Covenant Transportation Group, Inc. — Q2 2014 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2014. The company, which reported under the name Covenant Transportation Group, Inc., operates asset-based truckload fleets and related brokerage, less-than-truckload, and factoring services. Financial figures below are in millions of dollars unless noted.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $173.7 | $172.5 | $334.6 | $337.2 |
| Freight revenue, excluding fuel surcharges | $137.7 | $136.0 | $264.0 | $264.2 |
| Operating income | $9.1 | $6.4 | $9.4 | $5.6 |
| Net income (loss) | $3.8 | $1.9 | $2.4 | $(0.1) |
| Diluted EPS | $0.25 | $0.13 | $0.16 | $(0.00) |
| Operating ratio, as reported in financial statements/MD&A | 93.4% | 95.3% | Not clearly stated | Not clearly stated |
- Q2 operating margin on total revenue was approximately 5.2%, versus 3.7% a year earlier; net margin was approximately 2.2%, versus 1.1%.
- For the first half, operating income improved despite slightly lower revenue, and the company moved from a small net loss to net income.
- Six-month operating cash flow was $25.1 million, compared with $14.3 million in 2013. Investing used $10.6 million, including $59.4 million of equipment purchases partly offset by $48.5 million of disposal proceeds. Financing used $4.5 million. Cash rose to $19.4 million from $9.3 million at year-end 2013.
- At June 30, working capital was $29.5 million, compared with $14.1 million at December 31, 2013. Total current assets were $137.1 million and current liabilities $107.6 million.
- Balance-sheet debt was approximately $211.1 million; capital lease obligations were $20.5 million. Including those leases, debt and capital leases totaled approximately $231.5 million. The company also reported $283.6 million of net indebtedness after cash and including the present value of off-balance-sheet operating leases, up $6.6 million since year-end.
- Credit Facility borrowings were $16.8 million, with $35.7 million available capacity and $37.2 million of undrawn letters of credit. The company said it expected adequate liquidity for at least the next 12 months and did not expect to test the fixed-charge covenant in the foreseeable future.
Material changes versus comparable periods
- Q2 total revenue increased 0.7%; freight revenue rose 1.2%. Truckload revenue declined as the average tractor fleet was 7.8% smaller, partly offset by a 6.8% increase in average freight revenue per tractor per week and higher rates. Management reported average freight revenue per total mile increased 5.2% and average miles per unit increased 1.5%.
- Q2 operating income rose to $9.1 million from $6.4 million. Truckload operating income increased $4.1 million, while higher operating costs per mile—including driver wages, workers’ compensation, and capital costs—partly offset improved rates and lower net fuel costs.
- For the first half, total revenue fell 0.8%; Truckload revenue was affected by a smaller fleet, harsh winter weather, and SRT’s enterprise-system implementation. Management reported improved results at SRT sequentially in Q2.
- Q2 fuel expense fell $4.6 million. Management attributed the improvement to better fuel economy, fuel pricing, and a $0.9 million benefit from amended 2010–2013 fuel tax returns. Six-month net fuel expense fell $8.5 million.
- Solutions revenue grew 25.6% in Q2 to $13.3 million. The company closed an underperforming Solutions service offering near quarter-end.
- Equity-method income from the 49% TEL investment was $0.9 million in Q2 and $1.7 million for the first half, compared with $0.6 million and $1.0 million, respectively, in 2013.
Outlook, risks, and unusual items
- Management cited robust freight volumes, higher rates, and tight industry capacity, principally due to a shortage of qualified drivers, and expected positive rate trends to continue into the foreseeable future. No specific earnings or revenue guidance was provided.
- The company reduced capacity across its three truckload subsidiaries. It said fleet size appeared to stabilize during Q2 and driver turnover improved 12% year over year. Driver recruitment and retention, compensation, and hours-of-service rules remain important cost and utilization risks.
- Management expected the Solutions closure to reduce revenue and could pressure near-term margins by limiting coverage of fixed overhead, while also expecting it to reduce purchased transportation and support collections in the second half.
- Q2 results included the $0.9 million fuel-tax credit, net of related professional fees. Fuel hedges covered approximately 24.8% of projected remaining 2014 fuel requirements, 20.0% of 2015 requirements, and 8.2% of 2016 requirements. The company expected to reclassify approximately $0.6 million of hedge gains into earnings over the next 12 months.
- Operating leases were a material off-balance-sheet funding source: remaining payments had a stated present value of $71.4 million, and undiscounted residual-value guarantees were $10.9 million. Management believed equipment sale proceeds would exceed obligations on substantially all such leases.
- Risks include driver shortages and pay pressure, fuel-price and surcharge-recovery variability, accident frequency/severity and self-insured claims, interest-rate exposure, credit-facility covenants and cross-default provisions, and routine personal-injury and property-damage litigation. Management said pending litigation exposure was adequately provided for.
- After quarter-end, on August 6, 2014, the company amended its Credit Facility to permit certain real-property dispositions and acquisitions. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Reconcile the operating-ratio figures: the executive overview refers to 93.2% for Q2 2014, while the financial statements and other MD&A passages report 93.4%.
- Confirm the appropriate operating-ratio basis and first-half comparison; the filing does not clearly state a six-month operating ratio in the cited discussion.
- Assess how much of the earnings improvement was attributable to the nonrecurring fuel-tax credit, fuel-cost changes, TEL earnings, and improved freight rates.
- Track truckload fleet size, unseated trucks, driver turnover and compensation, and whether higher pricing can offset per-mile cost inflation.
- Monitor liquidity and leverage, including revolver availability, equipment financing, capital and operating lease commitments, and covenant/cross-default exposure.
- Evaluate the effects of the Solutions service closure and TEL’s contribution, including the volatility of used-equipment and leasing markets.