Knight-Swift Transportation Holdings Inc. quarterly report, Q1 FY2017

Business context and reporting period

Swift Transportation Company’s unaudited Form 10-Q covers the quarter ended March 31, 2017, compared with the quarter ended March 31, 2016. Swift operated Truckload, Dedicated, Refrigerated and Intermodal segments, plus non-reportable logistics and support businesses. The Dedicated and Refrigerated segment presentation was reorganized, and prior-period segment figures were recast.

After quarter-end, Swift announced an all-stock merger with Knight Transportation, expected to close in the third quarter of 2017, subject to shareholder and regulatory approvals. Knight was expected to be the accounting acquirer. Swift holders were to receive 0.72 shares of the combined company for each Swift share; Swift and Knight holders were expected to own approximately 54% and 46%, respectively.

Key financial results

Amounts below are in U.S. dollars; financial statement figures are rounded to millions.

Fuel surcharge revenue rose to $92.7m from $60.9m as fuel prices increased; higher surcharges largely offset the effect of lower revenue excluding fuel surcharges on reported revenue. The average DOE diesel index was $2.57 per gallon versus $2.08.

Segment results

• Truckload: Revenue fell 2.2% to $481.5m; operating income fell to $15.9m from $36.3m. Adjusted operating ratio worsened to 96.3% from 92.0%, amid weaker pricing and volumes.
• Dedicated: Revenue rose 5.5% to $150.8m, but operating income declined to $11.6m from $18.7m. Adjusted operating ratio worsened to 91.5% from 86.0%.
• Refrigerated: Revenue rose 4.6% to $177.5m, but the segment recorded a $6.3m operating loss versus $4.8m income. Results included an $11.7m increase in legal accruals.
• Intermodal: Revenue increased 4.5% to $86.2m; operating loss narrowed to $0.1m from $2.9m.

Financial position, debt and liquidity

• Cash and cash equivalents were $61.8m at March 31, 2017, down from $89.4m at year-end. Restricted cash was $54.9m and restricted investments were $22.9m.
• Working capital surplus was $185.9m, versus $246.0m at December 31, 2016. Total unrestricted liquidity was $565.3m, including $494.8m available under the revolver and $8.7m available under the receivables securitization facility.
• Material debt and capital lease obligations were approximately $1.0bn: $470.5m Term Loan A, $304.4m receivables securitization, $211.5m capital leases, $10.0m revolver borrowings and $6.4m other debt. The revolver had $600m capacity and $95.2m of letters of credit outstanding.
• Operating cash flow was $118.9m; investing activities used $5.2m and financing activities used $141.4m. Financing outflows included $120.0m of net revolver repayments and $47.4m of long-term debt and capital lease repayments.

Changes, outlook and risks

• Management attributed weaker earnings principally to a $35.8m reduction in Revenue xFSR, higher fuel and operating costs, and the $11.7m Refrigerated litigation accrual. Merger transaction costs were $2.2m. Higher fuel surcharge revenue partially offset the revenue decline.
• Management described freight demand and pricing as challenging, with industry capacity exceeding demand. The company had reduced its core truckload fleet, emphasized utilization and cost controls, and selectively increased spot-market activity. Management noted some strengthening in Dedicated bids and Refrigerated pricing and new Intermodal business awards.
• Management expected the remaining 2017 quarterly GAAP effective tax rate to be 36% before discrete items. It expected net cash capital expenditures for the remainder of 2017 to exceed Q1 spending, while stating that expected cash flow and available financing should cover planned capital expenditures for at least the next twelve months. No broader earnings or revenue guidance was provided in the filing.
• Capital expenditure commitments included $277.0m for revenue equipment for the rest of 2017, of which $195.4m was for tractors; some tractor orders were no longer cancellable. Additional facility and non-revenue equipment commitments totaled $23.4m across the remainder of 2017 and 2018–2019.
• A tentative settlement in a Refrigerated owner-operator classification matter was finalized after quarter-end, subject to court approval; Swift increased its Q1 legal accrual. The filing reported $36.7m of aggregate accruals for the owner-operator matters discussed, and said outcomes of several other claims could not be determined. Actual outcomes could affect results or liquidity in a particular period.
• The merger carried completion, integration, disruption, litigation, financing and synergy risks. Specified termination circumstances could trigger an $89.1m fee payable by Swift or a $75.3m fee payable by Knight; failure to obtain shareholder approval could also require reimbursement of transaction expenses up to $10.0m.
• Other noted exposures included fuel-price and surcharge timing risk, variable-rate debt (a one-percentage-point rate increase was estimated to raise annual interest expense by $7.9m), severe weather and insurance claims, driver recruitment and retention, owner-operator classification, regulation, and substantial ongoing fleet investment needs.

Swift adopted ASU 2016-09 on share-based compensation, including recognizing excess tax benefits or deficiencies in income tax expense. The filing said the impact of upcoming revenue-recognition guidance remained under evaluation and was not yet quantified; the new lease standard was expected to be material but not yet quantifiable.

Important facts for investors to verify

1. Whether the Knight merger received required approvals and closed on the anticipated terms and timetable, and how merger costs and integration affect results.
2. Whether the Refrigerated litigation settlement obtained final court approval and whether the recorded accrual adequately reflects ultimate exposure.
3. Whether operating performance improves from Q1 levels, particularly Truckload pricing and volumes, Refrigerated profitability, and segment operating ratios.
4. Whether cash generation, fleet investment commitments and debt service remain compatible with liquidity and debt covenant requirements.
5. How fuel prices, claims experience, driver availability and adoption of new accounting standards affect future reported results.