Covenant Logistics Group, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023; comparisons are with the same 2022 periods. Amounts are in millions except per-share data and where stated. The interim financial statements are unaudited.
Business context
Covenant operates Expedited, Dedicated, Managed Freight, and Warehousing businesses. It acquired dedicated carrier Lew Thompson & Son Trucking (LTST) on April 26, 2023, expanding its Dedicated segment. Management described freight demand and rates as challenging and characterized the market as likely near the trough of the freight cycle.
Financial results
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Total revenue | $274.0 | $317.4 | $540.9 | $609.0 |
| Freight revenue, excluding fuel surcharges | $243.7 | $266.9 | $477.1 | $524.5 |
| Operating income | $11.8 | $26.9 | $29.4 | $50.7 |
| Net income | $12.3 | $24.5 | $28.9 | $46.7 |
| Diluted EPS | $0.91 | $1.56 | $2.10 | $2.86 |
| GAAP operating ratio | 95.7% | 91.5% | 94.6% | 91.7% |
| Adjusted operating ratio | 93.3% | 89.4% | 94.0% | 89.9% |
Q2 total revenue declined 13.7% and freight revenue declined 8.7% year over year. Lower fuel surcharge revenue contributed to the total-revenue decline. Operating income and net income also fell substantially; the adjusted operating ratio, a company-defined non-GAAP measure, worsened. For the first half, total revenue declined 11.2% and net income declined 38.0%.
- Cash flow and investment: First-half operating cash flow was $12.4, versus $76.9 in 2022. Investing cash flow was negative $113.3, including the LTST acquisition and equipment investment; reported net capital expenditures were $111.9. Financing cash flow was positive $40.1. Cash fell to $7.8 from $68.7 at year-end 2022.
- Liquidity: Working capital was $44.9, down from $66.5 at December 31, 2022. At quarter-end the company had $48.2 of available borrowing capacity under its revolving facility and $45.0 available under the separate TFS-related Draw Note, which may be used only for qualifying indemnification obligations.
- Debt and leases: Debt and lease obligations totaled $248.6, including $189.7 of debt, $5.4 of finance leases, and $53.5 of operating leases. Net indebtedness, defined by the company as debt and finance leases less cash, was $187.2, up $140.9 since year-end. The leverage ratio reported by the company was 1.68. Revolver borrowings were $40.2; the $110.0 facility matures in May 2027.
- Capital returns: The company paid $2.9 in dividends in the first half and repurchased $25.5 of stock. Q2 repurchases were 129,320 shares at an average $34.71, all in April; no further repurchases were reported through August 7.
Material changes and segment performance
- Expedited: Q2 revenue was $104.1 versus $121.6 and operating income was $5.8 versus $14.6. Management cited lower rates and a smaller fleet, including an intentional fleet reduction amid weaker demand for expedited freight.
- Dedicated: Q2 revenue was $81.2 versus $96.8, while operating income rose to $3.2 from $2.9. The average tractor count was down 14.8% year over year as the company exited underperforming contracts; LTST added approximately 144 weighted-average tractors.
- Managed Freight: Q2 revenue fell to $63.3 from $80.3 and operating income fell to $1.9 from $8.6, reflecting reduced high-margin overflow freight from the asset-based segments.
- Warehousing: Q2 revenue rose to $25.5 from $18.7, supported by new customer business; operating income was $0.8 versus $0.8.
Outlook, unusual items, and risks
- Management gave no specific earnings or revenue guidance. It said it was optimistic but cautious about the pace of freight-market recovery, emphasizing cost control, capital allocation, market-share growth, and a more diversified operating model.
- Management expects salaries and wages and depreciation and amortization to increase year over year for the remainder of 2023. It expects interest expense to rise with LTST-related borrowing and expects TEL earnings to decline sequentially amid a soft used-equipment market. The company’s baseline estimate for net capital expenditures for the rest of 2023 was $45–$55.
- The first half included a $7.6 gain on sale of a Tennessee terminal, contributing to the $11.8 net gain on property and equipment dispositions. Results also included acquisition and executive-retirement costs and fair-value adjustments to contingent consideration; the company excludes specified items in its adjusted operating ratio.
- LTST’s preliminary acquisition-date consideration was $109.9, including $10.0 of contingent consideration, with up to $30.0 of additional earnout payments possible. Purchase-price allocation remains preliminary. LTST contributed $10.8 of revenue and $1.9 of net income from acquisition through June 30.
- The company’s 49% equity-method investment in TEL contributed $5.4 of Q2 pre-tax income, down from $7.1, primarily due to lower equipment-sale gains. TEL income can fluctuate with used-equipment sales.
- Insurance and claims costs remain volatile. The company disclosed that aggregate limits in a historical insurance layer were fully eroded; adverse development of claims from that policy period could lead to additional expense. Routine transportation-related litigation is also disclosed.
- Disclosure controls and procedures were deemed not effective at June 30, 2023, after a review failed to detect an incorrect input in the LTST acquisition significance calculation. The company said this did not affect current or historical financial statements; it filed an amendment to the acquisition Form 8-K and stated required financial statements and pro forma information would be filed when available.
Important facts for investors to verify
- Whether freight volumes, pricing, and Managed Freight overflow activity recover, and how the segments’ operating income responds.
- LTST’s final purchase accounting, audited financial statements and pro forma disclosures, and any earnout payments or performance effects.
- Cash conversion, working-capital movements, planned equipment spending, and the availability and cost of borrowing as debt has increased and cash has declined.
- Developments in insurance claims, including potential adverse development of claims tied to the eroded historical coverage layer and remaining TFS indemnification exposure.
- Remediation of the disclosure-control deficiency and whether subsequent filings provide the LTST information identified as required.