Covenant Logistics Group, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022; comparative periods are the corresponding 2021 periods. Amounts below are in U.S. dollars.
Business context
Covenant operates Expedited, Dedicated, Managed Freight and Warehousing businesses. Expedited and Dedicated provide asset-based truckload services; Managed Freight provides brokerage and transportation management; Warehousing provides warehouse management and related services. The company also holds a 49% equity-method investment in Transport Enterprise Leasing (TEL). Results include AAT Carriers, acquired in February 2022, within Expedited.
Financial performance and key metrics
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Total revenue | $311.8m | $274.6m | $920.8m | $751.8m |
| Freight revenue, excluding fuel surcharges | $266.6m | $250.3m | $791.1m | $682.9m |
| Operating income | $59.1m | $20.1m | $109.8m | $48.9m |
| Net income | $50.5m | $16.4m | $97.2m | $43.0m |
| Diluted EPS | $3.39 | $0.97 | $6.12 | $2.52 |
| GAAP operating ratio | 81.1% | 92.7% | 88.1% | 93.5% |
| Adjusted operating ratio (non-GAAP) | 91.6% | 91.5% | 90.5% | 92.3% |
Q3 adjusted diluted EPS was $1.52, according to management; the principal adjustment was exclusion of the $38.5m pre-tax gain on sale of a California terminal. Adjusted operating income was $22.5m in Q3, compared with $21.2m a year earlier. These are non-GAAP measures and are not substitutes for GAAP results.
Q3 revenue rose 13.6%, while freight revenue increased 6.5%. The GAAP operating-income increase and reported margin improvement were heavily affected by the terminal-sale gain. Excluding unusual items under the company’s non-GAAP presentation, adjusted operating ratio was essentially flat year over year. For the first nine months, revenue rose 22.5% and net income more than doubled.
Fuel surcharge revenue was $45.2m in Q3 versus $24.3m a year earlier. Although fuel expense increased to $42.5m from $26.2m, net fuel expense after company fuel-surcharge recovery was $0.1m for Q3, compared with $3.7m. Q3 expense pressures included driver and employee pay, maintenance and parts, and insurance and claims. Insurance and claims expense was $12.9m, up from $11.0m.
Segments and material changes
- Expedited: Q3 revenue was $117.8m versus $85.3m; operating income was $30.7m versus $11.1m. Revenue benefited from higher rates, more tractors and the AAT acquisition. Management said driver-pay, fuel, parts and maintenance inflation pressured adjusted margins.
- Dedicated: Q3 revenue was $93.4m versus $83.5m; operating income was $19.4m versus a $0.7m loss. Higher rates supported revenue, while the company reduced its average tractor count by 8.7% after not renewing underperforming contracts. Management said cost headwinds limited sequential margin improvement.
- Managed Freight: Q3 revenue was $78.4m versus $90.1m and operating income was $8.6m versus $9.3m. Lower overflow freight volumes contributed to the revenue decline; the company expects this source of business to decline further in a softer freight market.
- Warehousing: Q3 revenue rose to $22.2m from $15.7m, while operating income was $0.4m versus $0.4m. New customer start-up costs and leased capacity investments weighed on margins; management expected those costs to decline in Q4.
TEL contributed $7.4m of pre-tax equity-method income in Q3, versus $3.2m, and $21.3m for the first nine months, versus $9.6m. Management attributed the increase to business growth and used-equipment gains, which may fluctuate.
Cash flow, balance sheet and liquidity
- Cash was $59.3m at September 30, 2022, compared with $8.4m at December 31, 2021. Working capital was $52.5m, up from $45.8m.
- Nine-month operating cash flow was $121.1m, versus $68.2m. Investing cash flow was a $49.8m use, including $38.5m net cash for the AAT acquisition and $61.4m of equipment purchases, partly offset by asset-sale proceeds. Financing cash flow was a $20.4m use, including $70.9m of share repurchases and $3.2m of dividends.
- Total debt and lease obligations were approximately $135.0m, compared with $74.3m at year-end 2021. This includes operating leases; management’s separate total-indebtedness measure excludes operating leases and nets cash. That net measure was $32.2m, up $3.8m from year-end, with a reported leverage ratio of 0.23.
- No borrowings were outstanding under the $110m revolving credit facility; $23.9m of letters of credit were outstanding and available borrowing capacity was $86.1m. The company also reported $45m available under a separate Triumph draw facility restricted to potential TFS settlement indemnification.
- Net capital expenditures for the first nine months were $49.8m. Management’s baseline estimate for remaining 2022 fleet net capital expenditures was $10m–$30m, subject to delivery and used-equipment sale assumptions.
Outlook, risks and unusual items
Management expected moderating freight demand, greater driver availability and continued cost inflation for the remainder of 2022. Absent substantial near-term deterioration, it expected full-year total revenue and freight revenue to exceed $1bn. It expected Q4 margin to worsen on a reported basis because Q3 included the terminal gain, but adjusted Q4 margin to be similar to Q3 adjusted margin. For 2023, management anticipated a difficult freight environment and inflationary pressure on margins; it cited execution and a more resilient operating model as intended mitigants. No specific 2023 financial guidance was provided.
- Terminal sale: Sale of a California terminal generated a $38.5m gain in Q3, a significant unusual item affecting GAAP earnings and margins.
- AAT acquisition: Acquisition-date consideration was approximately $54.7m, including contingent consideration. Potential earnout payments are up to $20m; the contingent-consideration liability was $17.0m at September 30 and remains subject to valuation changes.
- TFS settlement: A $4.4m contingent liability remained at September 30 after a $0.7m reversal in Q3. Further indemnification obligations could affect cash flow, liquidity and debt.
- Insurance and claims: Management noted volatility in claims costs, erosion of certain historical insurance limits and a less available insurance market. It also reported the lowest Q3 DOT accident rate on record, 11% below Q3 2021.
- Litigation: A California driver wage-and-hour class action remained pending; the company said it could not reasonably estimate potential loss and had recorded no related accrual. Other cited class actions were dismissed in 2022.
- Capital returns: The company repurchased $70.9m of shares during the first nine months and paid $3.2m in dividends. It repurchased an additional 0.4m shares for $13.8m through November 2, 2022.
Management stated that it expected adequate liquidity and debt-covenant compliance for the next 12 months, and did not expect a fixed-charge covenant test in the foreseeable future based on facility availability. The filing cautions that results are seasonal and interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Reconcile Q3 GAAP earnings and operating ratio with adjusted results, particularly the terminal-sale gain and the company’s non-GAAP adjustments.
- Track freight demand, rates, overflow volumes and segment margins against management’s Q4 and 2023 commentary.
- Monitor labor, maintenance, insurance and claims costs, and the extent to which fuel surcharges recover fuel costs.
- Review AAT earnout valuation and performance, and the remaining TFS indemnification exposure.
- Assess equipment spending, lease-versus-purchase financing, share repurchases and liquidity alongside the increase in debt and lease obligations.
- Follow the pending California wage-and-hour claim and potential development of insurance claims against available coverage.