Covenant Transportation Group, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Financial statements are unaudited; amounts below are in U.S. dollars and rounded to millions unless stated otherwise.
Business context and period
The company provides asset-based truckload transportation, alongside brokerage, factoring and other services. Management described a competitive market for qualified drivers, soft freight demand and falling fuel prices. The filing cautions that quarterly results are seasonal and may not indicate full-year results.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $173.5m | $177.6m | $516.2m | $512.2m |
| Freight revenue, excluding fuel surcharge | $153.5m | $141.9m | $449.0m | $405.8m |
| Operating income | $14.6m | $5.6m | $43.4m | $15.0m |
| Net income | $7.6m | $1.9m | $28.9m | $4.3m |
| Diluted earnings per share | $0.42 | $0.12 | $1.57 | $0.28 |
| Operating ratio | 90.5% | 96.1% | Not clearly stated | Not clearly stated |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $78.6m | $48.6m |
- Q3 fuel surcharge revenue fell to $20.0m from $35.7m as fuel prices declined. Freight revenue rose 8.2%, but total revenue declined 2.3%.
- Q3 Truckload operating income was $16.0m versus $10.9m; Other-segment income was $0.9m versus $0.5m. Nine-month Truckload operating income increased to $46.8m from $23.4m.
- Net fuel expense rose 27.6% in Q3 to $12.5m, despite lower fuel prices, reflecting weaker surcharge recovery and hedging losses. Fuel expense included $4.2m of losses reclassified from hedges during Q3 and $10.7m for the nine-month period.
- Cash and cash equivalents were $14.0m at September 30, 2015, versus $21.3m at December 31, 2014. Working capital was $13.7m, down from $52.7m.
- Operating cash flow of $78.6m was more than offset by $114.5m of investing outflows, including $145.6m of property and equipment acquisitions and $31.1m of disposition proceeds. Cash declined $7.3m over the nine months.
- Balance-sheet debt was $221.4m, with $15.0m of capital lease obligations; debt and leases totaled $236.4m. The company reported $244.0m of total indebtedness net of cash and including the present value of off-balance-sheet leases.
- The $95m revolving facility had no borrowings outstanding, $33.4m of undrawn letters of credit and $61.6m of available capacity at quarter-end. The company said liquidity should be adequate for at least 12 months.
Material changes versus the prior comparable period
- Profitability improved substantially: Q3 operating income rose to $14.6m from $5.6m, and net income to $7.6m from $1.9m. The 2014 quarter included a $7.5m reserve increase related to a cargo claim; management cited an approximately $4.6m after-tax impact, or $0.30 per share.
- Q3 freight revenue grew 8.2%, supported by a 3.0% increase in average rate per total mile and a 5.2% increase in average tractor fleet. Average miles per unit fell 2.5%, which management attributed to a weaker freight environment.
- Operating ratio improved to 90.5% from 96.1%. Management separately cited a 320-basis-point improvement in the Truckload segment’s operating ratio after excluding the 2014 cargo expense and a $3.1m year-over-year increase in fuel-hedging losses.
- Nine-month total revenue increased only 0.8%, while freight revenue increased 10.7%; lower fuel surcharge revenue largely offset freight growth.
- Depreciation and amortization increased to $14.7m in Q3 from $10.1m, and to $43.4m for nine months from $34.5m, reflecting increased ownership and additions of equipment.
Outlook, risks and unusual items
- Management expected a “solid” fourth quarter. Major peak-season customers had contracted for more committed capacity than in 2014 but at lower average contractual rates. Contract work was expected to be profitable, while less fleet capacity would remain for spot-market freight; management said spot opportunities might be less profitable than the prior year.
- Management reported October utilization below the prior year and noted that fourth-quarter results would depend on peak-season volumes, routes, pricing and customer mix. It expected driver pay, health costs and other wage-related expenses to rise amid a tight driver market.
- Fuel hedges covered 22.5% of projected remaining 2015 fuel needs, 21.9% of 2016 needs, 19.2% of 2017 needs and 8.2% of 2018 needs. Management expected approximately $8.9m, net of tax, of fuel-hedge losses to be reclassified into earnings over the next 12 months; lower market fuel prices could continue to weigh on results.
- In August, the company purchased its Chattanooga headquarters and related property for approximately $35.5m, partly financed by a $28m note. An interest-rate swap effectively fixes the rate at 4.2% through 2035. Management compared this with an 8.2% implied rate on the former lease, while noting the purchase price exceeded the $17.1m present value of remaining lease payments.
- An August amendment to the credit facility improved pricing and unused-line fees, added certain subsidiaries as guarantors and extended facility maturity from September 2017 to September 2018. Debt and hedges include cross-default provisions; the facility also restricts matters including debt, dividends and acquisitions.
- The company recorded a $3.6m insurance and claims expense reduction in Q2 following commutation of two liability policies; it also became responsible for claims from the covered prior period up to $20m per claim. Management expected favorable premium pricing under a new three-year auto-liability policy.
- A new wage-and-hour class action was filed during Q3, alleging meal/rest-break and wage violations. Separately, after quarter-end, on November 5, 2015, the Sixth Circuit reversed part of a district-court ruling concerning a 2008 cargo claim and remanded another claim for further factual findings. Management believed pending matters, considering reserves, were not likely to have a material adverse effect.
- The company recognized $3.7m of equity-method income from its 49% investment in Transport Enterprise Leasing, Inc. (TEL) for the nine months and held an option to acquire the remaining interest through May 31, 2016.
Important facts for investors to verify
- Whether freight demand, utilization, committed peak-season volume and lower contractual pricing developed as management anticipated.
- The earnings and cash-flow effects of fuel hedges, including the timing and amount of expected loss reclassifications and the degree of fuel-surcharge recovery.
- Equipment spending, used-tractor resale values, depreciation and the company’s shift from operating leases toward purchases and capital leases.
- Available borrowing capacity, debt and lease obligations, covenant compliance, and any cross-default implications.
- Developments in the wage-and-hour class action, the remanded cargo litigation, and the company’s self-insured claims exposure.
- The assumptions underlying deferred tax assets and reserves for uncertain tax positions; the filing reports a $1.6m increase in uncertain-tax-position liabilities since year-end.