Excuse me, everyone, we now have our speakers in conference [Operator Instructions] I would now like to turn the conference over to Richard Cribbs. Please begin. .

All right. Thank you, Victoria. Good morning. Welcome to our third quarter conference call. Joining me on the call this morning are David Parker and Joey Hogan. .

As a reminder, this conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements.

Please review our disclosures and filings with the SEC, including, without limitation, the Risk Factors section in the most recent Form 10-K. We undertake no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. .

A copy of our prepared comments and additional financial information is available on our website at covenanttransport.com. Our prepared comments will be brief, and then we will open up the call for questions. .

our Truckload segment's revenue, excluding fuel, increased 25.7% to $168.4 million, due primarily to a 547 or 21.6% average truck increase and a 6.1% increase in average rate revenue per truck in the 2018 period as compared to the 2017 period, partially offset by a $2.7 million year-over-year reduction in intermodal revenues.

Of the 547 increased average trucks, 428 average trucks were contributed by the Landair acquisition, as Landair contributed $18.4 million of revenue -- freight revenue to combined truckload operations in the third quarter of 2018. .

Versus the year-ago period, average rate revenue per total mile was up $0.277 per mile or 16.4% and our average miles per tractor were down 8.9%. Truckload rates were impacted favorably, and utilization was impacted unfavorably by the impact of the Landair operations on the combined Truckload segment.

Landair shorter average length of haul and dedicated contract solo-driven truck operations generally produce higher revenue per total mile and fewer miles per tractor than our other truckload business units. .

Versus the prior year quarter, freight revenue per tractor at our Covenant Transport subsidiary experienced an increase of 8.4%. Our SRT subsidiary experienced an increase of 18.1%, and our Star subsidiary experienced an increase of 4.2%. .

The Truckload segment operating cost per mile, net of surcharge revenue, were up approximately $0.179 per mile compared to year-ago period. This was mainly attributable to higher employee wages, casualty insurance claims cost and the impact of the Landair truckload operations' higher cost per mile model.

These increases were partially offset by lower net fuel costs and net depreciation expense as we recognized a small gain on disposal of equipment totaling $300,000 in the third quarter of 2018 versus a loss of $700,000 in the third quarter of 2017. .

The Truckload segment's adjusted operating ratio was 92.6% in the third quarter of 2018 compared with 95.1% in the third quarter of 2017. .

Our Managed Freight segment's total revenue increased 80.9% versus the year-ago quarter to $46.3 million from $25.6 million. Of the $20.7 million of increased total revenue, Landair contributed $20.4 million of revenue to combined Managed Freight operations in the third quarter of 2018.

The Managed Freight segment's adjustment OR was 90.5% in the third quarter of 2018 compared with 90.3% in the third quarter of 2017. The result was an increase of Managed Freight operating income contribution to $4.2 million in the current year quarter from $2.5 million in the prior year quarter. .

Our minority investment in Transport Enterprise Leasing contributed $2.1 million to pretax earnings or $0.08 per share. The average age of our tractor fleet continues to be young at 2.3 years as of the end of the quarter, slightly up from 2.2 years a year ago. .

In connection with the July 3 acquisition of Landair, we expended $83 million in cash and assumed $15.5 million of Landair's outstanding debt, which we have paid in full. Between December 31, 2017, and September 30, 2018, total balance sheet indebtedness, net of cash, increased by only $17.6 million to $216 million.

At September 30, 2018, our stockholders' equity was $326.2 million for a ratio of net debt to total balance sheet capitalization of 39.8%, which compares favorably to the 40.2% ratio as of December 31, 2017, even with the cash expended for the Landair acquisition.

In addition, our leverage ratio has improved to 1.5x as of September 30, 2018, from 1.9x as of December 31, 2017. .

one, the successful strategic addition of Landair, meeting our stated objective of entering into closer relationships with our customers and getting deeper in the supply chain; two, improvement in the operating profitability at each of our Truckload segment subsidiaries; three, an approximate 10% increase in average rate revenue per truck for our Truckload segment, excluding Landair's truckload operation, versus the same quarter of 2017; and four, improved year-over-year earnings from our investment in Transport Enterprise Leasing.

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The main negative in the quarter was increased truckload operating cost on a per mile basis, most notably the unfavorable employee wages and casualty insurance claims cost, partially offset by lower net fuel cost and improved net depreciation expense. .

Our fleet experienced an increase to 3,077 trucks by the end of September, a 445 truck increase from our reported fleet size of 2,632 trucks at the end of June. Of the 445 truck increase, 413 of those trucks were operated at Landair, which we acquired in July.

A large portion of the remaining growth was a 36 truck or 13% increase of independent contractor trucks to 312 trucks by the end of September from 276 trucks at the end of June. Our fleet of team-driven trucks averaged 880 teams in the third quarter of 2018, a small increase from 878 average teams in the second quarter of 2018. .

We expect the overall balance of business conditions to remain favorable through the fourth quarter of 2018 and into 2019. Freight demand has been and remains strong across our business units and indications from our holiday peak customers or peak season customers indicate robust expectations for the fourth quarter.

From a capacity perspective, attracting and retaining highly qualified OTR professional truck drivers remains our largest challenge. Low unemployment, alternative careers and an aging driver population are creating the competitive environment.

In this environment, we continue to work actively with our customers to improve driver comp, efficiency and working conditions while providing a high level of service and generating acceptable financial returns.

We intend to continue to allocate our assets where the returns are justified and use our managed freight units to supplement our internal capacity. .

