Business context and reporting period
Covenant Transportation Group, Inc. (the registrant named in the filing; the request metadata says Covenant Logistics Group, Inc.) filed this unaudited Form 10-Q for the quarter ended June 30, 2017. The company operates truckload transportation businesses and related brokerage, factoring, and other services. Its sole reportable segment is Truckload.
Financial results and liquidity
Unless otherwise noted, figures are in U.S. dollars; financial statement amounts are converted from thousands to millions.
- Q2 revenue: $164.3 million, up 3.5% year over year. Freight revenue, excluding fuel surcharges, was $145.6 million, up 0.8%.
- Q2 earnings: Operating income was $4.0 million versus $7.3 million; net income was $1.5 million versus $3.6 million. Diluted earnings per share were $0.08 versus $0.20.
- Q2 operating ratio: 97.6%, compared with 95.4% a year earlier. Adjusted operating ratio, a non-GAAP measure, was 97.3% versus 94.9%.
- First-half results: Revenue was $323.1 million versus $315.2 million; operating income was $4.3 million versus $14.7 million; net income was $1.5 million versus $8.0 million. Diluted EPS was $0.08 versus $0.44. The six-month operating ratio was 98.7% versus 95.3%.
- Cash flow: First-half operating cash flow was $46.3 million, down from $64.4 million. Investing cash outflow was $24.1 million, compared with $11.2 million; financing cash outflow was $11.3 million, compared with $49.2 million. Cash at June 30 was $18.7 million.
- Balance sheet and liquidity: Working capital was $49.8 million. Total assets were $615.9 million and stockholders’ equity was $237.2 million. Debt was $185.4 million, including current and long-term debt; capital lease obligations were another $21.9 million. The company reported $4.1 million drawn under its $95 million revolving facility, $30.9 million of undrawn letters of credit, and $55.9 million of available capacity. The facility matures in September 2018.
- Margins and key costs: Q2 net fuel expense fell to $8.0 million from $12.9 million, while insurance and claims expense rose to $7.9 million from $6.7 million and depreciation and amortization rose to $20.7 million from $16.0 million. First-half depreciation and amortization was $39.8 million versus $32.9 million.
Material changes versus the prior comparable period
- Q2 operating income and net income declined despite higher reported revenue. Management attributed weaker profitability principally to higher driver-related, insurance, and capital costs, including increased depreciation following lower estimated tractor salvage values and losses on equipment sales.
- Truckload freight revenue fell $1.4 million in Q2 and $5.5 million for the first half. Q2 average freight revenue per total mile improved, but lower utilization and a slightly smaller average tractor fleet weighed on revenue.
- Solutions revenue grew 18.1% in Q2 to $16.7 million; its operating income was $1.6 million versus $1.5 million.
- Net fuel expense improved substantially as fuel surcharge recovery increased and fuel-hedge losses were lower than in 2016. Fuel surcharge revenue itself increased, partly reflecting higher diesel prices.
- Management reported a $10.7 million decrease in total net indebtedness during Q2 and a $22.3 million decrease since year-end when including the present value of off-balance-sheet lease obligations.
Outlook, risks, contingencies, and unusual items
- Management expected a favorable year-over-year comparison in Q3 freight revenue per tractor, lower net fuel expense for the second half versus 2016, and a flattening of the depreciation impact from the 2016 salvage-value change. Higher maintenance expense and professional-driver wages were expected to offset some benefits. The company’s goal was second-half earnings improvement versus the second half of 2016; no specific earnings guidance was provided.
- Management anticipated possible industry capacity tightening later in 2017 and into 2018 from electronic logging device (ELD) implementation and economic growth, but timing and magnitude were uncertain. A July 2017 House committee bill could delay or repeal the ELD requirement and alter that outlook.
- SRT had recorded losses for six consecutive quarters, although management cited improving rates and sequential utilization and expected further progress.
- A court decision concerning a 2008 cargo claim led to an additional $0.9 million reserve in Q1, bringing the reserve to $7.2 million. The company was considering further appeals. SRT also faced a proposed California wage-and-hour class action; the company said the outcome of pending claims was not expected to materially adversely affect its financial statements, considering existing reserves.
- The company had fuel hedges covering approximately 24.6% of projected remaining 2017 fuel needs and 15.4% of projected 2018 needs. It expected to reclassify about $2.6 million of net-of-tax fuel-hedge losses into earnings over the next 12 months. Fuel-price movements, surcharge recovery, and hedge settlements may affect results.
- Lower used-tractor values could lead to further depreciation increases or equipment-sale losses. The company also cited driver availability and wage inflation, accident frequency and severity, and the September 2018 revolving-facility maturity as matters to monitor. Management said liquidity was adequate for at least the next 12 months and that it did not expect to test the facility’s fixed-charge coverage covenant in the foreseeable future.
- The company was evaluating revenue-recognition and lease accounting standards not yet adopted at the filing date. It expected the revenue-standard adoption’s net prospective impact on equity or earnings not to be material; the lease-standard impact remained under evaluation.
Most important facts for investors to verify
- Whether truckload utilization, freight yields, and operating profitability improved after the slow start to Q2.
- Whether higher wages, insurance claims, maintenance, and depreciation continue to pressure margins, and whether SRT returns to profitability.
- How cash generation, debt reduction, capital spending, lease commitments, and the September 2018 credit-facility maturity evolve.
- The eventual outcome and reserve adequacy for the 2008 cargo claim and California wage-and-hour litigation.
- Actual effects of ELD regulation, used-equipment values, fuel surcharges, and hedge settlements on capacity, costs, and earnings.