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 June 30, 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 at least 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 (June 30, 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 14 1
PART I FINANCIAL INFORMATION Page Number Item 1. Financial statements Condensed Consolidated Balance Sheets as of December 31, 1998 3 and June 30, 1999 (Unaudited) Condensed Consolidated Statements of Income for the three and 4 and six months ended June 30, 1998 and 1999 (Unaudited) Condensed Consolidated Statements of Cash Flows for the six 5 months ended June 30, 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 13 PART II OTHER INFORMATION Page Number Item 1. Legal Proceedings 14 Items 2 and 3. Not applicable 14 Item 4. Submission of Matters to a vote of Security Holders 14 Item 5. Not applicable 14 Item 6. Exhibits and reports on Form 8-K 14 2
<TABLE> <CAPTION> COVENANT TRANSPORT, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands except share data) December 31, June 30, 1998 1999 ----------------- ----------------- ASSETS (unaudited) <S> <C> <C> Current assets: Cash and cash equivalents $ 2,926 $ 763 Accounts receivable, net of allowance of $1,065 in 1998 and $1,024 in 1999 51,789 51,493 Drivers' advances and other receivables 2,476 3,246 Tire and parts inventory 1,929 2,507 Prepaid expenses 5,325 7,672 Deferred income taxes 1,674 1,836 ----------------- ----------------- Total current assets 66,119 67,517 Property and equipment, at cost 282,358 280,062 Less accumulated depreciation and amortization 81,821 77,680 ----------------- ----------------- Net property and equipment 200,537 202,382 Other 6,303 6,194 ----------------- ----------------- Total assets $ 272,959 $ 276,093 ================= ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Checks outstanding in excess of bank balances - 833 Current maturities of long-term debt 1,943 1,249 Accounts payable 3,485 9,333 Accrued expenses 14,318 13,292 ----------------- ----------------- Total current liabilities 19,747 24,707 Long-term debt, less current maturities 84,331 71,594 Deferred income taxes 27,359 29,068 ----------------- ----------------- Total liabilities 131,437 125,693 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 1999, 126 126 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 78,281 Retained earnings 63,112 72,293 ----------------- ----------------- Total stockholders' equity 141,522 150,724 ----------------- ----------------- Total liabilities and stockholders' equity $ 272,959 $ 276,093 ================= ================= </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 AND SIX MONTHS ENDED JUNE 30, 1998 AND 1999 (In thousands except per share data) Three months ended Six months ended June 30, June 30, (unaudited) (unaudited) 1998 1999 1998 1999 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenue $ 89,010 $ 113,211 $ 168,834 $ 210,975 Operating expenses: Salaries, wages, and related expenses 39,907 48,320 75,149 93,156 Fuel, oil and road expenses 16,334 20,484 32,256 37,821 Revenue equipment rentals and purchased Transportation 5,429 10,924 10,431 19,085 Repairs 1,809 2,431 3,643 4,374 Operating taxes and licenses 2,062 2,750 4,379 5,157 Insurance 2,304 2,854 4,818 5,648 General supplies and expenses 5,002 5,776 9,441 11,361 Depreciation and amortization, including gain on 7,262 8,560 14,035 16,531 disposal of equipment -------------- -------------- -------------- -------------- Total operating expenses 80,110 102,099 154,152 193,133 -------------- -------------- -------------- -------------- Operating income 8,901 11,112 14,682 17,842 Interest expense 1,542 1,225 3,003 2,525 -------------- -------------- -------------- -------------- Income before income taxes 7,358 9,887 11,679 15,317 Income tax expense 2,799 3,955 4,444 6,136 ============== ============== ============== ============== Net income $ 4,559 $ 5,932 $ 7,235 $ 9,181 ============== ============== ============== ============== Basic earnings per share $ 0.32 $ 0.40 $ 0.52 $ 0.62 Diluted earnings per share $ 0.32 $ 0.40 $ 0.52 $ 0.61 Weighted average shares outstanding 14,392 14,912 13,877 14,912 Adjusted weighted average shares and assumed conversions outstanding 14,413 14,966 13,901 15,015 </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 SIX MONTHS ENDED JUNE 30, 1998 AND 1999 (In thousands) Six months ended Six months ended June 30, 1998 June 30, 1999 --------------------- --------------------- (unaudited) (unaudited) <S> <C> <C> Cash flows from operating activities: Net