SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the Fiscal Year Ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED).
For the transition period from to
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 No.)
Incorporation or Organization)
400 Birmingham Highway
Chattanooga, Tennessee
37419
(Address of Principal Executive Offices)
(Zip Code)
Registrant's telephone number, including area code: 423/821-1212
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: $0.01 Par Value
Class A Common Stock
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 such
filing requirements for the past 90 days. YES [X] NO[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $62.0 million as of March 23, 1999 (based upon the
$14.125 per share closing price on that date as reported by Nasdaq). In making
this calculation the registrant has assumed, without admitting for any purpose,
that all executive officers, directors, and their family members, and no other
persons, are affiliates.
As of March 23, 1999, the registrant had 12,561,550 shares of Class A Common
Stock and 2,350,000 shares of Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: The information set forth under Part III,
Items 10, 11, 12, and 13 of this Report is incorporated by reference from the
registrant's definitive proxy statement for the 1999 annual meeting of
stockholders that will be filed no later than April 30, 1999.
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Cross Reference Index
The following cross reference index indicates the document and location of the
information contained herein and incorporated by reference into the Form 10-K.
Document and Location
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Part I
------
Item 1 Business Page 3 herein
Item 2 Properties Page 5 herein
Item 3 Legal Proceedings Page 5 herein
Item 4 Submission of Matters to a Vote of
Security Holders Page 6 herein
Part II
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Item 5 Market for the Registrant's Common Equity
and Related Stockholder Matters Page 6 herein
Item 6 Selected Financial Data Page 7 herein
Item 7 Management's Discussion and Analysis of
Financial Page 8 herein
Condition and Results of Operations
Item 7A Quantitative and Qualitative Disclosures
About Market Risk Page 15 herein
Item 8
Financial Statements and Supplementary
Data Page 16 herein
Item 9 Changes in and Disagreements with
Accountants on Page 16 herein
Accounting and Financial Disclosure
Part III
--------
Item 10 Directors and Executive Officers of the Pages 2-3 of Proxy Statement
Registrant
Item 11 Executive Compensation Pages 5-7 of Proxy Statement
Item 12 Security Ownership of Certain Beneficial
Owners and Page 9-10 of Proxy Statement
Management
Item 13 Certain Relationships and Related
Transactions Page 4 of Proxy Statement
Part IV
Item 14 Exhibits, Financial Statement Schedules,
and Reports on Form 8-K Page 18 herein
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This report contains "forward-looking statements" in paragraphs that are
marked with an asterisk. These statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
anticipated. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Cautionary Statement Regarding Forward-Looking
Statements" for additional information and factors to be considered concerning
forward-looking statements.
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PART I
ITEM 1. BUSINESS
General
Covenant Transport, Inc. ("Covenant," or the "Company") is a truckload carrier
that offers just-in-time and other premium transportation service for customers
throughout the United States. Covenant was founded by David and Jacqueline
Parker in 1985 with 25 tractors and 50 trailers. In thirteen years of operating,
the Company's fleet has grown to 2,608 tractors and 4,526 trailers, and in 1998
revenue grew to $370.5 million. In recent years, the Company has grown both
internally and through acquisitions, although prior to 1997 most growth was
internal. In 1995, Covenant acquired the assets of two small Dalton,
Georgia-based truckload carriers that specialized in transporting carpet to the
Pacific Northwest. In August 1997, the Company accelerated its acquisition
strategy. Covenant first acquired the customer relationships of $13 million
annual revenue Trans-Roads, Inc., a dry van team-driver operation based near
Atlanta, Georgia. In October 1997, Covenant acquired the stock of Bud Meyer
Truck Lines, Inc. ("Bud Meyer"), a $45 million annual revenue truckload carrier
that focuses on providing temperature-controlled transportation service for
shippers primarily in the frozen food and consumer products industries. In
August 1998, the Company purchased certain assets of Gouge Trucking, Inc., a $4
million truckload carrier located in North Carolina. In October 1998, Covenant
acquired all of the outstanding stock of Southern Refrigerated Transport, Inc.,
a $23 million annual revenue truckload carrier and Tony Smith Trucking, Inc.
(Southern Refrigerated Transport, Inc. and Tony Smith Trucking, Inc. shall be
referred to collectively as "SRT"), both located in southwest Arkansas. Also in
October 1998, the Company formed a new division, Covenant Transport Logistics to
support the needs of certain large customers.
The Company's corporate structure includes Covenant Transport, Inc., a Nevada
holding company organized in May 1994 and its wholly owned subsidiaries:
Covenant Transport, Inc., a Tennessee corporation organized in November 1985;
Covenant Leasing, Inc., a Nevada corporation; Intellectual Property Co., a
Nevada corporation, Covenant Acquisition Co., a Nevada shell corporation; Bud
Meyer Truck Lines, Inc., a Minnesota corporation; Southern Refrigerated
Transport, Inc., an Arkansas corporation; and Tony Smith Trucking, Inc., an
Arkansas corporation. Covenant Leasing, Inc. was formed in March 1997 with the
purpose of leasing equipment to the operating subsidiary. Intellectual Property
Co. was formed in March 1997 with the purpose of holding of the intellectual
property of the Company.
Operations
Covenant approaches its operations as an integrated effort of marketing,
customer service, and fleet management. The Company's customer service and
marketing personnel emphasize both new account development and expanded service
for current customers. Customer service representatives provide day-to-day
contact with customers, while the sales force targets driver-friendly freight
that will increase lane density.
The Company's primary customers include manufacturers, retailers, and other
transportation companies. Other transportation companies primarily consist of
less than truckload and air freight carriers, third-party freight consolidators,
and freight forwarders who seek Covenant's expedited and just-in-time service.
In 1998, other transportation companies were Covenant's two largest customers,
and manufacturing was the largest industry served. No single customer accounted
for 10% or more of the Company's revenue during any of the last three fiscal
years.
Covenant conducts its operations from its headquarters in Chattanooga,
Tennessee, the Bud Meyer headquarters in Lake City, Minnesota, and the SRT
headquarters in Ashdown, Arkansas. Fleet managers plan load coverage according
to customer information requirements and relay pick-up, delivery, routing, and
fueling instructions to the Company's drivers. The fleet managers attempt to
route most of the Company's trucks over selected operating lanes. The resulting
lane density assists the Company in balancing traffic between eastbound and
westbound movements, reducing empty miles, and improving the reliability of
delivery schedules.
Covenant utilizes proven technology, including the Qualcomm OmnitracsTM and
SensortracsTM systems, to increase operating efficiency and improve customer
service and fleet management. The Omnitracs system is a satellite based tracking
and communications system that permits direct communication between drivers and
fleet managers. The Omnitracs system also updates the tractor's position every
30 minutes to permit shippers and the Company to locate freight and accurately
estimate pick-up and delivery times. The Company uses the Sensortracs system to
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monitor engine idling time, speed, and performance, and other factors that
affect operating efficiency. All of the Company's tractors have been equipped
with the Qualcomm systems since 1995 and the Company has added Qualcomm systems,
if necessary, to the tractors obtained in its acquisitions.
As an additional service to customers, the Company offers electronic data
interchange ("EDI"), which allows customers and the Company to communicate
electronically, permitting real-time information flow, reductions or
eliminations in paperwork, and fewer clerical personnel. With EDI customers can
receive updates as to cargo position, delivery times, and other information. It
also allows customers to communicate electronically delivery, local
distribution, and account payment instructions. Since 1997, the Company has used
a document imaging system to reduce paperwork and enhance access to important
information.
Drivers and Other Personnel
Driver recruitment, retention, and satisfaction are essential to Covenant's
success, and the Company has made each of these factors a primary element of its
strategy. Driver-friendly operations are emphasized throughout the Company. The
Company has implemented automatic programs to signal when a driver is scheduled
to be routed toward home, and fleet managers are assigned specific tractor
units, regardless of geographic region, to foster positive relationships between
the drivers and their principal contact with the Company. In addition, Covenant
has offered per-mile wage increases to Company drivers in 1996, 1997, and 1998
and continues to aggressively seek rate increases from customers in part to fund
higher driver pay.
Covenant differentiates its primary dry van business from many shorter-haul
truckload carriers by its use of driver teams. Driver teams permit the Company
to provide expedited service over its long average length of haul, because
driver teams are able to handle longer routes and drive more miles while
remaining within Department of Transportation ("DOT") safety rules. Management
believes that these teams contribute to greater equipment utilization than most
carriers with predominately single drivers. The use of teams, however, increases
personnel costs as a percentage of revenue and the number of drivers the Company
must recruit. At December 31, 1998, teams operated over 49.2% of the Company's
tractors. The tractors of Bud Meyer and SRT are operated primarily by single
drivers. The single driver fleets operate fewer miles per tractor and experience
more empty miles but these higher expenses are being offset by higher revenue
per loaded mile because of reduced employee expense and the benefits of
increased density on Company lanes.
Covenant is not a party to a collective bargaining agreement and its employees
are not represented by a union. At December 31, 1998, the Company employed 4,003
drivers and 755 nondriver personnel. Management believes that the Company has a
good relationship with its personnel.
