SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549-1004 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-24960 Covenant Transport, Inc. (Exact name of registrant as specified in its charter) Nevada 88-0320154 (State or other jurisdiction of (I.R.S. employer identification number) incorporation or organization) 400 Birmingham Hwy. Chattanooga, TN 37419 (423) 821-1212 (Address, including zip code, and telephone number, including area code, of registrant's principal executive office) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. YES X NO __ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date (March 31, 1999). Class A Common Stock, $.01 par value: 12,561,550 shares Class B Common Stock, $.01 par value: 2,350,000 shares Exhibit Index is on Page 13 1
PART I FINANCIAL INFORMATION PAGE NUMBER Item 1. Financial statements Condensed Consolidated Balance Sheets as of December 31, 1998 3 and March 31, 1999 (Unaudited) Condensed Consolidated Statements of Income for the three 4 months ended March 31, 1998 and 1999 (Unaudited) Condensed Consolidated Statements of Cash Flows for the three 5 months ended March 31, 1998 and 1999 (Unaudited) Notes to Condensed Consolidated Financial Statements (Unaudited) 6 Item 2. Management's Discussion and Analysis of Financial Condition 8 and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 12 PART II OTHER INFORMATION PAGE NUMBER Item 1. Legal Proceedings 13 Items 2, 3, 4, and 5. Not applicable 13 Item 6. Exhibits and reports on Form 8-K 13 2
<TABLE> <CAPTION> COVENANT TRANSPORT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands except share data) December 31, March 31, 1998 1999 ----------------- ------------------ ASSETS (unaudited) <S> <C> <C> Current assets: Cash and cash equivalents $ 2,926 $ 794 Accounts receivable, net of allowance of $1,065 in 1998 and $1,218 in 1999 51,789 50,557 Drivers' advances and other receivables 2,476 3,492 Tire and parts inventory 1,929 2,126 Prepaid expenses 5,325 6,861 Deferred income taxes 1,674 2,034 ----------------- ------------------ Total current assets 66,119 65,864 Property and equipment, at cost 282,358 281,222 Less accumulated depreciation and amortization 81,821 80,280 ----------------- ------------------ Net property and equipment 200,537 200,942 Other 6,303 6,284 ----------------- ------------------ Total assets $ 272,959 $ 273,090 ================= ================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt 1,943 1,747 Accounts payable 3,485 9,116 Accrued expenses 12,914 14,560 Accrued income tax 1,404 2,306 ----------------- ------------------ Total current liabilities 19,746 27,729 Long-term debt, less current maturities 84,331 72,895 Deferred income taxes 27,359 27,675 ----------------- ------------------ Total liabilities 131,437 128,299 Stockholders' equity: Class A common stock, $.01 par value; 20,000,000 shares authorized; 12,560,250 and 12,561,550 shares issued and outstanding as of 1998 and 126 126 1999, respectively Class B common stock, $.01 par value; 5,000,000 shares authorized; 2,350,000 shares issued and outstanding as of 1998 and 1999 24 24 Additional paid-in-capital 78,261 78,280 Retained earnings 63,112 66,361 ----------------- ------------------ Total stockholders' equity 141,522 144,791 ================= ================== Total liabilities and stockholders' equity $ 272,959 $ 273,090 ================= ================== </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 3
<TABLE> <CAPTION> COVENANT TRANSPORT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME THREE MONTHS ENDED MARCH 31, 1998 AND 1999 (In thousands except per share data) Three months ended Three months ended March 31, 1998 March 31, 1999 ---------------------- ---------------------- (unaudited) (unaudited) <S> <C> <C> Revenue $ 79,824 $ 97,764 Operating expenses: Salaries, wages, and related expenses 35,242 44,836 Fuel, oil, and road expenses 15,921 17,338 Revenue equipment rentals and purchased transportation 5,002 8,161 Repairs 1,925 1,943 Operating taxes and licenses 2,317 2,407 Insurance 2,424 2,795 General supplies and expenses 4,438 5,582 Depreciation and amortization, including 6,773 7,971 gain on disposition of equipment ---------------------- --------------------- Total operating expenses 74,042 91,033 ---------------------- --------------------- Operating income 5,781 6,731 Interest expense 1,461 1,301 ---------------------- --------------------- Income before income taxes 4,320 5,430 Income tax expense 1,645 2,181 ---------------------- --------------------- Net income $ 2,675 $ 3,249 ====================== ===================== Basic and diluted earnings per share $ .20 $ .22 Weighted average shares outstanding 13,361 14,912 Adjusted weighted average shares and assumed conversions outstanding 13,387 15,040 </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 4