income $ 7,235 $ 9,181 Adjustments to reconcile net income to net cash provided by operating activities: Provision for losses on receivables 180 149 Depreciation and amortization 15,668 16,715 Deferred income tax expense 1,965 1,547 Gain on disposition of property and equipment (1,633) (184) Changes in operating assets and liabilities: Receivables and advances (8,485) (785) Prepaid expenses (3,264) (2,347) Tire and parts inventory (468) (578) Accounts payable and accrued expenses 1,347 4,821 --------------------- --------------------- Net cash flows provided by operating activities 12,545 28,520 Cash flows from investing activities: Acquisition of property and equipment (57,231) (43,697) Proceeds from disposition of property and equipment 17,906 25,592 --------------------- --------------------- Net cash flows used in investing activities (39,325) (18,105) Cash flows from financing activities: Changes in checks outstanding in excess of bank balances - 833 Exercise of stock option 67 20 Proceeds from issuance of long-term debt 38,000 25,000 Repayments of long-term debt (41,337) (38,431) Proceeds from equity offering 27,551 - --------------------- --------------------- Net cash flows provided by/(used in) financing activities 24,281 (12,578) --------------------- --------------------- Net change in cash and cash equivalents (2,499) (2,163) Cash and cash equivalents at beginning of period 2,610 2,926 --------------------- --------------------- Cash and cash equivalents at end of period $ 111 $ 763 ===================== ===================== </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 Six months ended ended June 30, June 30, 1998 1999 1998 1999 ---- ---- ---- ---- <S> <C> <C> <C> <C> Numerator: Net Income $ 4,560 $ 5,932 $ 7,235 $ 9,181 Denominator: Denominator for basic earnings per share - weighted-average shares 14,392 14,912 13,877 14,912 Effect of dilutive securities: Employee stock options 21 54 24 103 ---------- ---------- ---------- ---------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 14,413 14,966 13,901 15,015 ========== ========== ========== ========== Basic earnings per share $ .32 $ .40 $ .52 $ .62 ========== ========== ========== ========== Diluted earnings per share $ .32 $ .40 $ .52 $ .61 ========== ========== ========== ========== </TABLE> Note 3. 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 2.0% higher in the quarter ended June 30, 1999, as compared with the quarter ended June 30, 1998. Note 4. 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 6
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 2001. 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 The Company grew its revenue 25.0%, to $211.0 million in the six months ended June 30, 1999, from $168.8 million during the same period of 1998. The Company's pretax margin increased to 7.3% of revenue from 6.9% 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 26.9%, to $9.2 million in the six months ended June 30, 1999, from $7.2 million during the same period of 1998. Several factors contributed to the increase, including lower 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 and SRT'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 249 owner-operators as of June 30, 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 June 30, 1999, the Company had financed approximately 625 tractors under operating leases as compared to 316 tractors under operating leases as of June 30, 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, 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 and six months ended June 30: <TABLE> <CAPTION> Three Months Ended June 30, Six Months Ended June 30, 1998 1999 1998 1999 --------------- --------------- --------------- --------------- <S> <C> <C> <C> <C> Revenue 100.0% 100.0% 100.0% 100.0% Operating expenses: Salaries, wages, and related expenses 44.8 42.7 44.5 44.2 Fuel, oil, and road expenses 18.4 18.1 19.1 17.9 Revenue equipment rentals and purchased transportation 6.1 9.6 6.2 9.0 Repairs 2.0 2.1 2.2 2.1 Operating taxes and licenses 2.3 2.4 2.6 2.4 Insurance 2.6 2.5 2.8 2.7 General supplies and expenses 5.6 5.1 5.6 5.4 Depreciation and amortization 8.2 7.6 8.3 7.8 --------------- --------------- --------------- --------------- Total operating expenses 90.0 90.2 --------------- --------------- --------------- --------------- Operating income 10.0 9.8 8.7 8.5 Interest expense 1.7 1.1 1.8 1.2 --------------- --------------- --------------- --------------- Income before income taxes 8.3 8.7 6.9 7.3 Income tax expense 3.2 3.5 2.6 2.9 =============== =============== =============== =============== Net income 5.1% 5.2% 4.3% 4.4% =============== =============== =============== =============== </TABLE> 8