Revenue Equipment
Management believes that operating high-quality, efficient equipment is an
important part of providing excellent service to customers. The Company's policy
is to operate its tractors while under warranty to minimize repair and
maintenance cost and reduce service interruptions caused by breakdowns. The
Company also orders most of its equipment with uniform specifications to reduce
its parts inventory and facilitate maintenance.
The Company's fleet of 2,608 tractors had an average age of 18 months at
December 31, 1998, and all tractors remained covered by manufacturer's
warranties. Management believes that a late model tractor fleet is important to
driver recruitment and retention and contributes to operating efficiency. The
Company utilizes conventional tractors equipped with large sleeper compartments.
At December 31, 1998, the Company owned 4,526 trailers. Over 83% of the
Company's trailers were 53-feet long by 102-inch wide, dry vans. The Company
also operated approximately 567 53-foot and approximately 186 48-foot
temperature-controlled trailers. At year end the trailers had a fleetwide
average age of 40 months.
Competition
The United States trucking industry is highly competitive and includes thousands
of for-hire motor carriers, none of which dominates the market. Service and
price are the principal means of competition in the trucking industry. The
Company targets primarily the market segment that demands just-in-time and other
premium services. Management believes that this segment generally offers higher
freight rates than the segment that is less dependent upon timely service and
4
that the Company's size and use of driver teams are important in competing in
this segment. The Company competes to some extent with railroads and rail-truck
intermodal service but differentiates itself from rail and rail-truck intermodal
carriers on the basis of service because rail and rail-truck intermodal
movements are subject to delays and disruptions arising from rail yard
congestion, which reduces the effectiveness of such service on traffic with
time-definite pick-up and delivery schedules.
Regulation
The Company is a common and contract motor carrier of general commodities.
Historically, the Interstate Commerce Commission (the "ICC") and various state
agencies regulated motor carriers' operating rights, accounting systems, mergers
and acquisitions, periodic financial reporting, and other matters. In 1995,
federal legislation preempted state regulation of prices, routes, and services
of motor carriers and eliminated the ICC. Several ICC functions were transferred
to the DOT. Management does not believe that regulation by the DOT or by the
states in their remaining areas of authority has had a material effect on the
Company's operations. The Company's employee and independent contractor drivers
also must comply with the safety and fitness regulations promulgated by the DOT,
including those relating to drug and alcohol testing and hours of service. The
DOT has rated the Company "satisfactory," which is the highest safety and
fitness rating.
The Company's operations are subject to various federal, state, and local
environmental laws and regulations, implemented principally by the Federal
Environmental Protection Agency and similar state regulatory agencies, governing
the management of hazardous wastes, other discharge of pollutants into the air
and surface and underground waters, and the disposal of certain substances. If
the Company should be involved in a spill or other accident involving hazardous
substances, if any such substances were found on the Company's property, or if
the Company were found to be in violation of applicable laws and regulations,
the Company could be responsible for clean-up costs, property damage, and fines
or other penalties, any one of which could have a materially adverse effect on
the Company. The Company does not have on-site underground fuel storage tanks at
any of its locations. Management believes that its operations are in material
compliance with current laws and regulations.
Fuel Availability and Cost
The Company actively manages its fuel costs by routing the Company's
drivers through fuel centers with which the Company has negotiated volume
discounts. Average fuel prices were lower in 1998 than 1997, and the cost of
fuel was below the level at which the Company received fuel surcharges. The
Company historically has been able to pass through most increases in fuel prices
and taxes to customers in the form of higher rates and surcharges, although
short-term fluctuations are not fully recovered. At December 31, 1998,
approximately 28.3% of the Company's projected 1999 purchases of fuel were
subject to hedging contracts.
ITEM 2. PROPERTIES
Covenant maintains eleven terminals located on its major traffic lanes in
Chattanooga, Tennessee; Lake City, Minnesota; Oklahoma City, Oklahoma; Fremont,
California; Dalton, Georgia; Pomona, California; Dallas, Texas; El Paso, Texas;
Delanco, New Jersey; Indianapolis, Indiana; and Ashdown, Arkansas. The terminals
provide driver recruiting centers, a base for drivers in proximity to their
homes, transfer locations for trailer relays on transcontinental routes, and
parking space for equipment dispatch and maintenance.
In 1996, the Company's headquarters and main terminal was relocated to
approximately 75 acres of property in Chattanooga, Tennessee. The facilities
include an office building of approximately 82,000 square feet, which houses all
of the Company's administrative and operations personnel, the Company's 45,000
square-foot principal maintenance facility, and a truck wash. The Company's
other maintenance facilities are Oklahoma City, Dalton, Lake City, and Ashdown.
The Company leased property in Chattanooga, Tennessee and in Greer, South
Carolina from related parties until June 1998 when both leases were terminated
without any further obligation by the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company from time to time is a party to litigation arising in the ordinary
course of its business, substantially all of which involves claims for personal
injury and property damage incurred in the transportation of freight. The
Company maintains insurance covering losses in excess of a $2,500 deductible
5
from cargo loss and physical damage claims, and losses in excess of a $5,000
deductible from personal injury and property damage. The Company maintains a
fully insured workers' compensation plan for its employees. Each of the primary
insurance policies has a limit of $1.0 million per occurrence, and the Company
carries excess liability coverage, which management believes is adequate to
cover exposure to claims at any level reasonably anticipated. The Company is not
aware of any claims or threatened claims that might materially adversely affect
its operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the year ended December 31, 1998, no matters were
submitted to a vote of security holders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
The Company's Class A Common Stock has been traded on the National Market under
the symbol "CVTI." The following table sets forth for the calendar periods
indicated the range of high and low sales price for the Company's Class A Common
Stock as reported by Nasdaq from January 1, 1997 to December 31, 1998.
Period High Low
Calendar Year 1997
1st Quarter $16.000 $11.250
2nd Quarter $18.125 $13.750
3rd Quarter $20.250 $16.250
4th Quarter $20.125 $14.750
Calendar Year 1998
1st Quarter $23.000 $14.375
2nd Quarter $23.313 $15.000
3rd Quarter $20.500 $9.188
4th Quarter $19.500 $9.250
As of March 26, 1999, the Company had approximately 46 stockholders of record of
its Class A Common Stock. However, the Company estimates that it has
approximately 2,000 stockholders because a substantial number of the Company's
shares are held of record by brokers or dealers for their customers in street
names.
Dividend Policy
The Company has never declared and paid a cash dividend on its common stock. It
is the current intention of the Company's Board of Directors to continue to
retain earnings to finance the growth of the Company's business rather than to
pay dividends. The payment of cash dividends is currently limited by agreements
relating to the Company's $100 million line of credit, $25 million in senior
notes due October 2005, and the operating lease covering the Company's
headquarters and terminal facility. Future payments of cash dividends will
depend upon the financial condition, results of operations, and capital
commitments of the Company, restrictions under then-existing agreements, and
other factors deemed relevant by the Board of Directors.
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ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
SELECTED FINANCIAL AND OPERATING DATA
(In thousands except per share
and operating data amounts)
Years Ended December 31,
---- ---- ---- ---- ----
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
Statement of Operations Data:
Revenue $131,926 $180,346 $236,267 $297,861 $370,546
Operating expenses:
Salaries, wages, and
related expenses 57,675 83,747 108,818 131,522 164,589
Fuel, oil, and road expenses 27,282 37,802 55,340 64,910 68,292
Revenue equipment rentals and
purchased transportation 2,785 1,230 605 8,492 24,250
Repairs 2,285 3,569 4,293 5,885 8,366
Operating taxes and licenses 3,479 4,679 6,065 7,514 9,393
Insurance 4,510 4,907 6,115 8,655 10,370
General supplies and expenses 8,650 9,648 12,825 16,277 19,397
Depreciation and
amortization 9,310 16,045 22,139 26,482 30,192
----- ------ ------ ------ ------
Total operating expenses 115,976 161,627 216,200 269,737 334,849
------- ------- ------- ------- -------
Operating income 15,950 18,719 20,067 28,124 35,697
Interest expense 4,736 4,162 5,987 6,274 5,924
------ ------ ------ ------ ------
Income before income taxes 11,214 14,557 14,080 21,850 29,773
Income tax expense 3,951 5,274 5,102 8,148 11,490
------ ------ ------ ------ ------
Net income (1) $ 7,263 $ 9,283 $ 8,978 $ 13,702 $ 18,283
======== ======== ======== ======== ========
Basic and diluted earnings
per share $ 0.69 $ 0.70 $ 0.67 $ 1.03 $ 1.27
Weighted average common
shares outstanding 10,496 13,350 13,350 13,360 14,393
Adjusted weighted average
common shares outstanding
and assumed conversions
outstanding 10,496 13,350 13,353 13,360 14,440
Balance Sheet Data:
Net property and equipment $ 87,882 $ 127,408 $144,384 $161,621 $200,537
Total assets 112,552 169,381 187,148 215,256 272,959
Long-term debt, less current
maturities 27,734 80,150 83,110 80,812 84,331
Stockholders' equity $ 63,469 $ 72,752 $ 81,730 $ 95,597 $141,522
Selected Operating Data:
Pretax Margin (2) 8.5% 8.1% 6.0% 7.3% 8.0%
Average revenue per loaded
mile (3) 1.09 1.09 1.10 1.13 1.18
Average revenue per total mile 1.03 1.03 1.04 1.07 1.10
Average length of haul in
miles 1,840 1,811 1,780 1,653 1,508
Average miles per tractor per
year 159,921 148,669 150,778 149,117 144,000
Average revenue per tractor
per week $ 3,165 $ 2,942 $ 2,994 $ 3,059 $ 3,045
Weighted average tractors for
year (4) 796 1,179 1,509 1,866 2,333
Total tractors at end of
period (4) 1,001 1,343 1,629 2,136 2,608
Total trailers at end of
period (4) 1,651 2,554 3,048 3,948 4,526
(1) Tenn-Ga Leasing, Inc. ("Tenn-Ga"), was a revenue equipment leasing company
formed by a related party to serve as a financing alternative for a portion of
the Company's revenue equipment prior to May 31, 1994. Tenn-Ga was an S
corporation and was not subject to federal and state corporate income taxes. If
Tenn-Ga had been subject to corporate income taxes in 1994, the Company's
consolidated pro forma net income would have been $7,038,000 in 1994. As a
result of the Company's acquisition of substantially all of Tenn-Ga's assets
effective May 31, 1994, the results of the Company and Tenn-Ga were not combined
in future periods.