<TABLE> <CAPTION> COVENANT TRANSPORT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1999 (In thousands) Three months ended Three months ended March 31, 1998 March 31, 1999 --------------------- --------------------- (unaudited) (unaudited) <S> <C> <C> Cash flows from operating activities: Net income $ 2,675 $ 3,249 Adjustments to reconcile net income to net cash provided by operating activities: Provision for losses on receivables 15 153 Depreciation and amortization 7,761 8,101 Deferred income tax expense 1,276 (44) Gain on disposition of property and equipment (988) (130) Changes in operating assets and liabilities: Receivables and advances (1,701) (57) Prepaid expenses (3,973) (1,536) Tire and parts inventory (66) (197) Accounts payable and accrued expenses 2,000 8,159 ---------------------- --------------------- Net cash flows provided by operating activities 6,998 17,698 Cash flows from investing activities: Acquisition of property and equipment (29,834) (20,627) Proceeds from disposition of property and equipment 9,895 12,389 ---------------------- --------------------- Net cash flows used in investing activities (19,939) (8,238) Cash flows from financing activities: Exercise of stock option 50 20 Proceeds from issuance of long-term debt 22,000 8,000 Repayments of long-term debt (4,366) (19,612) ---------------------- --------------------- Net cash flows provided by/(used in) financing activities 17,684 (11,592) ---------------------- --------------------- Net change in cash and cash equivalents 4,744 (2,132) Cash and cash equivalents at beginning of period 2,610 2,926 ---------------------- --------------------- Cash and cash equivalents at end of period $ 7,353 $ 794 ====================== ===================== </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 5
COVENANT TRANSPORT, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (In thousands except per share data) Note 1. Basis of Presentation The condensed consolidated financial statements include the accounts of Covenant Transport, Inc., a Nevada holding company, and its wholly-owned subsidiaries (the Company). All significant intercompany balances and transactions have been eliminated in consolidation. The financial statements have been prepared, without audit, in accordance with generally accepted accounting principles, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying financial statements include all adjustments which are necessary for a fair presentation of the results for the interim periods presented, such adjustments being of a normal recurring nature. Certain information and footnote disclosures have been condensed or omitted pursuant to such rules and regulations. The December 31, 1998 Condensed Consolidated Balance Sheet was derived from the audited balance sheet of the Company for the year then ended. It is suggested that these condensed consolidated financial statements and notes thereto be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 1998. Results of operations in interim periods are not necessarily indicative of results to be expected for a full year. Note 2. Basic and Diluted Earnings Per Share The following table sets forth for the periods indicated the calculation of net earnings per share included in the Company's Condensed Consolidated Statements of Income: <TABLE> <CAPTION> Three months ended Three months ended March 31, 1998 March 31,1999 --------------------- --------------------- <S> <C> <C> Numerator: Net Income $ 2,675 $ 3,249 Denominator: Denominator for basic earnings per share - weighted-average shares 13,361 14,912 Effect of dilutive securities: Employee stock options 26 128 ====================== ===================== Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 13,387 15,040 ====================== ===================== Basic earnings per share $ .20 $ .22 ====================== ===================== Diluted earnings per share $ .20 $ .22 ====================== ===================== </TABLE> Note 3. Audit The Internal Revenue Service has completed its audit of the Company's tax return for 1995. The Company was not assessed for any additional tax having received a no change letter for the applicable period. Note 4. Income Taxes Income tax expense varies from the amount computed by applying the federal corporate income tax rate of 37% to income before income taxes primarily due to state income taxes, net of federal income tax effect, which were approximately 2.1% higher in the quarter ended March 31, 1999, as compared with the quarter ended March 31, 1998. 6