COMPARISON OF THREE MONTHS ENDED JUNE 30, 1999 TO THREE MONTHS ENDED JUNE 30, 1998 Revenue increased $24.2 million (27.2%), to $113.2 million in the 1999 period from $89.0 million in the 1998 period. The revenue increase was primarily generated by a 22.7% increase in weighted average tractors, to 2,782 during the 1999 period from 2,268 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 revenue per tractor per week increased 4.9%, to $3,167 in the 1999 quarter from $3,019 in the 1998 quarter as a result of improved equipment utilization and a slight increase in revenue per total mile. Salaries, wages, and related expenses increased $8.4 million (21.1%), to $48.3 million in the 1999 period from $39.9 million in the 1998 period. As a percentage of revenue, salaries, wages, and related expenses decreased to 42.7% in the 1999 period from 44.8% in the 1998 period. Driver wages as a percentage of revenue decreased to 30.8% in the 1999 period from 32.9% in the 1998 period as the Company utilized more owner-operators. The Company experienced an increase in non-driving employee payroll expense to 5.7% 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 $4.2 million (25.4%), to $20.5 million in the 1999 period from $16.3 million in the 1998 period. As a percentage of revenue, fuel, oil, and road expenses decreased to 18.1% of revenue in the 1999 period from 18.4% in the 1998 period. The increased use of owner-operators who pay for their own fuel purchases more than offset an approximately four cent per gallon increase in the average price of fuel versus the prior period. The expense for owner-operators is reflected in the revenue equipment rentals and purchased transportation category. Revenue equipment rentals and purchased transportation increased $5.5 million (101.2%), to $10.9 million in the 1999 period from $5.4 million in the 1998 period. As a percentage of revenue, revenue equipment rentals and purchased transportation increased to 9.6% in the 1999 period from 6.1% 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 249 in the 1999 period compared to 120 in the 1998 period, a increase of 107.5%). The Company also entered into additional operating leases. During the 1999 period, 622 tractors were leased compared to 316 leased tractors during the 1998 period. Repairs increased $0.7 million (34.4%), to $2.4 million in the 1999 period from $1.8 million in the 1998 period. As a percentage of revenue, repairs increased to 2.1% in the 1999 period from 2.0% in the 1998 period. The 1999 increase was primarily the result of costs related to the preparation of certain equipment for trade-in following the SRT, Inc. acquisition. Operating taxes and licenses increased approximately $0.7 million (33.4%), to $2.8 million in the 1999 period from $2.1 million in the 1998 period. As a percent of revenue, operating taxes and licenses remained essentially constant at 2.4% in the 1999 period and 2.3% in the 1998 period. Insurance, consisting primarily of premiums for liability, physical damage, and cargo damage insurance, and claims, increased $0.6 million (23.9%), to $2.9 million in the 1999 period from $2.3 million in the 1998 period. As a percentage of revenue, insurance remained essentially constant at 2.5% in the 1999 period and 2.6% in the 1998 period. General supplies and expenses, consisting primarily of driver recruiting, communications expenses, and facilities expenses, increased $0.8 million (15.5%), to $5.8 million in the 1999 period from $5.0 million in the 1998 period. As a percentage of revenue, general supplies and expenses decreased to 5.1% in the 1999 period from 5.6% in the 1998 period. The 1999 decrease is primarily related to the fixed nature of a portion of these costs, which was more effectively spread over higher revenues. Depreciation and amortization, consisting primarily of depreciation of revenue equipment, increased $1.3 million (17.9%), to $8.6 million in the 1999 period from $7.3 million in 1998 period. As a percentage of revenue, depreciation and amortization decreased to 7.6% in the 1999 period from 8.2% 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. Interest expense decreased $0.3 million (20.6%), to $1.2 million in the 1999 period from $1.5 million in the 1998 period. As a percentage of revenue, interest expense decreased to 1.1% in the 1999 period from 1.7% in the 1998 period, as the Company financed 9