(2) Because obtaining equipment from owner-operators and under operating leases
effectively shifts financial 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.
(3) Includes fuel surcharge in 1996 and 1997. Excluding the fuel surcharge,
the Company estimates that average revenue per loaded mile was $1.09 and $1.12
respectively.
(4) Includes monthly rental tractors and excludes monthly rental trailers.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
During the three year period ended December 31, 1998, the Company increased its
revenue at a compounded annual growth rate of 27.1%, as revenue increased to
$370.5 million in 1998 from $180.3 million in 1995. 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 four acquisitions during
the three-year period ended 1998. In August 1997, the Company acquired the
customer relationships of Trans-Roads, Inc., a $13 million annual revenue
carrier based near Atlanta, Georgia. In October 1997, the Company purchased all
of the outstanding capital stock of Bud Meyer, a $45 million annual revenue
temperature-controlled carrier based in Lake City, Minnesota. 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
Transport, Inc., a $23 million annual revenue truckload carrier and Tony Smith
Trucking, Inc., both located 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 33.4% to $18.3 million in
1998 from $13.7 million in 1997. Several factors contributed to the increase,
including declining fuel prices and negotiating higher freight rates from
substantially all 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 has taken in 1997 and 1998. Both Bud Meyer and
SRT operate 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. 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 also initiated the use of owner-operators of tractors in 1997 and
had contracted with approximately 175 owner-operators as of December 31, 1998.
Owner-operators provide a tractor and a driver and bear all operating expenses
in exchange for a fixed lease payment per mile. In addition, the Company does
not have the capital outlay of purchasing the tractor. In 1997, the Company also
financed approximately 240 tractors under operating leases. In 1998, the Company
financed an additional 185 tractors and 69 trailers under operating leases. The
lease payments to owner-operators and the financing of tractors under operating
leases appear as operating expenses 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.(*)
(*) May contain "forward looking" statements.
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The following table sets forth the percentage relationship of certain items to
revenue for each of the three years-ended December 31:
1996 1997 1998
---- ---- ----
Revenue 100.0% 100.0% 100.0%
Operating expenses:
Salaries, Wages, and related expenses 46.1 44.2 44.4
Fuel, oil and road expenses 23.4 21.8 18.4
Revenue equipment rentals and purchased
transportation 0.2 2.9 6.5
Repairs 1.8 2.0 2.3
Operating taxes and licenses 2.6 2.5 2.5
Insurance 2.6 2.9 2.8
General supplies and expenses 5.4 5.5 5.2
Depreciation and amortization 9.4 8.9 8.1
------ ------ ------
Total operating expenses 91.5 90.6 90.4
Operating income 8.5 9.4 9.6
Interest expense 2.5 2.2 1.6
------ ------ ------
Income before income taxes 6.0 7.3 8.0
Income tax expense 2.2 2.7 3.1
------ ------ ------
Net income 3.8% 4.6% 4.9%
====== ====== ======
COMPARISON OF YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997
Revenue increased $72.6 million (24.4%), to $370.5 million in 1998 from $297.9
million in 1997. The revenue increase was primarily generated by a 25.0%
increase in weighted average tractors, to 2,333 in 1998 from 1,866 in 1997, as
the Company expanded internally to serve new customers and higher volumes from
existing customers, as well as externally through the acquisitions of Bud Meyer
in October 1997, Gouge Trucking, Inc. in August 1998, and SRT in October 1998.
The Company's average revenue per loaded mile increased to approximately $1.18
in 1998 from $1.13 in 1997. The increase was attributable to per-mile rate
increases negotiated by the Company as well as higher revenue per loaded mile at
Bud Meyer. The increase in average revenue per loaded mile more than offset an
increase in the empty miles percentage. Revenue per total mile increased to
approximately $1.10 in 1998 from $1.07 in 1997.
Salaries, wages, and related expenses increased $33.1 million (25.1%), to $164.6
in 1998 from $131.5 million in 1997. As a percentage of revenue, salaries,
wages, and related expenses increased to 44.4% in 1998 from 44.2% in 1997.
Driver wages as a percentage of revenue decreased to 32.3% in 1998 from 32.7% in
1997 primarily because the use of owner-operators more than offset a $.025 per
mile pay increase for employee drivers that went into effect in April 1998.
Non-driving employee payroll expense increased to 5.5% of revenue in 1998 from
5.3% in 1997. Although the Company continued to reduce the number of non-driving
employees per tractor, a larger number of participants in the Company's bonus
program contributed to the increase. Health insurance, employer paid taxes, and
workers' compensation increased to 6.3% of revenue in 1998 from 6.1% in 1997.
The increase as a percentage of revenue was primarily the result of a higher
state unemployment tax rate in 1998 as compared to the 1997 tax rate.
Fuel, oil, and road expenses increased $3.4 million (5.2%), to $68.3 million in
1998 from $64.9 million in 1997. As a percentage of revenue, fuel, oil, and road
expenses decreased to 18.4% in 1998 from 21.8% in 1997. The increase reflects
the greater number of tractors in service in 1998. The decrease as a percentage
of revenue was primarily the result of improving fuel prices during 1998 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 expense category. Fuel surcharges were not in effect during 1998
and amounted to nearly $.01 per mile or approximately $2.4 million during 1997.
Revenue equipment rentals and purchased transportation increased $15.8 million
(185.5%), to $24.2 million in 1998 from $8.5 million in 1997. As a percentage of
revenue, revenue equipment rentals and purchased transportation increased to
6.5% in 1998 from 2.9% in 1997. During 1998, the Company increased its use of
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.
Expenses such as driver salaries, fuel, repairs, depreciation, and interest
9
normally associated with Company-owned equipment are consolidated in revenue
equipment rentals and purchased transportation when owner-operators are
utilized. The Company contracted with an average of 134 owner-operators during
1998. The Company also entered into operating leases for approximately 240
tractors during the fourth quarter of 1997 as well as 185 tractors and 69
trailers during 1998. The equipment leases will increase this expense category
in the future, while reducing depreciation and interest. The Company also formed
a logistics division in the fourth quarter of 1998 that is being reflected in
this expense category.(*)
Repairs increased $2.5 million (42.2%) to $8.4 million in 1998 from $5.9 million
in 1997. As a percentage of revenue, repairs increased to 2.3% in 1998 from 2.0%
in 1997. The increase was attributable to an increase in fleet size, a slight
increase in fleet age, the costs associated with preparing certain Bud Meyer
equipment for trade-in, as well as an increase in repairs related to the change
to a higher deductible limit under the Company 's physical damage insurance
($5,000 compared to $2,500).
Operating taxes and licenses increased $1.9 million (25.0%), to $9.4 million in
1998 from $7.5 million in 1997. As a percentage of revenue, operating taxes and
licenses remained essentially constant at 2.5% in the 1998 period and in the
1997 period.
Insurance, consisting primarily of premiums for liability, physical damage, and
cargo damage insurance, and claims, increased $1.7 million (19.8%), to $10.4
million in 1998 from $8.7 million in 1997. As a percentage of revenue, insurance
decreased to 2.8% in 1998 from 2.9% in 1997 as the Company continued to reduce
premiums per million dollars of revenue.
General supplies and expenses, consisting primarily of headquarters and other
terminal lease expense, driver recruiting expenses and communications and
utilities, increased $3.1 million (19.2%), to $19.4 million in 1998 from $16.3
million in 1997. As a percentage of revenue, general supplies and expenses
decreased to 5.2% in 1998 from 5.5% in 1997. The 1998 decrease as a percentage
of revenue is related to the termination of the lease of the former headquarters
as well as the fixed nature of a portion of these costs which was more
effectively spread over higher revenue.
