Covenant Logistics Group, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods. The company changed its name from Covenant Transportation Group, Inc. on July 1, 2020. Dollar amounts below are in millions unless noted.
Business context and results
The company provides expedited and over-the-road trucking, dedicated transportation, and managed freight services. Its Factoring segment was presented as discontinued operations and substantially all of TFS’s operations and assets were sold on July 8, 2020, after quarter-end.
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $191.7 | $217.0 | $402.5 | $434.4 |
| Freight revenue, excluding fuel surcharge | $179.6 | $192.7 | $369.1 | $386.6 |
| Operating income (loss) | $(29.0) | $7.0 | $(30.4) | $11.0 |
| Net income (loss) | $(22.3) | $6.1 | $(24.6) | $10.5 |
| Net income (loss) per share | $(1.31) | $0.33 | $(1.40) | $0.57 |
| GAAP operating ratio | 115.1% | 96.8% | 107.6% | 97.5% |
| Adjusted operating ratio (non-GAAP) | 99.5% | 96.0% | 99.9% | 96.8% |
Q2 revenue declined 11.7%, including a 6.8% decrease in freight revenue; lower fuel surcharges contributed to the decline. The operating loss included a $26.6 million impairment charge and was partly offset by gains on asset dispositions. Adjusted operating income was $0.9 million in Q2 versus $7.8 million a year earlier. Adjusted operating ratio is a company-defined non-GAAP measure.
- Segments: Q2 Highway Services revenue was $79.8 million and operating loss was $12.8 million; Dedicated revenue was $65.9 million and operating loss was $13.2 million; Managed Freight revenue was $46.0 million and operating loss was $2.9 million. Managed Freight revenue grew from $41.6 million, but the segment moved from operating income of $1.8 million to a loss.
- Discontinued operations: Factoring generated Q2 revenue of $2.5 million and net income of $0.8 million, versus $2.3 million and $0.8 million, respectively, in Q2 2019.
Cash flow, debt, and liquidity
- Six-month operating cash flow was $24.1 million, compared with $23.6 million in 2019. Investing activities provided $4.1 million, versus $65.3 million used in 2019; financing activities used $4.6 million, versus $47.4 million provided.
- Cash was $67.1 million at June 30, 2020, up from $43.6 million at December 31, 2019. Working capital was $180.2 million, compared with $93.1 million; this includes assets and liabilities associated with discontinued operations and assets held for sale.
- Total debt was $270.1 million, comprising $53.5 million current and $216.6 million long-term debt. Debt and lease obligations together were $351.5 million. The company reported $284.3 million of total indebtedness, net of cash, and said this was down $20.2 million since year-end.
- There were no revolver borrowings, $36.7 million of undrawn letters of credit, and $58.3 million of available borrowing capacity under the $95 million credit facility. The facility matures in September 2021.
- In April, the company elected 90 days of interest-only payments, extending the due dates of $177.3 million of equipment debt by three months. It also obtained a Q2 waiver for a financial covenant breach on a real-estate note; management expected compliance with debt covenants over the next 12 months.
- Six-month net capital expenditures were a $4.9 million source of cash, versus $33.5 million of expenditures in 2019. The company repurchased 1.4 million shares for $17.5 million in Q1 and suspended the program on March 26, leaving about $2.5 million authorized but unused.
Material changes, outlook, and risks
- Management undertook a broad restructuring: reducing tractors and refrigerated trailers, shifting capacity toward selected expedited, dedicated, and irregular-route services, closing or exiting facilities, reducing headcount, simplifying systems, and phasing out the Landair brand. Management said most actions were completed in Q2 but expected additional costs in Q3 and Q4.
- Q2 unusual items included $26.6 million of long-lived asset impairments, a $5.7 million gain on sale of a terminal, $1.8 million of employee separation costs, and a $2.6 million increase in bad-debt allowance. A change in useful-life estimates increased Q2 depreciation and amortization by about $3.2 million and net loss by about $2.2 million, or $0.13 per share.
- For the balance of 2020, stated priorities were to optimize fleet size, sell assets held for sale and reduce debt, shift capacity toward targeted services, lower fixed costs, and restore Managed Freight margins to pre-COVID levels. Management expected an average fleet of roughly 2,550–2,650 tractors for the remainder of 2020. No earnings or revenue guidance was provided.
- COVID-19 affected demand, including from automotive, airline, and certain retail customers; management said future effects remained uncertain. It cited a customer bankruptcy and elevated retail-customer credit risk in raising its bad-debt allowance.
- Insurance and claims expense rose to $11.6 million in Q2 from $10.5 million and to $27.2 million for the half-year from $21.7 million. The company estimated that a $9 million excess-insurance layer was fully eroded and warned of possible additional claims accruals and policy reinstatement charges. Renewed coverage also had higher premiums, greater self-insured retention, and lower aggregate limits.
- The TFS purchaser disputed the sale, asserting that approximately $66 million of acquired assets involved advances against future services that were not contemplated by the purchase agreement. The company said the outcome, potential liability, cash impact, leverage effect, and final gain or loss were not yet determinable; the previously estimated transaction gain was $26.5 million.
- Disclosure controls were deemed ineffective because of a material weakness in TFS credit approvals and monitoring. The company said it identified no resulting financial-statement misstatement and believed the weakness was isolated to TFS, whose assets were subsequently sold.
- Other legal exposures include a putative California wage-and-hour class action, a related penalty action, and a putative antitrust/no-poaching class action. The company had not recorded accruals for these matters because it could not reasonably estimate potential losses.
Investor verification priorities
- Track resolution of the TFS purchaser dispute, including any repayment, earnout, litigation, leverage, or transaction-gain consequences.
- Verify whether restructuring produces lasting margin improvement and whether the targeted fleet reductions and asset sales occur as planned.
- Monitor insurance-claim development, erosion of coverage limits, renewal terms, and resulting expense or cash requirements.
- Review liquidity and covenant compliance, including the September 2021 revolver maturity and the covenant waiver on the real-estate note.
- Follow remediation or elimination of the TFS-related control weakness and developments in the disclosed class-action litigation.