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 8.7% in the 1999 period versus 8.3% in the 1998 period. The Company's effective tax rate was 40.0% in the 1999 period compared with 38.0% 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 $1.4 million (30.1%), to $5.9 million in the 1999 period (5.2% of revenue) from $4.6 million in the 1998 period (5.1% of revenue). COMPARISON OF SIX MONTHS ENDED JUNE 30, 1999 TO SIX MONTHS ENDED JUNE 30, 1998 Revenue increased $42.1 million (25.0%), to $211.0 million in the 1999 period from $168.8 million in the 1998 period. The revenue increase was primarily generated by a 23.9% increase in weighted average tractors, to 2,722 during the 1999 period from 2,197 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 revenue per tractor per week increased 1.5%, to $3,015 in the 1999 period from $2,972 in the 1998 period, as a result of a one cent per total mile increase in freight rates and improved equipment utilization. Salaries, wages, and related expenses increased $18.0 million (24.0%), to $93.2 million in the 1999 period from $75.1 million in the 1998 period. As a percentage of revenue, salaries, wages, and related expenses decreased to 44.2% in the 1999 period from 44.5% in the 1998 period. Driver wages as a percentage of revenue decreased to 31.7% in the 1999 period from 32.2% in the 1998 period as the use of owner-operators more than offset a $.025 pay increase that went into effect in April 1998. The Company experienced an increase in non-driving employee payroll expense to 5.9% 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 $5.6 million (17.3%), to $37.8 million in the 1999 period from $32.3 million in the 1998 period. As a percentage of revenue, fuel, oil, and road expenses decreased to 17.9% of revenue in the 1999 period from 19.1% in the 1998 period primarily as a result of 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 $8.7 million (83.0%), to $19.1 million in the 1999 period from $10.4 million in the 1998 period. As a percentage of revenue, revenue equipment rentals and purchased transportation increased to 9.0% in the 1999 period from 6.1% 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 utlized. The Company increased the fleet size of owner-operators during the 1999 period (averaged 218 in the 1999 period compared to 118 in the 1998 period, a increase of 84.7%). The Company also entered into additional operating leases. During the 1999 period, 622 tractors were leased compared to 316 leased tractors during the 1998 period. Repairs increased $0.8 million (20.1%), to $4.4 million in the 1999 period from $3.6 million in the 1998 period. As a percentage of revenue, repairs remained essentially constant at 2.1% in the 1999 period and 2.2% in the 1998 period. Operating taxes and licenses increased approximately $0.8 million (17.8%), to $5.2 million in the 1999 period from $4.4 million in the 1998 period. As a percent of revenue, operating taxes and licenses decreased to 2.4% in the 1999 period from 2.6% in the 1998 period. Insurance, consisting primarily of premiums for liability, physical damage, and cargo damage insurance, and claims, increased $0.8 million (17.2%), to $5.6 million in the 1999 period from $4.8 million in the 1998 period. As a percentage of revenue, insurance remained essentially constant at 2.7% in the 1999 period and 2.8% in the 1998 period. General supplies and expenses, consisting primarily of driver recruiting, communications expenses, and facilities expenses, increased $1.9 million (20.3%), to $11.4 million in the 1999 period from $9.4 million in the 1998 period. As a percentage of revenue, general supplies and expenses decreased to 5.4% in the 1999 period from 5.6% in the 1998 period. The 1999 decrease is primarily related to the fixed nature of a portion of these costs, which was more effectively spread over higher revenues. 10
Depreciation and amortization, consisting primarily of depreciation of revenue equipment, increased $2.5 million (17.8%), to $16.5 million in the 1999 period from $14.0 million in 1998 period. As a percentage of revenue, depreciation and amortization decreased to 7.8% in the 1999 period from 8.3% 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. Interest expense decreased $0.5 million (15.9%), to $2.5 million in the 1999 period from $3.0 million in the 1998 period. As a percentage of revenue, interest expense decreased to 1.2% 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 7.3% in the 1999 period versus 6.9% in the 1998 period. The Company's effective tax rate was 40.1% in the 