Depreciation and amortization, consisting primarily of depreciation of revenue
equipment, increased $3.7 million (14.0%), to $30.2 million in 1998 from $26.5
million in 1997. As a percentage of revenue, depreciation and amortization
decreased to 8.1% in 1998 from 8.9% in 1997 as the Company utilized more owner
operators, leased more revenue equipment, and realized an increase in revenue
per tractor per week, which more efficiently spread this fixed cost over a
larger revenue base. 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 (5.6%), to $5.9 million in 1998 from
$6.3 million in 1997. As a percentage of revenue, interest expense decreased to
1.6% in 1998 from 2.2% in 1997 as the result of utilizing more owner-operators,
leasing more revenue equipment and averaging lower debt balances related to the
Company's secondary stock offering in April 1998.
As a result of the foregoing, the Company's pretax margin improved to 8.0% in
1998 from 7.3% in 1997.
The Company's effective tax rate was 38.6% in 1998 and 37.3% in 1997 due to the
Company paying taxes to a greater number of states.
As a result of the factors described above, net income increased $4.6 million
(33.4%), to $18.3 million in 1998 (4.9% of revenue) from $13.7 million in 1997
(4.6% of revenue).
(*) May contain "forward looking" statements.
10
COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996
Revenue increased $61.6 million (26.1%) to $297.9 million in 1997 from $236.3
million in 1996. The revenue increase was attributable to three primary factors.
First, the Company added tractors to meet demand from new and existing
customers. Second, the Company negotiated rate increases with customers of
approximately $.04 per loaded mile, net of fuel surcharges. Third, the Company
acquired the customer relationships of Trans-Roads, Inc., a $13 million annual
revenue dry van carrier in August 1997 and all the capital stock of Bud Meyer
Truck Lines, Inc., a $45 million annual revenue temperature-controlled carrier
in October 1997. Covenant operated 1,866 weighted average tractors during 1997
as compared with 1,509 during 1996, a 23.7% increase.
Salaries, wages, and related expenses increased $22.7 million (20.9%), to $131.5
in 1997 from $108.8 million in 1996. As a percentage of revenue, salaries,
wages, and related expenses decreased to 44.2% in 1997 from 46.1% in 1996.
Driver wages as a percentage of revenue increased to 35.0% in 1997 from 33.5% in
1996 primarily as a result of the pay increase that went into effect in May
1997. Non-driving employee payroll expense decreased to 5.3% of revenue in 1997
from 5.4% in 1996. Health insurance, employer paid taxes, and workers'
compensation decreased to 6.1% of revenue in 1997 from 6.8% in 1996. This was
primarily attributed to reduced worker's compensation premiums negotiated in
August 1997 with a fixed rate for a three-year period.
Fuel, oil, and road expenses increased $9.5 million (17.3%), to $64.9 million in
1997 from $55.3 million in 1996. As a percentage of revenue, fuel, oil, and road
expenses decreased to $21.8% in 1997 from 23.4% in 1996. The increase reflects
the greater number of tractors in service in 1997. The decrease as a percentage
of revenue was primarily a result of improving fuel prices during 1997. In
addition to decreased fuel prices, the fuel expense was further offset by fuel
surcharges charged to customers totaling $2.4 million in 1997 and $1.7 million
in 1996.
Revenue equipment rentals and purchased transportation increased $7.9 million
(1336.8%), to $8.5 million in 1997 from $0.6 million in 1996. As a percentage of
revenue, revenue equipment rentals and purchased transportation increased to
2.9% in 1997 from 0.2% in 1996. Revenue equipment rentals and purchased
transportation historically had represented payments under operating leases or
short term rentals of tractors and trailers. 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 had contracted with approximately 100 owner-operator at
December 31, 1997. In the fourth quarter of 1997, the Company also entered into
a sale and leaseback of 227 tractors, which will increase this expense in the
future, while reducing depreciation and interest.(*)
Repairs increased $1.6 million (37.1%), to $5.9 million in 1997 from $4.3
million in 1996. As a percentage of revenue, repairs increased 2.0% in 1997 from
1.8% in 1996. The increase was attributable to an increase in fleet size, a
slight increase in fleet age, and to repairs made to improve the condition of
equipment prior to sales and trades of older equipment acquired in the Bud Meyer
transaction.
Insurance, consisting primarily of premiums for liability, physical damage, and
cargo damage insurance, and claims, increased $2.5 million (41.5%), to $8.7
million in 1997 from $6.1 million in 1996. As a percentage of revenue, insurance
increased to 2.9% in 1997 from 2.6% in 1996. An increase in accident claims more
than offset a reduction in insurance premiums per million dollars of revenue.
General supplies and expenses, consisting primarily of headquarters and other
terminal lease expense, driver recruiting expenses, communications and agent
commissions, increased $3.5 million (26.9%), to $16.3 million in 1997 from $12.8
million in 1996. As a percentage of revenue, general supplies and expenses
remained essentially constant at 5.5% in 1997 compared with 5.4% in 1996.
(*) May contain "forward looking" statements.
11
Depreciation and amortization, consisting primarily of depreciation of revenue
equipment, increased $4.3 million (19.6%), to $26.5 million in 1997 from $22.1
million in 1996. As a percentage of revenue, depreciation and amortization
decreased to 8.9% in 1997 from 9.4% in 1996 as the Company utilized more owner
operators, leased more revenue equipment, and realized an increase in revenue
per tractor per week, which more efficiently spread this fixed cost over a
larger revenue base. Amortization expense relates to deferred debt costs
incurred and covenants not to compete from two 1995 asset acquisitions, as well
as goodwill from two 1997 acquisitions.
Interest expense increased $0.3 million (5.0%), to $6.3 million in 1997 from
$6.0 million in 1996. As a percentage of revenue, interest expense decreased to
2.1% in 1997 from 2.5% in 1996. Lower average debt balances more than offset
slightly higher average interest rates (7.2% in 1997 compared with 7.0% in 1996)
contributed to improving this expense item.
As a result of the foregoing, the Company's pretax margin improved to 7.3% in
1997 from 6.0% in 1996.
The Company's effective tax rate was 37.2% in 1997 and 36.2% in 1996.
As a result of the factors described above, net income increased $4.7 million
(52.6%), to $13.7 million in 1997 (4.6% of revenue) from $9.0 million in 1996
(3.8% of revenue).
Liquidity and capital resources
The growth of the Company's business has required significant investments in new
revenue equipment. The Company historically 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 December 31, 1998
were funds provided by operations, borrowings under its primary credit
agreement, which had maximum available borrowing of $100.0 million at December
31, 1998 (the "Credit Agreement") and the proceeds from a stock offering that
closed May 1998. 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 1998 were net
income increased by depreciation and amortization, and deferred income taxes.
The most significant use of cash provided by operations were to fund prepaid
expenses (primarily license plates for revenue equipment) and to finance
increases in receivables and advances associated with growth in the business.
The Company's number of days sales in accounts receivable increased from 43 days
in 1997 to 48 days in 1998. Net cash provided by operating activities was $39.9
million in 1998 and $45.2 million in 1997. The 1998 decrease resulted from
higher receivables associated with a billing delay caused by the Company's
imaging system (which has since been corrected).(*)
Net cash used in investing activities was $59.1 million in 1998 and $27.6
million in 1997. Such amounts were used primarily to acquire additional revenue
equipment as the Company expanded its operations. In addition, approximately
$1.0 million represented the purchase price for the assets of Gouge Trucking,
Inc. of which approximately $220,000 was allocated to goodwill and
covenants-not-to-compete, and approximately $6.3 million represented the
purchase price for the acquisition of SRT of which approximately $1.2 million
was allocated to goodwill. The Company expects capital expenditures (primarily
for revenue equipment), net of trade-ins, to be approximately $60 million in
1999 exclusive of acquisitions.(*)
The Company sold 1,540,000 shares of Class A Common Stock and certain
stockholders of the Company sold 960,000 shares in a public offering that closed
in May 1998. The Company received net proceeds of $27.5 million in connection
with the offering. The proceeds were used to reduce the Company's indebtedness
under the revolving line of credit. The indebtedness was incurred primarily to
acquire revenue equipment.
(*) May contain "forward looking" statements.
12
Net cash provided by financing activities was $19.5 million in 1998 and was
related primarily to proceeds from the sale of Company shares as well borrowings
under the Credit Agreement. This compared with net cash used in financing
activities of $18.5 million in 1997. At December 31, 1998, the Company had
outstanding debt of $86.3 million, primarily consisting of $54 million drawn
under the Credit Agreement, $25 million in 10-year senior notes, $3.5 million in
term equipment financing, $3 million interest bearing note to the former primary
stockholder of SRT related to the acquisition and $0.8 million in notes related
to non-compete agreements. Interest rates on this debt range 5.9% 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 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 .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 two years 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 on the second
anniversary date of the Credit Agreement (or any renewal). 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 December 31, 1998, the margin was .425%. The
Company has entered into interest rate swap agreements that fixed the interest
rate on $35 million of borrowing under the Credit Agreement at rates between
5.95% and 6.13% plus applicable margin. The swaps expire between February 26,
1999 and October 29, 1999.
In December 1997, the Company engaged in a sale-and-leaseback transaction
involving 199 of the Company's tractors that had been newly acquired or were
awaiting delivery. The proceeds of the sale were used to reduce debt under the
Credit Agreement. The Company entered into a three-year lease of the equipment,
with a 5.15% implied interest rate and a residual value guaranteed by the
Company at a level equal to the Company's salvage value on owned tractors.
