Covenant Logistics Group, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; unaudited. Amounts below are in millions of dollars except per-share data and where noted. The company operates Expedited, Dedicated, Managed Freight, and Warehousing businesses.
Financial performance
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Total revenue | $266.9 | $291.6 | Down 8.5% |
| Freight revenue, excluding fuel surcharges | $233.4 | $257.6 | Down 9.4% |
| Operating income | $17.6 | $23.8 | Down 26.1% |
| Net income | $16.6 | $22.2 | Down 25.0% |
| Diluted EPS | $1.20 | $1.32 | Down 9.1% |
| Operating ratio (GAAP) | 93.4% | 91.8% | Higher by 1.6 percentage points |
| Adjusted operating ratio (non-GAAP) | 94.6% | 90.5% | Higher by 4.1 percentage points |
| Adjusted operating income (non-GAAP) | $12.6 | $24.4 | Down |
Operating margin was approximately 6.6%, versus 8.2% a year earlier. The adjusted operating ratio excludes fuel surcharges, intangible amortization, and specified unusual items; it is a supplemental non-GAAP measure, not a substitute for GAAP results.
Cash flow: Operating cash flow was $7.2, down from $39.4. Investing activities provided $7.1, compared with $45.0 used in Q1 2022. Financing activities used $28.4, versus $4.3 provided. Cash declined to $54.6 from $68.7 at December 31, 2022. The filing attributes weaker operating cash flow chiefly to higher receivable days, lower net income, and lower noncash adjustments.
Liquidity and debt: Working capital was $65.9, compared with $66.5 at year-end. Debt and lease obligations totaled $172.8, including $117.2 of debt and $55.7 of lease obligations; cash was $54.6. Net indebtedness, defined by the company as debt and finance leases less cash, was $32.2, up $3.8 since year-end. There were no borrowings under the $110 million revolving facility or the separate $45 million TFS-related Draw Note; revolver availability was $86.1 after $23.9 of letters of credit. The company reported a 0.40 leverage ratio at quarter-end and expected no fixed-charge covenant testing in the foreseeable future based on availability.
Margins and cost drivers: Insurance and claims expense rose to $12.7 from $9.2, or 5.4% of freight revenue versus 3.6%; claims cost per mile increased to 20.5 cents from 14.1 cents. Salaries and related expenses rose to $99.2 and 42.5% of freight revenue, from 37.0%. Purchased transportation and equipment rentals fell to $63.0 from $83.7 as the freight market softened. A $9.8 net gain on property and equipment dispositions included a $7.6 gain on sale of a Tennessee terminal.
Material changes and segment results
- Expedited: Revenue increased to $100.9 from $98.8; operating income was nearly flat at $9.3 versus $9.3. Modestly higher revenue per tractor was offset by lower average rate per total mile and increased costs.
- Dedicated: Revenue declined to $80.2 from $88.9, while operating income improved to $7.1 from $2.6. The company operated about 14% fewer average tractors after exiting underperforming contracts; average rate per total mile increased 5.6%.
- Managed Freight: Revenue fell to $60.9 from $86.2 and operating income to $1.2 from $10.8, mainly reflecting less overflow freight, weaker brokerage volumes and rates, and little project-related freight.
- Warehousing: Revenue grew to $24.8 from $17.7, but the segment recorded a $0.01 operating loss versus $1.0 of income. New customer startups and capacity investments supported growth, while cost and inflation pressures weighed on margins.
The 49%-owned TEL equity-method investment contributed $5.9 of pretax income, down from $6.8, primarily because of lower gains on equipment sales. Share repurchases totaled $20.8 in Q1; dividends paid were $1.5, or $0.11 per share. Weighted-average diluted shares fell to 13.9 million from 16.8 million.
Outlook, risks, and unusual items
- Management expects a softer freight market and continued inflationary pressures for the rest of 2023. It emphasized cost savings while continuing investment in equipment, people, and technology, and expects less earnings volatility than in prior periods of economic weakness. No specific full-year earnings or revenue guidance was provided.
- The company’s baseline net capital expenditure expectation for the balance of 2023 is $60–$70 million. Its stated 2023 fleet plan included 763 additional replacement tractors and 536 trailers.
- On April 26, 2023, after quarter-end, the company acquired Lew Thompson & Son for approximately $100 million of closing enterprise value, plus a potential earnout of up to $30 million. The closing price was funded with about $45 million cash and $55 million of revolver borrowings. The company reported a pro forma leverage ratio of approximately 1.2 after the acquisition.
- Q1 included a $7.6 million terminal-sale gain. AAT contingent consideration was paid in part during the quarter: the company paid $10.0 million based on first-year results and reported an $8.5 million remaining fair-value liability at March 31. Discontinued operations contributed $0.15 million net income from a reversal of a TFS-related contingent loss liability.
- Insurance and claims remain a notable risk: a prior $9 million excess insurance layer was fully eroded, and adverse development on claims from that policy period could require additional expense accruals. Management also cited claims volatility, inflation in wages and parts, freight-market weakness, and potential equipment supply and pricing pressures.
- A California wage-and-hour case remains pending on the individual plaintiff’s claims after class claims were dismissed by stipulated agreement in April 2023; the company intends to defend the matter. Credit-facility covenants restrict, among other things, debt and dividends. Management said it expects to comply with debt covenants for the next 12 months.
- Management reported disclosure controls and procedures were effective as of March 31, 2023, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the freight-market downturn and reduced Managed Freight overflow volumes persist, and whether that segment’s profitability recovers.
- Whether elevated insurance and claims costs continue, including potential adverse development on the fully eroded policy layer.
- Lew Thompson & Son’s integration, realized performance, potential earnout, and effect on leverage, interest expense, and liquidity.
- Cash conversion and working-capital trends, given the sharp year-over-year decline in operating cash flow.
- Execution of the 2023 fleet replacement and $60–$70 million net capital expenditure plan amid equipment availability, pricing, and used-asset-value uncertainty.
- Continued TEL earnings contribution and variability in its equipment-sale gains; remaining AAT contingent consideration and TFS indemnification exposure.