Note 5. Recent Accounting Pronouncement In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. The statement established accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. The Company may engage in hedging activities using futures, forward contracts, options, and swaps to hedge the impact of market fluctuations on energy commodity prices and interest rates. The Company is currently assessing the effect, if any, on its financial statements of implementing SFAS No. 133. The Company will be required to adopt the standard in 2000. FORWARD LOOKING STATEMENTS This document contains forward-looking statements in paragraphs that are marked with an asterisk. Statements by the Company in press releases, public filings, and stockholder reports, as well as oral public statements by Company representatives, also may contain certain forward-looking information. Forward-looking information is subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Without limitation, these risks and uncertainties include economic factors such as recessions, downturns in customers' business cycles, surplus inventories, inflation, fuel price increases, and higher interest rates; the resale value of the Company's used revenue equipment; the availability and compensation of qualified drivers; competition from trucking, rail, and intermodal competitors; and the ability to identify acceptable acquisition targets and negotiate, finance, and consummate acquisitions and integrate acquired companies. Readers should review and consider the various disclosures made by the Company in its press releases, stockholder reports, and public filings, as well as the factors explained in greater detail in the Company's annual report on Form 10-K. 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company grew its revenue 22.5%, to $97.8 million in the three months ended March 31, 1999, from $79.8 million during the same period of 1998. The Company's pretax margin increased to 5.6% of revenue from 5.4% of revenue. A significant increase in fleet size to meet customer demand as well as an increase in the freight rates contributed to revenue growth over this period. In addition to internal growth, the Company completed two acquisitions during 1998. In August 1998, the Company acquired certain assets of Gouge Trucking, Inc., a $4 million annual revenue carrier located in North Carolina. In October 1998, the Company purchased all of the outstanding capital stock of Southern Refrigerated Transportation, Inc., ("SRT"), a $23 million annual revenue carrier based in southwest Arkansas. Additionally, the Company formed a new division, Covenant Transport Logistics, in October 1998. The Company intends to continue to grow both internally and through acquisitions, with the main constraint on internal growth being the ability to recruit and retain sufficient numbers of qualified drivers. (*) The Company has increased net income approximately 21.5%, to $3.2 million in the three months ended March 31, 1999, from $2.7 million during the same period of 1998. Several factors contributed to the increase, including declining fuel prices and negotiating higher freight rates from customers. Although higher driver compensation partially offset the increased freight rates, management believes the Company benefited from attracting and retaining more drivers. Changes in several operating statistics and expense categories are expected to result from actions the Company took in 1997 and 1998. The operations of Bud Meyer Truck Lines, acquired in 1997, and SRT use predominately single-driver tractors, as opposed to the primarily team-driver tractor fleet operated by Covenant's long-haul, dry van operation. The single driver fleets operate fewer miles per tractor and experience more empty miles. In addition, Bud Meyer's operations must bear additional expenses of fuel for refrigeration units, pallets, and depreciation and interest expense of more expensive trailers associated with temperature-controlled service. The additional expenses and lower productive miles are offset by generally higher revenue per loaded mile and the reduced employee expense of compensating only one driver. The Company's operating statistics and expenses are expected to shift in future periods with the mix of single, team, and temperature-controlled operations. The Company initiated the use of owner-operators of tractors in 1997 and had contracted with approximately 211 owner-operators as of March 31, 1999. Owner-operators provide a tractor and a driver and bear all operating