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May 2, 2017 5:00 PM, EDT

Celadon's Financial Statements Called Into Question

Alan Petersime/Bloomberg News

Auditors at BKD have withdrawn their support of Celadon Group Inc.’s financial statements for the last three fiscal quarters because the trucking company didn’t produce sufficient documents on the value of used trucks, according to a letter in a filing with the Securities and Exchange Commission.

An internal audit committee wanted accountants to take a second look at the market value of trucks transferred from Celadon to 19th Capital Group, a joint venture between the truckload carrier and Element Fleet Management.

On the balance sheet, Celadon records used trucks as “revenue equipment held for sale,” then transfers the trucks to 19th Capital Group and records it as an “investment in unconsolidated companies.” Based on accounting standards, a company must record the lower of the depreciated value or market value for the used truck, a concept known as the “lower of cost or market” rule.

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“The joint venture represents the combination of the former equipment leasing portfolios of Celadon, Element, and 19th Capital that were managed by [subsidiary Quality Cos.]. The joint venture holds over 10,000 tractors for use in leasing operations, with a business plan focused on leasing to trucking fleets,” Celadon said when it announced the joint venture.

Prescience Point Research Group alleges that Celadon drastically overvalued the used trucks on the balance sheet to artificially inflate its book value. The group further alleges that Celadon and 19th Capital are in dire financial shape and that the truckload carrier will default on its debt and the banks will recall the loans. However, Prescience Point Research Group is short selling Celadon stock and has a financial motive to drive down the stock price of the company.

Nevertheless, BKD expressed a difference of opinion with management regarding the fair value of the used trucks. Celadon valued the equipment in question and held for sale at $45 million and $29 million in recent quarters. However, the two numbers only represent between 3% and 4% of the carrier’s overall assets, far less than the Prescience Point Research Group questioned in its report.

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BKD wrote that it was “unable to obtain sufficient appropriate audit evidence” and thus the June 30, Sept. 30 and Dec. 31, 2016 financial reports “should no longer be relied upon.”

“We should assume that BKD applied a reasonable level of diligence not once, but three times in its previous audit opinions, and that valuing trucks available for sale should be a fairly straightforward exercise, given age, model of vehicle, and miles driven,” wrote Aegis Capital Corp. analyst Jeffrey Kauffman in a note to investors, “This could be code for ‘get a 3rd party view of our bookkeeping’, addressing public questions of its accounting for its recent divestiture of its sales and leasing assets.”

Bank of America doesn’t seem to be too concerned about the issue because it just signed a term sheet with Celadon on a new $225 million credit line and agreed to waive defaults on its existing debt.

“While we are encouraged by the potential new credit agreement, the operating miss and the withdrawal of the auditor's report creates much uncertainty, and begs the question: If this is a sign of potentially deeper issues or is limited to a one-off situation? At this point, management has a lot to explain and potentially a long road ahead to restore credibility, in our view,” said Seaport Global Securities analyst Rhem Wood.

The Indianapolis carrier, which ranks No. 32 on the Transport Topics Top 100 list of the largest U.S. and Canadian for-hire carriers, will hold a call on May 3 to discuss the situation.

Meanwhile, the company also reported that it will have a $10 million operating loss when it reports quarterly earnings before May 10 due primarily to its irregular route business. Before the announcement, the Bloomberg News consensus forecast was a loss of $1.2 million in the first three months of 2017, or 2 cents per share.

Celadon also promoted Jon Russell to chief operating officer, overseeing trucking operations, and Douglas Schmidt to president, running the truckload division.