1999 period compared with 38.0% 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 $1.9 million (26.9%), to $9.2 million in the 1999 period (4.4% of revenue) from $7.2 million in the 1998 period (4.3% 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 June 30, 1999, were funds provided by operations and borrowings under its primary credit agreement, amended June 18, 1999, which had maximum available borrowing of $130.0 million at June 30, 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. Net cash provided by operating activities was $28.5 million in the 1999 period and $12.5 million in the 1998 period. The increase in the 1999 period resulted from a significant improvement in the cash flow of receivables and a higher payables level caused by timing of the month end in June. Net cash used in investing activities was $18.1 million and $39.3 million in the 1999 and 1998 periods, respectively. These investments were primarily to acquire additional revenue equipment as the Company expanded its operations. The decrease in the 1999 period as compared to the 1998 period resulted from the Company's entering into more operating leases and increasing its fleet through the use of owner-operators who provide a tractor. The Company expects to expend approximately an additional $27.0 million on capital expenditures during the remainder of 1999 (excluding planned operating leases of equipment). Total projected capital expenditures for 1999 are expected to be approximately $45.0 million excluding operating leases and the effect of any potential acquisitions. (*) Net cash used in financing activities of $12.6 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 $24.3 million in the 1998 period. At June 30, 1999, the Company had outstanding debt of $72.8 million, primarily consisting of approximately $42.0 million drawn under the Credit Agreement, $25.0 million in 10-year senior notes, $3.0 million in an interest bearing note to the former primary stockholder of SRT related to the acquisition, $2.1 million in term equipment financing, and $0.7 million in notes related to non-compete agreements. Interest rates on this debt range from 5.7% to 10.8%. The Credit Agreement is with a group of banks and has a maximum borrowing limit of $130.0 million. Borrowings related to revenue equipment are limited to the lesser of 90% of the net book value of revenue equipment. 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, that is adjusted quarterly between 0.125% and 0.275% per annum based on cash flow coverage, 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 Company renewed the loan in June 1999. The Credit Agreement revolves through December 31, 2000 and then has a three-year term out if not renewed. Payments for interest are due quarterly in arrears with principal payments due in 12 equal quarterly 11
installments beginning in 2001 if not renewed. 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 0.55% and 0.925% based on cash flow coverage. At June 30, 1999, the margin was 0.60%. The Company has 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. 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 are cross-defaulted. At June 30, 1999, the Company was in compliance with the agreements. SEASONALITY In the trucking industry, revenue generally decreases as customers reduce shipments during the winter holiday season and as inclement weather impedes operations. At the same time, operating expenses generally increase, with fuel efficiency declining because of engine idling and weather creating more equipment repairs. First quarter net income historically has been lower than net income in each of the other three-quarters of the year because of the weather. The Company's equipment utilization typically improves substantially between May and October of each year because of the trucking industry's seasonal shortage of equipment on traffic originating in California and the Company's ability to satisfy some of that requirement. The seasonal shortage typically occurs between May and August because California produce carriers' equipment is fully utilized for produce during those months and does not compete for shipments hauled by the Company's dry van operation. During September and October, business increases as a result of increased retail merchandise shipped in anticipation of the holidays. (*) 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 mission critical systems/equipment were completed by July 31, 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 phase to be ongoing throughout the rest of the year. 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. 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's financial reporting system also is provided by a third party. In addition to our own completed testing, the Company has been informed by the providers of these systems that they are Y2K compliant. The Company believes it is Y2K compliant in its EDI applications. As customers will allow, the Company will be performing Y2K testing of EDI transmissions with its customers throughout the remainder of the year. (*) 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. (*) 12