expenses in exchange for a fixed lease payment per mile. The Company does not have the capital outlay of purchasing the tractor. As of March 31, 1999, the Company had financed approximately 577 tractors under operating leases as compared to 316 tractors under operating leases as of March 31, 1998. The lease payments to owner-operators and the financing of tractors under operating leases appear as operating leases under revenue equipment rentals and purchased transportation. Expenses associated with owned equipment, such as interest and depreciation, are not incurred, and for owner-operator tractors, driver compensation, fuel, communications, and other expenses are not incurred. Because obtaining equipment from owner-operators and under operating leases effectively shifts financing expenses from interest to "above the line" operating expenses, the Company intends to evaluate its efficiency using pretax margin and net margin rather than operating ratio. The following table sets forth the percentage relationship of certain items to revenue for the three months ended March 31: <TABLE> <CAPTION> 1998 1999 ---------------- ----------------- <S> <C> <C> Revenue 100.0% 100.0% Operating expenses: Salaries, wages, and related expenses 44.1 45.9 Fuel, oil, and road expenses 20.0 17.7 Revenue equipment rentals and purchased transportation 6.3 8.3 Repairs 2.4 2.0 Operating taxes and licenses 2.9 2.5 Insurance 3.0 2.9 General supplies and expenses 5.6 5.6 Depreciation and amortization 8.5 8.2 ---------------- ----------------- Total operating expenses 92.8 93.1 ---------------- ----------------- Operating income 7.2 6.9 Interest expense 1.8 1.3 ---------------- ----------------- Income before income taxes 5.4 5.6 Income tax expense 2.1 2.2 ================ ================= Net income 3.4% 3.3% ================ ================= </TABLE> 8
COMPARISON OF THREE MONTHS ENDED MARCH 31, 1999 TO THREE MONTHS ENDED MARCH 31, 1998 Revenue increased $17.9 million (22.5%), to $97.8 million in the 1999 period from $79.8 million in the 1998 period. The revenue increase was primarily generated by a 25.3% increase in weighted average tractors, to 2,662 during the 1999 period from 2,125 during the 1998 period, as the Company expanded internally to meet demand from new customers and higher volume from existing customers, as well as externally through the acquisitions of Gouge Trucking, Inc. and SRT during August and October of 1998, respectively. The Company's average revenue per loaded mile increased to approximately $1.18 during the 1999 period from $1.15 during the 1998 period. The increase was attributable to per-mile rate increases negotiated by the Company. The increase in average revenue per loaded mile more than offset an increase in empty miles percentage. Revenue per total mile increased to $1.09 in the 1999 period from $1.08 in the 1998 period. Salaries, wages, and related expenses increased $9.6 million (27.2%), to $44.8 million in the 1999 period from $35.2 million in the 1998 period. As a percentage of revenue, salaries, wages, and related expenses increased to 45.9% in the 1999 period from 44.1% in the 1998 period. Driver wages as a percentage of revenue increased to 32.7% in the 1999 period from 31.5% in the 1998 period as the use of owner-operators partially offset a $.025 pay increase that went into effect in April 1998. The Company also experienced an increase in non-driving employee payroll expense to 6.1% of revenue in the 1999 period from 5.3% of revenue in the 1998 period due to the start up of Covenant Transport Logistics and the acquisition of SRT. Fuel, oil, and road expenses increased $1.4 million (8.9%), to $17.3 million in the 1999 period from $15.9 million in the 1998 period. As a percentage of revenue, fuel, oil, and road expenses decreased to 17.7% of revenue in the 1999 period from 20.0% in the 1998 period primarily as a result of improved fuel prices during the 1999 period as well as the increased use of owner-operators who pay for fuel purchases. The expense for owner-operators is reflected in the revenue equipment rentals and purchased transportation category. Revenue equipment rentals and purchased transportation increased $3.2 million (63.2%), to $8.2 million in the 1999 period from $5.0 million in the 1998 period. As a percentage of revenue, revenue equipment rentals and purchased transportation increased to 8.3% in the 1999 period from 6.3% in the 1998 period. During 1997, the Company began using owner-operators of revenue equipment, who provide a tractor and driver and cover all of their operating expenses in exchange for a fixed payment per mile. Accordingly, expenses such