The Company's headquarters facility was completed in December 31, 1996. The cost
of the approximately 75 acres and construction of the headquarters and shop
buildings was approximately $15 million. The Company financed the land and
improvements under a "build to suit" operating lease.
The Credit Agreement, senior notes, and the headquarters and terminal lease
agreement contain certain restrictions and covenants relating to, among other
things, dividends, tangible net worth, cash flow, acquisitions and dispositions,
and total indebtedness. All of these instruments are cross-defaulted. The
Company was in compliance with the agreements at December 31, 1998.
Inflation and Fuel Costs
Most of the Company's operating expenses are inflation-sensitive, with inflation
generally producing increased costs of operations. During the past three years,
the most significant effects of inflation have been on revenue equipment prices
and the compensation paid to the drivers. Innovations in equipment technology
and comfort have resulted in higher tractor prices, and there has been an
industry-wide increase in wages paid to attract and retain qualified drivers.
The Company historically has limited the effects of inflation through increases
in freight rates and certain cost control efforts. In addition to inflation,
fluctuations in fuel prices can affect profitability. Fuel expense comprises a
larger percentage of revenue for Covenant than many other carriers because of
Covenant's long average length of haul. Most of the Company's contracts with
customers contain fuel surcharge provisions. Although the Company historically
has been able to pass through most long-term increases in fuel prices and taxes
to customers in the form of surcharges and higher rates, shorter-term increases
are not fully recovered. At December 31, 1998, approximately 28.3% of the total
purchases of fuel by the Company were subject to hedging contracts. In March
1999, the percentage will decrease to approximately 20% and will be in effect
for the remainder of 1999 unless further action is taken by the Company.(*)
(*) May contain "forward looking" statements.
13
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.(*)
The table below sets forth quarterly information reflecting the Company's
equipment utilization (miles per tractor per period) during 1996, 1997 and 1998.
The Company believes that equipment utilization more accurately demonstrates the
seasonality of its business than changes in revenue, which are affected by the
timing of deliveries of new revenue equipment. The results in 1998 also were
affected by the acquisition of Bud Meyer and SRT, which operate primarily single
driver fleets and thus generate fewer miles per tractor. Results of any one or
more quarters are not necessarily indicative of annual results or continuing
trends.
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
1996 35,067 38,462 38,989 38,036
1997 34,389 37,325 38,850 38,314
1998 34,828 35,796 36,455 36,813
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, 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 has been 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 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.(*)
(*) May contain "forward looking" statements.
14
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
plans to be completed by June 30, 1999.(*)
ITEM 7A. 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 debts.
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.
Accordingly, the price and availability of diesel fuel can be unpredictable.
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. For 1998, diesel fuel
expenses represented 16.8% of the Company's total operating expenses. Based upon
the Company's 1998 fuel consumption, a ten percent increase in the average
annual price per gallon of diesel fuel would increase the Company's annual
diesel fuel expense by $5.3 million before considering the effect of fuel
hedging. The Company uses derivative instruments, including purchased
commitments through supplier, to reduce a portion of its exposure to fuel price
fluctuations. At December 31, 1998, the notional amount for purchased
commitments during 1999 was 13.2 million gallons. Net unrealized losses were
approximately $2.9 million. At December 28, 1998, the national average price of
diesel fuel as provided by the U.S. Department of Energy was $0.986 per gallon.
At December 31, 1998, a ten percent change in fuel prices would impact 1999 net
unrealized losses by approximately $1.1 million.
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
December 31, 1998, the Company had drawn $54.0 million under the Credit
Agreement. Approximately $19.0 million was subject to variable rates and the
remaining $35.0 million was subject to interest rate swaps that fixed the
interest rates at 5.95% and 6.13% plus applicable margin per annum. The swaps
expire between February 26, 1999 and October 29, 1999. Assuming the December 31,
1998 variable rate borrowings, each one percentage point increase in LIBOR would
increase the Company's pretax interest expense by $190,000.
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 transaction related exposures.
(*) May contain "forward looking" statements.
15
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's audited consolidated balance sheets, statements of income, cash
flows, and stockholders' equity, and notes related thereto, are contained at
Pages 21 to 32 of this report. The supplementary quarterly financial data
follows:
Quarterly Financial Data:
(In thousands except for share
data amounts)
Fourth Third Second First
Quarter Quarter Quarter Quarter
1998 1998 1998 1998
------- ------- ------- -------
Revenue $106,146 $95,566 $89,010 $79,824
Operating income 10,723 10,293 8,901 5,781
Income before taxes 9,185 8,910 7,358 4,320
Income taxes 3,582 3,463 2,799 1,645
Net income 5,603 5,447 4,559 2,675
Net income per share $ 0.38 $ 0.37 $ 0.32 $ 0.20
Fourth Third Second First
Quarter Quarter Quarter Quarter
1997 1997 1997 1997
------- ------- ------- -------
Revenue $ 89,905 $75,308 $70,060 $62,588
Operating income 8,837 7,888 7,118 4,282
Income before taxes 6,791 6,504 5,641 2,914
Income taxes 2,578 2,406 2,088 1,076
Net income 4,213 4,098 3,553 1,838
Net income per share $ 0.32 $ 0.31 $ 0.27 $ 0.14
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
No reports on Form 8-K have been filed within the twenty-four months prior to
December 31, 1998, involving a change of accountants or disagreements on
accounting and financial disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information respecting executive officers and directors set forth under
the captions "Election of Directors Information Concerning Directors and
Executive Officers" and "Compliance with Section 16(a) of the Securities
Exchange Act of 1934" on Pages 2 to 3 and Page 12 of the Registrant's Proxy
Statement for the 1999 annual meeting of stockholders, which will be filed with
the Securities and Exchange Commission in accordance with Rule 14a-b promulgated
under the Securities Exchange Act of 1934, as amended (the "Proxy Statement") is
incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information respecting executive compensation set forth under the caption
"Executive Compensation" on Pages 5 to 7 of the Proxy Statement is incorporated
herein by reference; provided, that the "Compensation Committee Report on
Executive Compensation" contained in the Proxy Statement is not incorporated by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information respecting security ownership of certain beneficial owners
and management set forth under the caption "Security Ownership of Principal
Stockholders and Management" on Pages 9 and 10 of the Proxy Statement is
incorporated herein by reference.
16
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information respecting certain relationships and transactions of
management set forth under the captions "Compensation Committee Interlocks and
Insider Participation" and "Certain and Relationships and Related Transactions"
on Page 4 of the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements.
The Company's audited consolidated financial statements are set forth at the
following pages of this report:
Report of Independent Accountants...........................................20
Consolidated Balance Sheets.................................................21
Consolidated Statements of Income...........................................22
Consolidated Statements of Stockholders' Equity.............................23
Consolidated Statements of Cash Flows.......................................24
Notes to Consolidated Financial Statements..................................25
2. Financial Statement Schedules.
Financial statement schedules are not required because all required information
is included in the financial statements.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the fourth quarter ended December
31, 1998.
(c) 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.
10.3++ 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.
10.8+ Incentive Stock Plan filed as Exhibit 10.9.
10.9+ 401(k) Plan filed as Exhibit 10.10.
10.12+++ Note Purchase Agreement dated October 15, 1995, among Covenant
Transport, Inc., a Tennessee corporation and CIG & Co.
10.13+++ First Amendment to Credit Agreement and Waiver dated October 15,
1995.
10.14++++ 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.
10.15++++ Second Amendment to Credit Agreement and Waiver dated April 12,
1996.
10.16++++ First Amendment to Note Purchase Agreement and Waiver dated April 1,
1996.
10.17+++++ Third Amendment to Credit Agreement and Waiver dated March 31, 1997,
filed as Exhibit 10.11.
10.18+++++ Waiver to Note Purchase Agreement dated March 31, 1997, filed as
Exhibit 10.12.
10.19# Second Amendment to Note Purchase Agreement dated December 30, 1997.
10.20# Fourth Amendment to Credit Agreement dated December 31, 1997.
17
10.21# 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.
10.22 Stock Purchase Agreement made and entered into as of October 5,
1998, by and among Covenant Transport, Inc., a Nevada corporation;
Smith Charitable Remainder Trust; Southern Refrigerated Transport,
Inc., an Arkansas corporation; Tony Smith Trucking, Inc., an
Arkansas corporation; and Tony and Kathy Smith, husband and wife and
residents of Arkansas.
21 List of subsidiaries.
23.1 Consent of PricewaterhouseCoopers LLP, independent accountants.
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.
# Files 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.
18
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities 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: March 26, 1999
By: /s/ Joey B. Hogan
Joey B. Hogan
Treasurer and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Position Date
/s/ David R. Parker Chairman of the Board, President, and
David R. Parker Chief Executive Officer (principal
executive officer) March 26, 1999
/s/ Joey B. Hogan Treasurer and Chief Financial Officer
Joey B. Hogan (principal financial and accounting
officer) March 26, 1999
/s/ R. H. Lovin, Jr.
R. H. Lovin, Jr. Director March 26, 1999
/s/ Michael W. Miller
Michael W. Miller Director March 26, 1999
/s/ William T. Alt
William T. Alt Director March 26, 1999
/s/ Robert E. Bosworth
Robert E. Bosworth Director March 26, 1999
/s/ Hugh O. Maclellan, Jr.
