revenue it declined to 7.0% from 9.9%. Management attributed the improvement to fuel efficiency, surcharge recovery, and fuel prices.
Cash flow, balance sheet, and liquidity
- Nine-month operating cash flow was $48.6 million, compared with $30.2 million in 2013. Investing cash outflow was $24.0 million and financing cash outflow was $16.7 million. Capital-equipment purchases were $93.4 million and sale proceeds were $69.2 million.
- Cash was $17.2 million at September 30, 2014, versus $9.3 million at year-end 2013. Working capital was $26.3 million, up from $14.1 million.
- Reported debt was $205.6 million; capital-lease obligations were $17.6 million. Management reported total indebtedness, net of cash and including the present value of operating leases, of $271.7 million, down $33.5 million since December 31, 2013.
- The $95 million revolving credit facility had less than $0.1 million drawn, $34.8 million of undrawn letters of credit, and $52.6 million of available capacity. The facility matures in September 2017. No fixed-charge covenant test was required at the reporting date based on availability.
- Off-balance-sheet operating-lease payments had a reported present value of approximately $65.7 million; related undiscounted residual-value guarantees were approximately $8.3 million.
Material changes, outlook, and risks
- Significant litigation charge: A September 2014 court decision in a lawsuit over a 2008 SRT cargo claim resulted in an approximately $7.5 million increase to the reserve, bringing it to approximately $8.1 million. The company reported an approximately $4.6 million after-tax impact, or $0.30 per share, in Q3 and said it was appealing. The court award was approximately $5.9 million plus prejudgment interest and costs.
- Management expected strong customer demand to continue in Q4 2014, exceeding both Q3 2014 and Q4 2013, particularly in expedited team and Solutions brokerage services. It also cited driver shortages, wage and health-cost inflation, and premium peak-season compensation as cost pressures. No numerical earnings or revenue guidance was provided.
- Fuel hedges covered approximately 24.3% of expected remaining 2014 fuel needs, 22.8% of 2015 needs, and 16.4% of 2016 needs. Management noted that falling fuel prices could produce hedge losses; it expected about $1.6 million of accumulated hedge losses to be reclassified into earnings over the next 12 months.
- Other risks include claims frequency and severity, the outcome of the cargo-claim appeal, driver availability and retention, fuel-price and surcharge volatility, and operating-lease residual obligations. Management believed liquidity was adequate for at least the next 12 months.
- The company reported $2.5 million of equity-method earnings from its 49% TEL investment for the nine-month period and held an option to acquire the remaining interest through May 31, 2016.
Important facts for investors to verify
- Progress and potential financial impact of the cargo-claim appeal, including whether the $8.1 million reserve remains adequate.
- Whether Q4 demand, freight rates, driver staffing, and operating costs developed as management expected.
- Realized fuel-hedge losses and fuel-surcharge recovery versus the company’s estimates.
- Cash generation, equipment spending, debt reduction, and available revolver capacity, including operating-lease commitments.
- TEL’s contribution to earnings and any decision concerning the option to acquire the remaining interest.