Covenant Transportation Group, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing reports full-year results and unaudited quarterly results, including Q4. The registrant is identified in the filing as Covenant Transportation Group, Inc.
Business context
The company provides truckload transportation and managed freight services, including expedited, dedicated, temperature-controlled, brokerage, warehousing, and transportation management. On July 3, 2018, it acquired Landair for approximately $106.7 million in cash, including repayment of Landair debt. Landair contributed $85.1 million of revenue and $7.4 million of net income after acquisition.
Key financial results
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Total revenue | $885.5 million | $705.0 million |
| Freight revenue, excluding fuel surcharges | $779.7 million | $626.8 million |
| Operating income | $59.0 million | $28.2 million |
| Operating ratio | 93.3% | 96.0% |
| Adjusted operating ratio | 92.2% | 95.5% |
| Net income | $42.5 million | $55.4 million |
| Diluted earnings per share | $2.30 | $3.02 |
| Operating cash flow | $124.8 million | $82.9 million |
Revenue grew 25.6% and freight revenue grew 24.4%; operating income more than doubled. Net income and diluted EPS declined because 2017 included a one-time $40.1 million tax benefit related primarily to the Tax Act. Management described 2018 as the company’s highest annual earnings in its history excluding that 2017 tax benefit.
Q4 2018 revenue was $272.3 million, operating income was $22.3 million, net income was $16.5 million, and diluted EPS was $0.89. Q4 2017 included a $40.1 million Tax Act benefit and reported net income of $49.3 million.
Truckload segment revenue was $727.0 million and operating income $45.4 million; Managed Freight revenue was $158.4 million and operating income $13.6 million. TEL, the company’s 49%-owned investment, contributed $7.7 million of pre-tax earnings, versus $3.4 million in 2017.
Liquidity, debt, and capital
- Cash and cash equivalents were $23.1 million at year-end. Working capital was $84.3 million, compared with $81.1 million a year earlier.
- Credit Facility borrowings were $3.9 million; undrawn letters of credit were $36.3 million and available borrowing capacity was $54.8 million.
- Total debt and capital lease obligations were approximately $235.8 million, including current maturities. Management reported aggregate lease-adjusted indebtedness, net of cash, of $255.7 million.
- Cash used in investing activities was $120.9 million, including $105.9 million for the Landair acquisition, net of cash acquired. Financing activities provided $3.9 million.
- Revenue equipment purchase commitments totaled approximately $156.3 million, primarily for 2019. Management anticipated paying down approximately $40–$60 million of financing and lease liabilities in 2019, absent strategic investments.
Material changes and management outlook
- Landair expanded both Truckload and Managed Freight and increased average tractor count. Its shorter-haul, dedicated operations raised revenue per mile but contributed to lower average miles per tractor. The company planned to integrate Landair into its systems over the following two years.
- Average freight revenue per total mile rose 13.9% year over year, while average miles per tractor fell 6.1%. Average freight revenue per tractor per week increased 7.0%.
- Insurance and claims expense increased 30.7% to $43.3 million; the company cited a 15.0% increase in DOT-reportable accidents per million miles and higher insurance cost per mile. Driver wages, healthcare costs, and other expenses also rose.
- Fuel expense increased with higher diesel prices, but improved surcharge recovery and fuel-hedging gains helped reduce net fuel expense to $28.2 million from $32.9 million. No fuel hedge contracts remained at year-end.
- Management expected a relatively balanced 2019 freight market, with intra-period volatility; modest full-year adjusted EPS growth over 2018; and lower combined on- and off-balance-sheet debt. It expected a first-quarter earnings improvement versus Q1 2018 and mid-single-digit percentage increases in Truckload revenue per total mile, while noting January conditions were weaker than January 2018.
- Management planned to grow dedicated, warehousing, TMS, and brokerage offerings, partly reallocating capital away from less-profitable solo refrigerated OTR operations. Brokerage growth investment could pressure Managed Freight margins in the near term.
Risks, contingencies, and unusual items
- Material weakness in financial controls: IT change-management controls supporting financial reporting were ineffective. Management and the auditor concluded internal control over financial reporting was ineffective at December 31, 2018; KPMG issued an adverse controls opinion. The financial statement audit opinion was unqualified, and the company reported no identified financial statement misstatements. Landair was excluded from the controls assessment. Management targeted remediation before the end of 2019.
- Insurance and claims exposure: The company self-insures significant portions of claims and noted the potential for reserve changes, severe claims, or losses exceeding insurance limits.
- Driver and regulatory risks: Recruiting and retention remain challenging; wage inflation, hours-of-service and ELD requirements, safety ratings, and possible reclassification of independent contractors could affect capacity and costs. Some subsidiaries exceeded intervention thresholds in certain CSA safety categories, although all operating subsidiaries retained satisfactory DOT safety ratings.
- Customer and operating concentration: Walmart represented $112.4 million of 2018 revenue, and the top five customers accounted for approximately 34%. The company generally has no guaranteed minimum customer volumes.
- Litigation: A former driver filed a proposed California wage-and-hour class action and sought PAGA penalties. Management said pending litigation, considering reserves, was not expected to materially adversely affect consolidated financial statements; the outcome remains uncertain.
- Tax and accounting items: The 2017 Tax Act benefit makes year-over-year net income comparisons less representative of operating performance. The company adopted revenue recognition guidance in 2018, recording a $0.6 million after-tax cumulative adjustment to retained earnings. It expected the 2019 lease-accounting adoption to add approximately $43 million to assets and liabilities, without a material net-income impact.
- Other principal exposures include used-equipment values, fuel prices and incomplete surcharge recovery, acquisition integration, self-insured claims, interest rates, and compliance with environmental and transportation rules.
Important facts for investors to verify
- Whether Landair integration delivers expected earnings, operating efficiencies, and cross-selling benefits, and whether its purchase-price allocation is finalized.
- Progress and testing of the IT controls remediation plan, including whether the material weakness is resolved on schedule and controls over Landair are established.
- Whether 2019 adjusted EPS and debt-reduction expectations are achieved as freight rates, utilization, driver costs, and brokerage investment evolve.
- Claims development and insurance costs, including the consequences of higher accident frequency and any decision to commute auto-liability policies.
- Customer retention and concentration, particularly Walmart, alongside driver availability and the impact of regulatory or legal changes on the workforce.