Hugh O. Maclellan, Jr. Director March 26, 1999
/s/ Mark A. Scudder
Mark A. Scudder Director March 26, 1999
19
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Covenant Transport, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Covenant
Transport, Inc. and its subsidiaries at December 31, 1997 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Knoxville, Tennessee
February 3, 1999
20
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
1997 1998
---- ----
ASSETS
------
Current assets:
Cash and cash equivalents $ 2,609,520 $ 2,926,135
Accounts receivable, net of allowance of
$810,000 in 1997 and $1,064,788 in 1998 37,792,308 51,789,018
Drivers advances and other receivables 964,575 2,476,044
Tire and parts inventory 1,120,684 1,928,639
Prepaid expenses 3,773,556 5,324,921
Deferred income taxes 1,111,000 1,674,485
------------ ------------
Total current assets 47,371,643 66,119,242
Property and equipment, at cost 228,931,936 282,358,419
Less accumulated depreciation and amortization 67,310,934 81,821,335
----------- ------------
Net property and equipment 161,621,002 200,537,084
Other 6,263,491 6,302,525
------------ ------------
Total assets $215,256,136 $272,958,851
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt 1,565,639 1,943,485
Accounts payable 5,328,346 3,485,098
Accrued expenses 9,073,554 12,913,953
Accrued income tax 724,815 1,404,172
------------ ------------
Total current liabilities 19,746,708
Long-term debt, less current maturities 80,811,783 84,331,368
Deferred income taxes 22,155,000 27,358,848
------------ ------------
Total liabilities 119,659,137 131,436,924
Stockholders' equity:
Class A common stock, $.01 par value;
20,000,000 shares authorized; 11,010,250
and 12,560,250 shares issued and
outstanding as of 1997 and 1998, respectively 110,103 125,603
Class B common stock, $.01 par value;
5,000,000 shares authorized; 2,350,000 shares
issued and outstanding as of 1997 and 1998 23,500 23,500
Additional paid-in-capital 50,634,369 78,260,928
Retained earnings 44,829,027 63,111,896
------------ ------------
Total stockholders' equity 95,596,999 141,521,927
------------ ------------
Total liabilities and stockholders' equity $215,256,136 $272,958,851
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
21
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1997, AND 1998
1996 1997 1998
---- ---- ----
Revenue $236,266,945 $297,861,080 $370,545,721
Operating expenses:
Salaries, wages, and related expenses 108,817,623 131,521,804 164,589,088
Fuel, oil, and road expenses 55,340,234 64,910,201 68,291,653
Revenue equipment rentals and purchased
transportation 604,924 8,492,445 24,249,704
Repairs 4,293,141 5,884,881 8,366,205
Operating taxes and licenses 6,064,652 7,514,241 9,393,176
Insurance 6,114,526 8,655,465 10,369,687
General supplies and expenses 12,825,287 16,276,834 19,397,219
Depreciation and amortization, including
gain on disposition of equipment 22,139,456 26,481,578 30,192,060
------------ ------------ ------------
Total operating expenses 216,199,843 269,737,449 334,848,792
------------ ------------ ------------
Operating income 20,067,102 28,123,631 35,696,929
Interest expense 5,987,148 6,273,324 5,924,486
------------ ----------- ------------
Income before income taxes 14,079,954 21,850,307 29,772,443
Income tax expense 5,102,000 8,148,000 11,489,574
------------ ------------ ------------
Net income $ 8,977,954 $ 13,702,307 $ 18,282,869
============ ============ ============
Basic and diluted earnings per share:
Net income $0.67 $1.03 $1.27
============ ============ ============
Weighted average shares outstanding 13,350,000 13,360,000 14,393,000
Adjusted weighted average shares
outstanding and assumed conversions
outstanding 13,352,528 13,360,000 14,440,000
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
22
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997, and 1998
Series I Class A Class B Additional Total
Preferred Common Common Paid-In Retained Stockholders'
Stock Stock Stock Capital Earnings Equity
--------- --------- -------- --------- --------- --------
Balances at January 1, 1996 $ -- $110,000 $ 23,500 $50,469,596 $22,148,766 72,751,862
Net income -- -- -- -- 8,977,954 8,977,954
--------- --------- -------- ----------- ----------- -------------
Balances at December 31, 1996 -- 110,000 23,500 50,469,596 31,126,720 81,729,816
Exercise of employee
stock options -- 103 -- 164,773 -- 164,876
Net income -- -- -- -- 13,702,307 13,702,307
--------- --------- -------- ----------- ---------- -------------
Balances at December 31, 1997 -- 110,103 23,500 50,634,369 44,829,027 95,596,999
Exercise of employee
stock options -- 100 -- 156,650 -- 156,748
Secondary offering,
net of offering expenses -- 15,400 -- 27,469,909 -- 27,485,311
Net income -- -- -- -- 18,282,869 18,282,869
--------- --------- -------- ----------- ----------- -------------
Balances at December 31, 1998 $ -- $ 125,603 $ 23,500 $78,260,928 $63,111,896 $ 141,521,927
========= ========= ======== =========== =========== =============
The accompanying notes are an integral part of these consolidated financial
statements.
23
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997, AND 1998
1996 1997 1998
----- ---- ----
Cash flows from operating activities:
Net income $ 8,977,954 $ 13,702,307 $ 18,282,869
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for losses on receivables 407,655 457,665 455,953
Depreciation and amortization 22,781,481 27,363,501 32,074,888
Deferred income tax expense 4,050,000 4,354,000 4,146,233
Gain on disposition of property and
equipment (642,025) (881,922) (1,882,829)
Changes in operating assets and
liabilities:
Receivables and advances 3,010,662 (2,580,948) (12,554,211)
Prepaid expenses (1,088,845) 200,113 (1,074,453)
Tire and parts inventory (78,626) (155,794) (617,349)
Accounts payable and accrued
expenses 1,707,242 2,786,653 1,071,815
------------ ----------- ------------
Net cash flows provided by operating
activities 39,125,498 45,245,575 39,902,916
Cash flows from investing activities:
Acquisition of property and equipment (49,142,303) (54,027,486) (80,302,553)
Proceeds from disposition of property
and equipment 10,219,276 32,023,244 27,760,409
Acquisition of intangibles -- (1,250,000) (220,000)
Acquisition of business- Bud Meyer(1) -- (4,350,442) --
Acquisition of business- SRT(2) -- -- (6,295,405)
------------ ------------ ------------
Net cash flows from investing activities (38,923,027) (27,604,684) (59,057,549)
Cash flows from financing activities:
Proceeds from equity offering -- -- 27,485,311
Exercise of stock option -- 164,876 156,748
Proceeds from issuance of long-term debt 3,000,000 -- 84,000,000
Repayments of long-term debt (40,000) (18,563,513) (92,093,557)
Deferred debt issuance cost (132,216) (124,277) (77,254)
------------ ------------ ------------
Net cash flows provided by/(used in)
financing activities 2,827,784 (18,522,914) 19,471,248
------------ ------------ ------------
Net change in cash and cash equivalents 3,030,255 (882,023) 316,615
Cash and cash equivalents at beginning
of period 461,288 3,491,543 2,609,520
============ ============ ============
Cash and cash equivalents at end of
period $ 3,491,543 $ 2,609,520 $ 2,926,135
============ ============ ============
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Interest $ 5,905,000 $ 6,147,050 $ 6,021,291
============ =========== ============
Income taxes $ 795,000 $ 2,927,376 $ 5,675,225
============ =========== ============
(1) Acquisition of business presented net of acquired cash of $347,688 and
receivable from officer of acquired company of $501,870.
(2) Acquisition of business presented net of acquired cash of $1,454,595 and
a note payable to former shareholder of Southern Refrigerated Transport, Inc.
and Tony Smith Trucking, Inc. in the amount of $3,000,000.
The accompanying notes are an integral part of these consolidated financial
statements.
24
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business - Covenant Transport, Inc. (the "Company") is a long-haul
truckload carrier that offers premium transportation services, such as team and
refrigerated services, to customers throughout the United States.
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company, a holding company incorporated in the state of Nevada
in 1994, and its wholly-owned operating subsidiaries, Covenant Transport, Inc.,
a Tennessee corporation, Bud Meyer Truck Lines, Inc., ("Bud Meyer") a Minnesota
corporation, Southern Refrigerated Transport, Inc., an Arkansas corporation,
Tony Smith Trucking, Inc. (Southern Refrigerated Transport, Inc. and Tony Smith
Trucking, Inc. shall be referred to collectively as "SRT"), Covenant Leasing,
Inc., a Nevada corporation, Covenant Acquisition Co., a Nevada corporation, and
Intellectual Property Co., a Nevada Corporation. All significant intercompany
balances and transactions have been eliminated in consolidation.
Revenue Recognition - Revenue, drivers' wages and other direct operating
expenses are recognized on the date shipments are delivered to the customer.
Cash and Cash Equivalents - The Company considers all highly liquid investments
with a maturity of three months or less when purchased to be cash equivalents.
