Covenant Logistics Group, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. The company changed its name from Covenant Transportation Group, Inc. in July 2020. Unless noted otherwise, financial amounts below are in millions. The former Factoring segment is presented as discontinued operations; comparisons reflect that presentation.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $210.8 | $220.5 | $613.3 | $654.8 |
| Freight revenue, excluding fuel surcharge | $196.2 | $197.4 | $565.4 | $584.0 |
| Operating income (loss) | $6.8 | ($3.9) | ($23.6) | $7.1 |
| Net income (loss) | $7.5 | ($3.2) | ($17.1) | $7.3 |
| Diluted EPS | $0.43 | ($0.17) | ($0.98) | $0.39 |
| GAAP operating ratio | 96.8% | 101.8% | 103.8% | 98.9% |
| Adjusted operating ratio | 93.2% | 101.6% | 97.6% | 98.4% |
Q3 operating income improved by $10.7 million year over year as operating expenses fell faster than revenue. The adjusted operating ratio is a non-GAAP measure; the company defines it excluding fuel surcharge revenue, intangible amortization and specified unusual items. Nine-month results include a $26.6 million long-lived asset impairment and a $2.6 million bad-debt reserve recorded in Q2.
Q3 continuing-operations income was $4.7 million, versus a $4.0 million loss a year earlier; discontinued-operations income was $2.8 million, versus $0.9 million. Nine-month continuing-operations loss was $21.5 million, while discontinued operations contributed $4.5 million of income.
Business trends and material changes
- Q3 total revenue declined 4.4%, while freight revenue was nearly flat, down 0.6%. Lower fuel surcharge revenue accounted for much of the total-revenue decline.
- Dedicated and Expedited Q3 revenue fell year over year by $16.2 million combined; Managed Freight revenue rose $14.3 million and Warehousing rose $1.6 million. Managed Freight operating income was $2.1 million, compared with $0.5 million.
- For the first nine months, Dedicated and Expedited revenue declined, partly offset by growth in Managed Freight and Warehousing. The company exited most solo-refrigerated operations, reduced its tractor fleet nearly 18% year over year, and reorganized segments; former Highway Services is now reported as Expedited, and Warehousing is separately reported.
- Management cited lower fuel, maintenance and depreciation costs and a smaller fleet as contributors to improved Q3 performance. Purchased transportation costs rose, reflecting Managed Freight growth and a more competitive market for third-party capacity.
- The Factoring business (TFS) was sold on July 8, 2020. Following a dispute and amended purchase terms, consideration was reduced to $108.4 million cash; the earn-out was terminated, and the company recorded a $3.7 million gain. The company later sold Triumph stock received in the transaction for $28.1 million and remitted the proceeds to Triumph in October.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $25.0 million, down from $39.8 million. Investing activities provided $131.0 million, chiefly reflecting TFS and asset-sale proceeds; financing activities used $185.8 million, including debt and lease paydowns and share repurchases.
- Cash was $13.7 million at September 30, down from $43.6 million at year-end 2019. Working capital was $53.5 million, versus $93.1 million at year-end.
- Total debt and lease obligations were $166.7 million at September 30, versus $348.2 million at year-end 2019; management reported net indebtedness of $152.9 million. The company said it had paid down approximately $175.6 million of debt and lease obligations during 2020.
- No borrowings were outstanding on the revolving credit facility at quarter-end. Undrawn letters of credit were $36.7 million, with $58.3 million of available borrowing capacity. A separate $45 million Triumph-related line is restricted to funding specified TFS-sale indemnification obligations.
- On October 23, 2020, the revolving credit facility was increased from $95 million to $110 million, extended to October 2025, and amended to improve pricing and certain other terms.
- Management stated that liquidity should be adequate for at least the next year and that it expected to remain in compliance with debt covenants. A real-estate-note covenant waiver was obtained for Q2; the covenant calculation was amended for Q3, when the company reported compliance.
Outlook, risks and unusual items
- For Q4 2020, management expected favorable volumes and pricing in a robust peak season with limited trucking capacity, sequential margin improvement, and an adjusted operating ratio slightly better than Q3’s 93.2%. It expected the operating fleet to remain around 2,550 tractors.
- For full-year 2021, management expected adjusted operating ratio to improve versus full-year 2020, but to be worse than Q3 2020. It described a multi-year strategy to grow Dedicated, Managed Freight and Warehousing, reduce overhead, and improve safety, service and productivity; cost pressures could offset some expected gains.
- Q3 unusual or adjusting items included $3.7 million gain on the TFS sale, $1.0 million employee separation costs, $4.4 million insurance policy erosion/reinstatement expense, and $1.2 million intangible amortization. Management’s net Q3 expense adjustment was $2.9 million.
- The company had not accrued the TFS indemnification obligation because a probable, estimable amount was not available. It could owe 100% of the first $30 million of covered losses and 50% of the next $30 million, up to $45 million total. Funding could adversely affect results, cash flow, liquidity and indebtedness.
- Insurance and claims exposure is elevated: the company estimated that the aggregate limits in a $9 million excess-of-$1-million coverage layer for the policy period through March 2021 were fully eroded. Additional claims could require accruals; renewal coverage also carries higher premiums, greater self-insured retention and lower aggregate limits.
- COVID-19 effects remained uncertain. The company had increased receivable reserves by $2.6 million in Q2 for a customer bankruptcy and other higher-risk customers, with no additional COVID-related reserves in Q3.
- Pending matters include California driver wage-and-hour/PAGA litigation and a putative no-poaching class action. The company reported no accruals because it could not reasonably estimate potential losses. It also noted possible future volatility from the TEL equity-method investment and the used-equipment market.
- A prior material weakness in TFS credit approval and monitoring controls was considered eliminated following the sale of substantially all TFS assets. Management concluded disclosure controls were effective at September 30, 2020.
Important facts for investors to verify
- Whether the TFS covered accounts generate indemnification losses, and the resulting liability, cash needs and debt impact.
- Whether the reported insurance-limit erosion or future claims lead to additional expense accruals or coverage costs.
- Whether Q4 and 2021 operating-ratio expectations are achieved, including the effect of driver costs, constrained fleet flexibility and purchased transportation pricing.
- Whether liquidity, borrowing-base availability and covenant compliance remain adequate as capital spending and working-capital needs change.
- How much of reported profitability depends on non-GAAP adjustments, asset-sale gains, discontinued operations and other unusual items.