as driver salaries, fuel, repairs, depreciation, and interest normally associated with Company-owned equipment are consolidated in revenue equipment rentals and purchased transportation when owner-operators are utilized. The Company increased the fleet size of owner-operators during the 1999 period (averaged 197 in the 1999 period compared to 116 in the 1998 period). The Company also entered into additional operating leases. During the 1999 period, 577 tractors were leased compared to 316 leased tractors during the 1998 period. Repairs remained constant at $1.9 million in the 1999 and 1998 periods. As a percentage of revenue, repairs returned to more normal levels at 2.0% in the 1999 period from 2.4% in the 1998 period. The 1998 increase was primarily the result of costs related to the preparation of certain equipment for trade-in following the Bud Meyer Truck Lines, Inc. acquisition. The gain on sale of equipment in the first quarter of 1998 partially offset the increased expense.(*) Operating taxes and license increased approximately $90,000 (3.9%), to $2.4 million in the 1999 period from $2.3 million in the 1998 period. As a percent of revenue, operating taxes and licenses returned to more normal levels at 2.5% in the 1999 period from 2.9% in the 1998 period. The 1998 expense as a percent of revenue was elevated by an unusual concentration of permits that normally would be issued over two quarters.(*) Insurance, consisting primarily of premiums for liability, physical damage, and cargo damage insurance, and claims, increased $0.4 million (15.3%), to $2.8 million in the 1999 period from $2.4 million in the 1998 period. As a percentage of revenue, insurance decreased to 2.9% in the 1999 period from 3.0% in the 1998 period, as the Company continued to reduce premiums per million dollars of revenue. General supplies and expenses, consisting primarily of driver recruiting, communications expenses, and facilities expenses, increased $1.1 million (25.8%), to $5.6 million in the 1999 period from $4.4 million in the 1998 period. As a percentage of revenue, general supplies and expenses remained constant at 5.6% in the 1999 and 1998 periods. Depreciation and amortization, consisting primarily of depreciation of revenue equipment, increased $1.2 million (17.7%), to $8.0 million in the 1999 period from $6.8 million in 1998 period. As a percentage of revenue, depreciation and amortization decreased to 8.2% in the 1999 period from 8.5% in the 1998 period as the Company utilized more owner-operators and leased more revenue equipment through operating leases. Amortization expense relates to deferred debt costs incurred and covenants not to compete from two 1995 and one 1998 asset acquisitions, as well as goodwill from two 1997 and two 1998 acquisitions. 9
Interest expense decreased $0.2 million (11.0%), to $1.3 million in the 1999 period from $1.5 million in the 1998 period. As a percentage of revenue, interest expense decreased to 1.3% in the 1999 period from 1.8% in the 1998 period, as the Company financed more equipment under operating leases, contracted with more owner-operators during the 1999 period, and benefited from an improvement in cash from operations. As a result of the foregoing, the Company's pretax margin improved to 5.6% in the 1999 period versus 5.4% in the 1998 period. The Company's effective tax rate was 40.2% in the 1999 period compared with 38.1% in the 1998 period reflecting increased state income taxes in the 1999 period. Primarily as a result of the factors described above, net income increased $0.6 million (21.5%), to $3.2 million in the 1999 period (3.3% of revenue) from $2.7 million in the 1998 period (3.4% of revenue). LIQUIDITY AND CAPITAL RESOURCES The growth of the Company's business has required significant investments in new revenue equipment. The Company has financed its revenue equipment requirements with borrowings under a line of credit, cash flows from operations, long-term operating leases, and a small portion with borrowings under installment notes payable to commercial lending institutions and equipment manufacturers. The Company's primary sources of liquidity at March 31, 1999, were funds provided by operations and borrowings under its primary credit agreement, which had maximum available borrowing of $100.0 million at March 31, 1999 (the "Credit Agreement"). The Company believes its sources of liquidity are adequate to meet its current and projected needs.