Tires and Parts Inventory - Tires on new revenue equipment are capitalized as a
component of the related equipment cost when the vehicle is placed in service
and recovered through depreciation over the life of the vehicle. Replacement
tires and parts on hand at year end are recorded at the lower of cost or market
with cost determined using the first-in, first-out method.
Replacement tires are expensed when placed in service.
Intangible Assets - The Company periodically evaluates the net realizability of
the carrying amount of intangible assets. Non-compete agreements are amortized
over the life of the agreement, deferred loan costs are amortized over the life
of the loan and goodwill is amortized over periods ranging from 20 to 40 years.
Property and Equipment - Depreciation is calculated on the straight-line method
over the estimated useful lives of the assets. Revenue equipment is depreciated
over five to seven years with salvage values ranging from 25% to 33 1/3%. In
accordance with industry practices, gains or losses on disposal of revenue
equipment are included in depreciation in the statements of income.
Impairment of Long-Lived Assets - The Company ensures that long-lived assets to
be disposed of are reported at the lower of the carrying amount or the fair
market value less costs to sell. The Company evaluates the carrying value of
long-lived assets for impairment losses by analyzing the operating performance
and future cash flows for those assets. The Company adjusts the net book value
of the underlying assets if the sum of expected cash flows is less than book
value.
Capital Structure - The shares of Class A and B Common Stock are substantially
identical except that the Class B shares are entitled to two votes per share.
The terms of any future issuances of preferred shares will be set by the Board
of Directors.
Insurance and Other Claims - Losses resulting from claims for personal injury,
property damage, cargo loss and damage, and other sources are covered by
insurance, subject to deductibles. Losses resulting from uninsured claims are
recognized when such losses are known and estimable.
Interest Rate Swaps - Interest rate swaps are entered into as a hedge against
interest exposure of variable rate debt. The differences to be paid or received
on swaps are included in interest expense. The fair value of the Company's
interest rate swap agreements is based on dealer quotes. These values represent
the amounts the Company would receive or pay to terminate the agreements taking
into consideration current interest rates.
Concentrations of Credit Risk - The Company performs ongoing credit evaluations
of its customers and does not require collateral for its accounts receivable.
The Company maintains reserves which management believes are adequate to provide
for potential credit losses. The Company's customer base spans the continental
United States.
25
Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
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.
2. OTHER ASSETS
A summary of other assets as of December 31, 1997 and 1998 is as follows:
1997 1998
---- -----
Covenants not to compete $ 1,575,000 $ 1,400,000
Deferred costs 614,812 692,193
Goodwill 2,488,832 3,842,441
Less accumulated amortization of
intangibles (588,542) (950,409)
Split dollar life insurance 556,877 608,553
Cash surrender value of life
insurance 106,078 239,750
Other 1,510,434 469,997
----------- ------------
$ 6,263,491 $ ,6,302,525
============= ============
3. PROPERTY AND EQUIPMENT
A summary of property and equipment, at cost, as of December 31, 1997 and 1998
is as follows:
1997 1998
---- ----
Revenue equipment $ 207,990,788 $256,766,668
Land and improvements 4,425,629 7,611,058
Buildings and leasehold improvements 3,135,866 2,641,786
Communications equipment 8,466,052 10,021,341
Other 4,913,601 5,317,566
------------- ------------
$ 228,931,936 $282,358,419
============= ============
26
4. LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1997 and 1998:
1997 1998
---- ----
Borrowings under $100 million
credit agreement $ 52,000,000 $ 54,000,000
10-year senior notes 25,000,000 25,000,000
Notes to unrelated individuals for
non-compete agreements 1,060,000 810,000
Equipment and vehicle obligations
with commercial lending
institutions, with fixed interest 4,317,422 3,464,853
rates ranging from 5.9% to 10.8% at 1998
Note payable to former SRT shareholder
interest bearing interest at 6.5% with
interest payable quarterly -- 3,000,000
------------- -------------
82,377,422 86,274,853
Less current maturities 1,565,639 1,943,485
------------- -------------
$ 80,811,783 $ 84,331,368
============= =============
The Company is party to a credit agreement with a group of banks with maximum
borrowings of $100 million with $25 million additional borrowing available upon
satisfaction of certain criteria. Borrowings related to revenue equipment are
limited to the lesser of 90% of the net book value of revenue equipment or $55
million. Working capital borrowings are limited to 85% of eligible accounts
receivable. Letters of credit are limited to an aggregate commitment of $10
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 floats between 0.10% and
0.25% per annum based on a ratio of total debt to trailing cash flow coverage is
due on the daily unused portion of the credit agreement. At December 31, 1998,
the fee was 0.125% per annum. The credit agreement is guaranteed by Covenant
Transport, Inc., a Nevada corporation, Bud Meyer Truck Lines, Inc., a Minnesota
corporation, Southern Refrigerated Transport, Inc., an Arkansas corporation,
Tony Smith Trucking, Inc., an Arkansas corporation, Covenant Leasing, Inc., a
Nevada corporation, Covenant Acquisition Co., a Nevada corporation, and
Intellectual Property Co., a Nevada Corporation.
The credit agreement revolves for 1998 and 1999 and then has a term out in 2000.
Payments for interest are due quarterly in arrears with principal payments due
in 12 equal quarterly installments beginning on the second anniversary of the
date of the credit agreement. The Company renewed the loan in December 1997 and
anticipates renewing the line of credit on an annual basis. Borrowings under the
credit agreement generally accrue interest based on one, two, or three month
LIBOR rates plus an applicable margin that is adjusted quarterly between .325%
and .75% based on a ratio of total debt to trailing cash flow coverage. At
December 31, 1998, the margin was .425%.
A $25 million interest rate swap agreement was completed in February 1997 that
expires February 1999 at 6.125% plus the applicable margin. During October 1997
the Company entered into an interest swap agreement with a fixed interest rate
on $10 million of the borrowing under the credit agreement at 5.95% plus the
applicable margin for two years. The fair value of the two interest swap
agreements was ($53,047) and ($39,191) at December 31, 1998. All remaining
borrowings under the credit agreement are at one, two, or three month LIBOR.
Senior notes with an insurance company are due October 2005. The term agreement
requires payments for interest semi-annually in arrears with principal payments
due in four equal annual installments beginning October 1, 2002. The notes are
collateralized by all accounts of the Company. Interest accrues at 7.39% per
annum.
The credit agreement and senior note agreement subject the Company to certain
restrictions and covenants related to, among others, dividends, tangible net
worth, cash flow, acquisitions and dispositions, and total indebtedness.
27
Maturities of long term debt at December 31, 1998 are as follows:
1999 $ 1,943,485
2000 $ 55,249,307
2001 $ 904,354
2002 $ 177,707
2003 $ --
5. RELATED PARTY TRANSACTIONS
Transactions involving related parties not otherwise disclosed herein are as
follows:
During 1997 and 1998, the Company sold certain of its used tractors and trailers
to corporations owned by related parties for an aggregate of approximately
$1,161,000 in 1997 and $768,000 in 1998. In all cases, the Company received
amounts equal to, or in excess of, the trade-in amounts guaranteed by the
tractor manufacturer or fair values listed in industry trailer publications.
In June 1997 the Company obtained a promissory note in the amount of $480,000
from a related party. The principal and related interest at the rate of 7% was
paid in full in May 1998. The Company also contracted with a related party for
airplane services in the amount of $262,940 during 1998.
6. LEASES
The Company has operating lease commitments for office and terminal properties,
revenue equipment, exclusive of owner/operator rentals, computer and office
equipment, and month-to-month equipment rentals, summarized for the following
fiscal years:
1999 $ 9,851,221
2000 $ 8,559,603
2001 $ 3,934,513
2002 $ 1,021,833
2003 $ 1,021,833
Rental expense is summarized as follows for each of the three years ended
December 31:
1996 1997 1998
---- ---- ----
Revenue equipment rentals $ 338,283 $ 1,618,973 $ 5,640,365
Owner/operator rentals -- 6,860,853 18,166,671
Terminal rentals 606,424 1,503,523 1,277,164
Other equipment rentals 505,062 1,181,589 1,289,497
----------- ----------- -----------
$ 1,449,769 $11,164,938 $26,373,697
=========== =========== ===========
During April 1996, the Company entered into an agreement to lease its
headquarters and terminal in Chattanooga under an operating lease. The lease
provides for rental payments to be variable based upon LIBOR interest rates for
five years. The Company entered into an agreement with the lessor to fix the
rental payments from January 1997 until July 2000 at approximately $77,000 per
month.
Covenant leased property in Chattanooga, Tennessee from the principal
stockholder of the Company. Effective July 1, 1997, the monthly rental was
approximately $15,000 per month. The Company also leased a property at Greer,
South Carolina for annual rent of $12,000 from the principal stockholder.
Effective June 1998, these two leases were terminated by the principal
stockholder without any penalties or additional payments coming due.
Included in terminal rentals are payments of $237,664, $224,172, and $78,905 for
the years ended December 31, 1996, 1997, and 1998, respectively, to the
principal stockholder of the Company.