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 August 31, 1999. (*) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 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 six months of 1999, diesel fuel expenses represented 16.6% of the Company's total operating expenses and 15.2% of total revenue. The Company uses derivative instruments, including purchased commitments through suppliers, to reduce a portion of its exposure to fuel price fluctuations. At June 30, 1999, the national average price of diesel fuel as provided by the U.S. Department of Energy was $1.087 per gallon. At June 30, 1999, the notional amount for purchased commitments for the remainder of 1999 was 6.0 million gallons. Net unrealized losses were approximately $100,000. At June 30, 1999, a ten percent change in the price of fuel would cause an approximately $650,000 change in losses or gains on the fuel purchase commitments. 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 0.925%. At June 30, 1999, the Company had drawn $42.0 million under the Credit Agreement. Approximately $32.0 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 $290,000. 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. 13
PART II OTHER INFORMATION Item 1. Legal Proceedings. None Items 2 and 3. Not applicable Item 4. Submission of Matters to a Vote of Security Holders. The Annual Meeting of Stockholders of Covenant Transport, Inc. was held on May 20, 1999, for the purpose of (a) electing seven directors for one-year terms (b) ratification of the selection of PricewaterhouseCoopers LLP as independent certified public accountants for the Company and (c) amending the Company's Incentive Stock Plan to reserve an additional 651,550 shares of the Company's Class A common stock for issuance to participants. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934, and there was no solicitation in opposition to management's nominees. Each of management's nominees for director as listed in the Proxy Statement was elected. The voting tabulation on the election of directors was as follows: <TABLE> <CAPTION> Shares Shares Shares Voted Voted Voted "FOR" "AGAINST" "ABSTAIN" <S> <C> <C> <C> David R. Parker 16,430,991 0 36,190 Michael W. Miller 16,430,991 0 36,190 R. H. Lovin, Jr. 16,430,991 0 36,190 Mark A. Scudder 16,430,991 0 36,190 William T. Alt 16,429,971 0 37,210 Hugh O. Maclellan, Jr. 16,430,991 0 36,190 Robert E. Bosworth 16,430,991 0 36,190 </TABLE> The voting tabulation on the selection of accountants was 16,461,756 shares "FOR," 1,600 shares "AGAINST," and 3,825 shares "ABSTAIN." The voting tabulation on amending the Company's Incentive Stock Plan was 12,724,525 shares "FOR," 3,112,255 shares "AGAINST," and 5,932 shares "ABSTAIN." Item 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+ Incentive Stock Plan, filed as Exhibit 10.9. 10.2+ 401(k) Plan, filed as Exhibit 10.10. 10.3++ Note Purchase Agreement dated October 15, 1995, among Covenant Transport, Inc., a Tennessee corporation and CIG & Co., filed as Exhibit 10.12. 10.4+++ 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. 10.5+++ First Amendment to Note Purchase Agreement and Waiver dated April 1, 1996, filed as Exhibit 10.16. 14
10.6++++ Waiver to Note Purchase Agreement dated March 31, 1997, filed as Exhibit 10.12. 10.7+++++ Second Amendment to Note Purchase Agreement dated December 30, 1997, filed as Exhibit 10.19. 10.8+++++ 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. 10.9# 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. 10.10 Amendment No. 2 to the Incentive Stock Plan. 10.11 Amended and Restated Credit Agreement dated June 18, 1999. 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-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. +++++ 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. 15
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: August 11, 1999 /s/ Joey B. Hogan ----------------- Joey B. Hogan Treasurer and Chief Financial Officer 16