(*) The Company's primary sources of cash flow from operations in the 1999 period were net income increased by depreciation and amortization and accounts payable and accrued expenses. The most significant use of cash provided by operations was to fund prepaid expenses (primarily permits for revenue equipment). Net cash provided by operating activities was $17.7 million in the 1999 period and $7.0 million in the 1998 period. The increase in the 1999 period resulted from a higher payables level caused by timing of the month end in March and an improvement in the cash flows of recievables. Net cash used in investing activities was $8.2 million and $19.9 million in the 1999 and 1998 periods, respectively. These investments were primarily to acquire additional revenue equipment as the Company expanded its operations. The Company expects to expend an additional $52 million on capital expenditures during the remainder of 1999. Total projected capital expenditures, net of trade-ins, for 1999 are expected to be $60 million excluding the effect of any potential acquisitions.(*) Net cash used in financing activities of $11.6 million in the 1999 period related primarily to repayment of debt under borrowings under the Credit Agreement. This compared with net cash provided by financing activities of $17.7 million in the 1998 period. At March 31, 1999, the Company had outstanding debt of $74.6 million, primarily consisting of approximately $43.0 million drawn under the Credit Agreement, $25.0 million in 10-year senior notes, $3.0 million in interest bearing note to the former primary stockholder of SRT related to the acquisition, $3.1 million in term equipment financing, and $0.5 million in notes related to non-compete agreements. Interest rates on this debt range from 5.3% to 10.8%. The Credit Agreement is with a group of banks and has a maximum borrowing limit of $100.0 million. Borrowings related to revenue equipment are limited to the lesser of 90% of the net book value of revenue equipment or $55.0 million. Working capital borrowings are limited to 85% of eligible accounts receivable. Letters of credit are limited to an aggregate commitment of $10.0 million. The Credit Agreement includes a "security agreement" such that the Credit Agreement may be collateralized by virtually all assets of the Company if a covenant violation occurs. A commitment fee of 0.25% per annum is due on the daily unused portion of the Credit Agreement. The Company, including all subsidiaries, are parties to the Credit Agreement and related documents. The Credit Agreement revolves for 1999 and then has a four-year term out if not renewed. Payments for interest are due quarterly in arrears with principal payments due in 12 equal quarterly installments beginning in 2000 if not renewed. The Company renewed the loan in December 1997 and anticipates renewing the Credit Agreement on an annual basis. Borrowings under the Credit Agreement are based on the banks' base rate or LIBOR and accrue interest based on one, two, or three month LIBOR rates plus an applicable margin that is adjusted quarterly between 0.325% and 0.75% based on cash flow coverage. At March 31, 1999, the margin was 0.425%. The Company has entered into an interest rate swap agreement that fixes the interest rate on $10 million of borrowing under the Credit Agreement at a rate of 5.95% plus applicable margin. The $10 million swap agreement will expire October 29, 1999.(*) 10
In October 1995, the Company placed $25 million in 10-year senior notes with an insurance company. The notes bear interest at 7.39%, payable semi-annually, and mature on October 1, 2005. Principal payments are due in equal annual installments beginning in the seventh year of the notes. Proceeds of the notes were used to reduce borrowings under the Credit Agreement. The Credit Agreement, senior notes, and the headquarters and terminal lease agreement entered into in 1996, contain certain restrictions and covenants relating to, among other things, dividends, tangible net worth, cash flows, acquisitions and dispositions, and total indebtedness. All of these instruments re cross-defaulted. The Company was in compliance with the agreements at March 31, 1999. YEAR 2000 The Year 2000 ("Y2K") issue concerns the inability of computer systems to recognize and process date-sensitive information after 1999 due to the use of only the last two digits to refer to a year. This problem could affect both information systems (software and hardware) and other equipment that relies on microprocessors. Management has completed a Company-wide evaluation of this impact on its computer systems, applications, and other date-sensitive equipment and has hired a nationally-recognized consulting firm to perform a status study of the Company's processes and activities related to the Company's Y2K project. All known remediation efforts and testing of systems/equipment are expected to be completed by July 30, 1999. The cost of the assessment and remediation efforts for the modifications and updates to existing software is estimated to be approximately $250,000. The Company is also in the process of monitoring the progress of material third parties, including shippers and suppliers, in their efforts to become Y2K compliant and expects this project to be completed by July 30, 1999.