Covenant Transportation Group, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. The filing names the registrant Covenant Transportation Group, Inc.; the request metadata identifies Covenant Logistics Group, Inc. Unless indicated otherwise, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $164.5 | $173.5 | $479.7 | $516.2 |
| Freight revenue, excluding fuel surcharges | $148.2 | $153.5 | $437.3 | $449.0 |
| Operating income | $5.4 | $14.6 | $20.2 | $43.4 |
| Net income | $2.9 | $7.6 | $10.9 | $28.9 |
| Diluted earnings per share | $0.16 | $0.42 | $0.59 | $1.57 |
| Operating ratio, based on freight revenue | 96.3% | 90.5% | 95.4% | 90.3% |
Q3 operating and net margins on total revenue were approximately 3.3% and 1.7%, respectively, versus 8.4% and 4.4% a year earlier. For the nine months, the corresponding margins were approximately 4.2% and 2.3%, versus 8.4% and 5.6%.
- Q3 total revenue fell 5.2%; freight revenue fell 3.4%. Nine-month total revenue declined 7.1%, while freight revenue decreased 2.6%.
- Truckload operating income was $5.5 million in Q3, down from $16.0 million; nine-month operating income was $22.6 million, down from $46.8 million. “Other” operations, including Solutions, improved: Q3 operating income was $1.8 million versus $0.9 million.
- Q3 fuel expense decreased to $26.4 million from $30.5 million, but nine-month net fuel expense rose to $38.2 million from $33.8 million. Expired fuel hedges added $4.0 million of fuel expense in Q3 and $13.1 million year to date.
- Depreciation and amortization rose 31.6% in Q3 to $19.3 million and 20.4% year to date to $52.2 million. Insurance and claims expense increased 25.1% in Q3 to $8.4 million.
Cash flow, debt, and liquidity
- For the nine months, operating cash flow was $82.1 million, compared with $78.6 million. Investing activities used $46.0 million, including $100.9 million of equipment purchases and $55.0 million of equipment-sale proceeds. Financing activities used $35.6 million; cash increased $0.5 million to $5.0 million.
- At September 30, current assets were $114.8 million and current liabilities $87.7 million, leaving working capital of $27.2 million, down from $46.4 million at year-end 2015.
- Balance-sheet debt was $207.7 million; capital lease obligations were $15.4 million. Management reported total indebtedness, net of cash and including the present value of off-balance-sheet lease obligations, of $238.2 million, down $25.9 million since December 31, 2015.
- The $95 million revolving credit facility had $15.8 million drawn, $26.8 million of undrawn letters of credit, and $47.6 million of available borrowing capacity. The facility matures in September 2018. Management said it did not expect to need to test the fixed-charge coverage covenant in the foreseeable future and believed liquidity would meet needs for at least 12 months.
- Off-balance-sheet operating lease payments remaining were approximately $19.4 million; undiscounted residual-value guarantees were approximately $4.0 million.
Changes, outlook, and risks
- Management attributed weaker Truckload results to lower freight rates and utilization, fewer seated trucks, and higher operating costs per mile. The quarter had moderate freight volumes and a depressed used-tractor market. SRT remained loss-making for a third consecutive quarter; management cited continued network redesign challenges.
- Solutions’ Q3 revenue increased 14.4% to $15.9 million, and its operating income rose to $1.8 million. Covenant and Star reported sequential revenue-per-tractor improvement; SRT’s declined 4.2% sequentially.
- Effective July 1, the company lowered estimated tractor salvage values, increasing depreciation expense by about $2.0 million per quarter before tax (about $1.2 million after tax, or $0.06 per share). Management expected elevated depreciation to continue; further declines in used-equipment values could affect results.
- For Q4, management expected seasonal improvement, particularly in e-commerce freight, but not to the extent seen in Q4 2015. Its 2017 outlook called for the first half to resemble the most recent six months of 2016, with improvement in the latter half. Management expected 2017 net capital expenditures to be below those of 2014 or 2015. No specific earnings-per-share guidance was provided.
- Management highlighted driver recruitment and retention, wage and healthcare inflation, accident frequency and severity, insurance costs, used-equipment prices, fuel surcharge recovery, and fuel-hedge results as significant operating uncertainties. Department of Transportation-reportable accidents rose 5.3% year over year in Q3.
- A 2008 SRT cargo-claim lawsuit remains pending after an appellate court partly reversed an approximately $5.9 million judgment and remanded the case for further proceedings. Management said existing reserves and its assessment of pending matters were not expected to have a material adverse effect, but an unfavorable outcome could increase expense.
- Fuel hedges covered approximately 26.5% of projected remaining 2016 fuel needs, 26.5% of 2017 needs, and 16.6% of 2018 needs. Management expected about $4.5 million of net-of-tax hedge losses to be reclassified into earnings over the next 12 months. The filing also reports an interest-rate swap fixing the rate on a $27 million headquarters-related note at 4.2% through 2035.
- The company adopted ASU 2016-09 early, recording $2.2 million in opening retained earnings and a $0.6 million tax benefit. The Q3 and year-to-date effective tax rates were 27.1% and 33.9%; management noted tax credits and said the lower rate was not expected to recur consistently.
Investor verification priorities
- Check subsequent Truckload and SRT performance, including freight rates, seated-truck levels, utilization, and whether Solutions’ growth continues.
- Assess whether lower tractor salvage values, used-equipment prices, and equipment-sale proceeds create further depreciation charges or cash-flow pressure.
- Track accident trends, insurance and claims expense, reserves, and developments in the SRT cargo-claim litigation.
- Review operating cash conversion, equipment spending and dispositions, lease obligations, borrowing-base availability, and covenant headroom.
- Monitor fuel surcharge recovery and hedge-loss reclassifications, as well as the sustainability of reported tax benefits and equity-method income from TEL.