28
7. INCOME TAX EXPENSE
Income tax expense for the years ended December 31, 1996, 1997, and 1998 is
comprised of:
1996 1997 1998
---- ---- ----
Federal, current $ 795,000 $3,940,000 $ 5,076,047
Federal, deferred 3,984,000 3,531,000 4,196,206
State, current 257,000 263,000 1,773,164
State, deferred 66,000 414,000 444,157
---------- ---------- ----------
$5,102,000 $8,148,000 $11,489,574
========== ========== ===========
Income tax expense varies from the amount computed by applying the federal
corporate income tax rate of 35% to income before income taxes for the years
ended December 31, 1996, 1997 and 1998 as follows:
1996 1997 1998
---- ---- ----
Computed "expected" income tax
expense $4,928,000 $7,648,000 $10,420,000
Adjustments in income taxes
resulting from:
State income taxes, net of
federal income tax effect 183,000 440,000 944,574
Permanent differences and other,
net (9,000) 60,000 125,000
---------- --------- -----------
Actual income tax expense $5,102,000 $8,148,000 $11,489,574
========== ========== ===========
The temporary differences and the approximate tax effects that give rise to the
Company's net deferred tax liability at December 31, 1997 and 1998 are as
follows:
1997 1998
---- ----
Deferred tax assets:
Accounts receivable $ 292,000 $ 181,436
Accrued expenses 1,111,000 1,674,485
Loss carryforwards 3,595,000 0
Alternative minimum tax credits 5,473,000 4,778,446
Investment tax credits 82,000 82,000
carryforward
Intangible assets 126,000 221,513
----------- -----------
10,679,000 6,937,880
Deferred tax liability:
Depreciation 31,723,000 32,622,243
----------- -----------
Net deferred tax liability 21,044,000 25,684,363
Portion reflected as current asset 1,111,000 1,674,485
=========== ===========
Deferred tax liability $22,155,000 $27,358,848
=========== ===========
The Company has available for federal income tax purposes an investment tax
credit carryforward of $82,000, which expires in 2001.
29
8. CONTINGENCIES AND COMMITMENTS
The Company, in the normal course of business, is involved in certain legal
matters for which it carries liability insurance. It is management's belief that
the losses, if any, from these lawsuits will not have a materially adverse
impact on the financial condition, operations, or cash flows of the Company.
Financial risks which potentially subject the Company to concentrations of
credit risk consist of deposits in banks in excess of the Federal Deposit
Insurance Corporation limits. The Company's sales are generally made on account
without collateral. Repayment terms vary based on certain conditions. The
Company maintains reserves which management believes are adequate to provide for
potential credit losses. The majority of the Company's customer base spans the
United States. The Company monitors these risks and believes the risk of
incurring material losses is remote.
The Company has entered into minimum purchase agreements for the purchase of
diesel fuel. Price is determined on a quarterly basis based on the weighted
average cost over the previous quarter. The agreements expire in 1999.
9. EARNINGS PER SHARE
The following table sets forth for the periods indicated the calculation of net
earnings per share included in the Company's Consolidated Statement of Income:
1996 1997 1998
---- ---- ----
Numerator:
Net Income $ 8,977,954 $13,702,307 $18,282,869
Denominator:
Denominator for basic earnings
per share - weighted-average
shares 13,350,000 13,360,000 14,393,000
Effect of dilutive securities:
Employee stock options 2,528 -- 47,000
=========== =========== ==========
Denominator for diluted earnings
per share - adjusted
weighted-average shares and assumed 13,352,528 13,360,000 14,440,000
conversions ========== =========== ==========
Basic earnings per share: $ 0.67 $ 1.03 $ 1.27
=========== =========== ==========
Diluted earnings per share $ 0.67 $ 1.03 $ 1.27
=========== =========== ==========
10. DEFERRED PROFIT SHARING EMPLOYEE BENEFIT PLAN
The Company has a deferred profit sharing and savings plan that covers
substantially all employees of the Company with at least six months of service.
Employees may contribute up to 17% of their annual compensation subject to
Internal Revenue Code maximum limitations. The Company may make discretionary
contributions as determined by a committee of the Board of Directors. The
Company contributed approximately $464,000, $538,000, and $873,000 in 1996,
1997, and 1998, respectively, to the profit sharing and savings plan.
11. INCENTIVE STOCK PLAN
The Company has two employee stock plans. Awards may be in the form of incentive
stock awards or other forms. The Company has reserved 859,750 shares of Class A
Common Stock for distribution at the discretion of the Board of Directors.
During October 1994, the Company granted options to purchase 122,500 shares
which are exercisable at the fair market value on the date of grant ($16.50) and
vest at varying dates through October 1999. During June 1996, the Company
30
granted options to purchase 267,500 shares which are exercisable at the fair
market value on the date of grant ($15.50) and vest at varying dates through
June 2001. During 1997 the Company granted options to purchase 149,000 shares
which are exercisable at the fair market value on the date of the grant
(weighted average of $16.43) and vest at varying dates through December 2002.
During 1998 the Company granted options to purchase 298,250 shares which are
exercisable at the fair market value on the date of the grant (weighted average
of $12.21) and vest at varying dates through November 2003. The options expire
10 years from the date of grant. The following table details the activity of the
incentive stock option plan:
1996 1997 1998
---- ---- ----
Balance January 1 117,000 383,250 501,500
Granted 267,500 149,000 298,250
Exercised -- (10,250) (10,000)
Canceled (1,250) (20,500) (20,000)
---------- -------- --------
Balance December 31 338,250 501,500 769,750
---------- -------- --------
Exercisable December 31 82,500 151,000 212,800
For the year ended December 31,1997, 10,250 options were exercised at an average
price of $16.09. For the year ended December 31,1998, 10,000 options were
exercised at an average price of $15.68. As of December 31,1998, the Company has
769,750 options outstanding with exercise prices which range from $10.38 to
$19.06 with an average price of $14.56 and average remaining life of 8 years.
The average exercise price of options exercisable at December 31, 1996, 1997,
and 1998 was $16.50, $15.98, and $15.90, respectively.
The Company accounts for its stock-based compensation plans under APB No. 25,
under which no compensation expense has been recognized because all employee
stock options have been granted with the exercise price equal to the fair value
of the Company's Class A Common Stock on the date of grant. The Company adopted
SFAS No. 123 for disclosure purposes only in 1996. Under SFAS No. 123, fair
value of options granted are estimated as of the date of grant using the
Black-Scholes option pricing model and the following weighted average
assumptions: risk-free interest rate of 5.5%, for 1995 to 1997 grants and 5.0%
for 1998 grants; expected life of 5 years; dividend rate of zero percent; and
expected volatility of 18.5% for 1995, 1996 and 1997 and 42.0% for 1998. Using
these assumptions, the fair value of the employee stock options granted in 1997
and 1998 is $600,000 and $1.2 million, respectively, which would be amortized as
compensation expense over the vesting period of the options. Had compensation
cost been determined in accordance with SFAS No. 123, utilizing the assumptions
detailed above, the Company's net income and net income per share would have
been reduced to the following pro forma amounts for the years ended December 31,
1997 and 1998:
1997 1998
---- ----
Net Income:
As reported $13,702,307 $18,282,869
Pro forma 13,402,696 17,736,350
Net income per share:
As reported $ 1.03 $ 1.27
Pro forma 1.00 1.23
12. BUSINESS COMBINATIONS
In October 1997 the Company purchased all of the outstanding stock of Bud Meyer.
The acquisition of Bud Meyer has been accounted for under the purchase method of
accounting. Accordingly, the operating results of Bud Meyer have been included
in the consolidated operating results since the date of acquisition. The
purchase price of $5,200,000, net of cash received of $347,688 and a receivable
from an officer of Bud Meyer to the acquired company of $501,870 has been
allocated to the net assets acquired based on appraised fair values at the date
of acquisition.
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In August 1997, the Company purchased certain intangible assets of Trans-Roads,
Inc. for $2,250,000, of which $1,000,000 will be paid out over the next five
years.
In October 1998 the Company purchased all of the outstanding stock of SRT. The
acquisition of SRT has been accounted for under the purchase method of
accounting. Accordingly, the operating results of SRT have been included in the
consolidated operating results since the date of acquisition. The purchase price
of $10,750,000, net of cash received of $1,454,595 and note payable in the
amount of $3 million to a former shareholder of SRT has been allocated to the
net assets acquired based on appraised fair values at the date of acquisition as
follows:
Property and equipment $ 15,929,256
Current assets 3,222,351
Goodwill 1,233,609
Accounts payable and accrued (1,604,693)
expenses
Deferred taxes (494,130)
Notes payable (11,990,988)
==============
$ 6,295,405
==============
The unaudited pro forma operating data for the Company, assuming the acquisition
of Bud Meyer occurred January 1, 1996 and assuming the acquisition of SRT
occurred January 1,1997.
1996 1997 1998
---- ---- ----
(unaudited) (unaudited) (unaudited)
Revenues $281,269,621 $356,918,523 $390,978,491
Net Income 9,531,607 13,991,530 18,745,805
Net earnings per share
Basic and diluted $ 0.71 $ 1.05 $ 1.30
The unaudited pro forma information is presented for informational purposes only
and is not necessarily indicative of the operating results that would have
occurred had the acquisitions been consummated as of the above date, nor are
they indicative of future operating results.
In August 1998, the Company purchased certain assets of Gouge Trucking, Inc. for
$1,047,405, of which $100,000 will be paid out over the next year.
32