(*) The Company's primary information technology systems ("IT Systems") include hardware and software for billing, dispatch, electronic data interchange ("EDI"), fueling, payroll, telephone, vehicle maintenance, inventory, and satellite communications systems. The majority of the Company's IT Systems are purchased from and maintained by third parties. A primary IT System designed by a third party is the satellite tracking system, which tracks equipment locations, provides dispatch and routing information, and allows in-cab communications with drivers. The Company's operating system that manages payroll, billing, and dispatch was purchased from the supplier in March 1999 on a long term lease. The Company's financial reporting system is provided by a third party. The Company has been informed by the providers of these systems that they are Y2K compliant. Another significant IT System provided by a third party transmits payroll funds to drivers and allows drivers to purchase fuel and other items outside the Company's terminal locations. The Company has been informed by this provider that it expects to be Y2K compliant by June 30, 1999. Although the Company believes it is Y2K compliant in its EDI applications, the Company has not completed its review of Y2K compliance of EDI applications of its shippers. The Company has reviewed its risks associated with microprocessors embedded in facilities and equipment ("Non-IT Systems"). The primary Non-IT Systems includes microprocessors in tractor engines and other components, terminal facilities, satellite communications units, and telecommunications and other office equipment. The Company's assessment of its revenue equipment, satellite communications units, and office equipment Non-IT Systems has revealed low risk of material replacement requirements. Such equipment is relatively new and was designed to be Y2K compliant. The Company is continuing to assess its Non-IT Systems in its terminal facilities but believes that the risk of a service-interrupting failure in these systems is low.(*) The Company could be faced with severe consequences if Y2K issues are not identified and resolved in a timely manner by the Company and material third parties. The Company's primary risk relating to Y2K compliance is the possibility of service disruption from third-party suppliers of satellite communications, telephone, fueling, and financial services. A worst-case scenario would result in the short term inability of the Company to deliver freight for its shippers. This would result in lost revenues; however, the amount would be dependent on the length and nature of the disruption, which cannot be predicted or estimated. The Company is in the process of developing contingency plans in case business interruptions do occur. Management expects these plans to be completed by June 30, 1999.(*) 11
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risks from changes in (i) certain commodity prices and (ii) certain interest rates on its debt. COMMODITY PRICE RISK Prices and availability of all petroleum products are subject to political, economic, and market factors that are generally outside the Company's control. Because the Company's operations are dependent upon diesel fuel, significant increases in diesel fuel costs could materially and adversely affect the Company's results of operations and financial condition. Historically, the Company has been able to recover a portion of short-term fuel price increases from customers in the form of fuel surcharges. The price and availability of diesel fuel can be unpredictable as well as the extent to which fuel surcharges could be collected to offset such increases. For the first quarter of 1999, diesel fuel expenses represented 16.1% of the Company's total operating expenses. The Company uses derivative instruments, including purchased commitments through suppliers, to reduce a portion of its exposure to fuel price fluctuations. At March 31, 1999, the notional amount for purchased commitments for the remainder of 1999 was 9.0 million gallons. Net unrealized losses were approximately $0.3 million. At March 31, 1999, the national average price of diesel fuel as provided by the U.S. Department of Energy was $1.046 per gallon. At March 31, 1999, a ten percent change in the price of fuel would eliminate any 1999 net unrealized losses and create a net unrealized gain of approximately $630,000. INTEREST RATE RISK The Credit Agreement, provided there has been no default, carries a maximum variable interest rate of LIBOR for the corresponding period plus 0.75%. At March 31, 1999, the Company had drawn $43.0 million under the Credit Agreement. Approximately $33.0 million was subject to variable rates and the remaining $10.0 million was subject to an interest rate swap that fixed the interest rate at 5.95% plus applicable margin per annum. The swap expires October 29, 1999. Considering the effect of the interest rate swap and all debt outstanding, each one-percentage point increase in LIBOR would increase the Company's pretax interest expense by $325,000. The Company does not trade in these derivatives with the objective of earning financial gains on price fluctuations, nor does it trade in these instruments when there are no underlying related exposures. 12
PART II OTHER INFORMATION Item 1. Legal Proceedings. None Items 2, 3, 4, and 5. Not applicable. Item 6. Exhibits and reports on Form 8-K. (a) Exhibits Exhibit Number Description 3.1+ Restated Articles of Incorporation. 3.2+ Amended By-Laws dated September 27, 1994. 4.1+ Restated Articles of Incorporation. 4.2+ Amended By-Laws dated September 27, 1994. 10.1++ Credit Agreement dated January 17, 1995, among Covenant Transport, Inc., a Tennessee corporation, ABN-AMRO Bank N.V., as agent, and certain other banks, filed as Exhibit 10. 10.2+ Incentive Stock Plan, filed as Exhibit 10.9. 10.3+ 401(k) Plan, filed as Exhibit 10.10. 10.4+++ Note Purchase Agreement dated October 15, 1995, among Covenant Transport, Inc., a Tennessee corporation and CIG & Co., filed as Exhibit 10.12. 10.5+++ First Amendment to Credit Agreement and Waiver dated October 15, 1995, filed as Exhibit 10.13. 10.6++++ Participation Agreement dated March 29, 1996, among Covenant Transport, Inc., a Tennessee corporation, Lease Plan USA, Inc., and ABN-AMRO Bank, N.V., Atlanta Agency, filed as Exhibit 10.14. 10.7++++ Second Amendment to Credit Agreement and Waiver dated April 12, 1996, filed as Exhibit 10.15. 10.8++++ First Amendment to Note Purchase Agreement and Waiver dated April 1, 1996, filed as Exhibit 10.16. 10.9+++++ Third Amendment to Credit Agreement and Waiver dated March 31, 1997, filed as Exhibit 10.11. 10.10+++++ Waiver to Note Purchase Agreement dated March 31, 1997, filed as Exhibit 10.12. 10.11# Second Amendment to Note Purchase Agreement dated December 30, 1997, filed as Exhibit 10.19. 10.12# Fourth Amendment to Credit Agreement dated December 31, 1997, filed as Exhibit 10.20. 10.13# Stock Purchase Agreement made and entered into as of October 10, 1997, by and among Covenant Transport, Inc., a Nevada corporation; Russell Meyer; and Bud Meyer Truck Lines, Inc., a Minnesota corporation, filed as Exhibit 10.21. 10.14## Stock Purchase Agreement made and entered into as of October 15, 1998, by and among Covenant Transport, Inc., a Nevada corporation; Smith Charitable Remainder Trust, Southern Refrigerated Transportation, Inc., an Arkansas corporation, and Tony and Kathy Smith, husband and wife and residents of Arkansas, filed as Exhibit 10.22. 27 Financial Data Schedule. + Filed as an exhibit to the registrant's Registration Statement on Form S-1, Registration No. 33-82978, effective October 28, 1994, and incorporated herein by reference. ++ Filed as an exhibit to the registrant's Form 10-Q for the quarter ended March 31, 1995, and incorporated herein by reference. +++ Filed as an exhibit to the registrant's Form 10-K for the year ended December 31, 1995, and incorporated herein by reference. ++++ Filed as an exhibit to the registrant's Form 10-Q for the quarter ended March 31, 1996, and incorporated herein by reference. +++++ Filed as an exhibit to the registrant's Form 10-Q for the quarter ended March 31, 1997, and incorporated herein by reference. 13
# Filed as an exhibit to the registrant's Annual Report on Form 10-K for the period ended December 31, 1997, and incorporated herein by reference. ## Filed as an exhibit to the registrant's Annual Report on Form 10-K for the period ended December 31, 1998, and incorporated herein by reference. (b) No reports on Form 8-K have been filed during the quarter for which this report is filed. 14
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COVENANT TRANSPORT, INC. Date: May 13, 1999 /s/ Joey B. Hogan ----------------- Joey B. Hogan Treasurer and Chief Financial Officer 15