Along with the Landair acquisition, we've increased our capital allocation to organically grow our dedicated truckload, 3PL and other managed freight solutions. As of September 31, 2018, the percentage of our truckload fleet operating under dedicated contracts was 1,535 trucks, representing 50% of our fleet.

This compares to a year ago when only 827 of our trucks or 32% of our fleet operated under dedicated contracts.

We believe the dedicated contract fleet provides a stronger partnership with our customers as we integrate deeper into their supply chains, offers more consistent and seasonably managed -- seasonally manageable freight volume, reduces earnings volatility of the cyclical freight economy and provides a favorable drivers' experience for professional drivers who desire greater consistency.

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For the fourth quarter, we'll remain a major participant in the holiday peak shipping season and anticipate our consolidated adjusted operating ratio and consolidated adjusting earnings per diluted share to improve compared with the fourth quarter of 2017.

However, due to changes in team versus solo driver mix, dedicated versus irregular route capacity and managed freight capacity as well as the impact of the Landair transaction, we're not offering more specific earnings guidance. Thanks for your time. .

And we'll now open up the call for any questions. .

[Operator Instructions] Our first question comes from Kevin Sterling with Seaport Global Securities. .

Let me just -- can I just ask a big picture here? As you guys travel the country and meet with your shippers and your customers, what are they telling you? Particularly as you think about 2019 and the capacity they may need, what are they saying regarding this environment? Are they seeing a slowdown? And they've probably have more insight than anyone.

Just curious maybe if you could just share with us big picture some customer conversations you're having. .

Kevin, I guess, the way I would sum it up is that I believe, whether it's our business or our customers' business and which have been quite a few customers there in the quarter, I would say that it's -- that second quarter was a 4.2% GDP, and let's say that third quarter, when it comes out, I personally believe it's probably around 3.5% GDP.

A number that we all would love, a number that we all will think is very good and strong, but it's not 4.2% in the second quarter. And that has been a way I would describe. They are very happy. They are very -- the state of the business is strong.

But they have seen a little bit of a slowdown, but only because it wasn't the second quarter kind of numbers they were seeing. I think we've also learned that there was definitely there in second quarter a push-forward of tariffs. Tariffs caught freight, as I think about imports from China as well as on the sales side of the business.

And I do believe that people were getting ahead of it. Even as I think about our parts for our Class A trucks and trying to get their hands on some of that product, there was definitely a purchase early on in the second quarter that there in the third quarter, I believe, they had even out the numbers.

But every customer I have seen, which is numerous ones there in the third quarter, are very, very happy with their business environment. .

Got you. That's great. Then let me ask you about some of the revenue synergies you're seeing with Landair. Obviously, that looks like to be a good acquisition, and you guys kind of hit your stride there.

So as we think about revenue synergies with Landair, what can we expect? And more importantly, what can Covenant bring to Landair? And on the flip side, what can Landair bring to Covenant as we think about this acquisition heading into 2019?.

Kevin, this is Joey. I think what I would -- there's a couple of points I would make. A, the integration of 2 operations has gone exceptionally well. In my long career, I've never -- a lot of transactions, I've never seen the integration go as well as it has. And I'm not saying that braggingly.

I'm just saying that as an observation, the attitudes and the energy to grow, to get the best out of both operations has been off the charts in my opinion.

Number two, I think that because of the Landair business model, which is much more, let's say, we keep using the definition of supply chain and further in the supply chain is much deeper than CTG as a whole was before. So their lead time for new business is much longer than what you would call CTG prior to Landair. That's just because of what it does.

It's dedicated, its warehousing, magic freight, things of that nature. So the onboarding of new business takes longer and so -- and then on the CTG side, you have what we call an enterprise sales team. It's more focused on one-way.

And so the synergies are between the 2 sales forces what I would call lead generation and the lead generation between the 2. And I believe that, that is going exceptionally well, very great in that. And so it takes some time on both parties to get immediate wins. I think the wins will start in 2019.

But we have seen some small wins, especially on the brokerage side from either their sales force into the brokerage opportunities where we are seeing some small wins already. I think the pipeline is building quickly.

I think the Landair sales team and me or us personally, we've been a little surprised that John and his team's energy about the automotive segment as far supply chain work. It's a large segment for CTG prior to Landair, getting opportunities into second- and third-tier suppliers and receptivity of that with some of those shippers has been good.

David has been personally engaged with that. And so I'm cautiously optimistic as far as what that could bring us. So I think on the sales generation side, we're early. I think the sales structures have been put in place. The lead generation pipeline and workflow has been put in place.

The 2 leaders of those 2 organizations are collaborating exceptionally well, in my opinion, exceptionally well. And so I think we're going to -- it's going to be neat to see how 2019 unfolds. Our small, what we would call, 3PL piece of business has been transitioned to Landair's team.

Their small brokerage operation has been transitioned to the CTG brokerage operation. And then other than that, we're up and running. So I think the short answer, Kevin, it's early. We're very, very excited about what we see, top line starting to develop.

I think Landair -- inside of Landair, it's going to grow faster than it has in the last 2 to 3 years with some capital constraints. And so Landair looking, let's call it Landair, John has a team looking for Landair type opportunities. It's only going to accelerate as we grow that operation, as we grow that sales team.

The capital constraints have been, what I will call, lifted for that business. .

I think to Joey's point on that, you see in the numbers through what we just read through the script that Landair had about $40 million of reported revenues in the third quarter.

As you compare that to the pro forma that we filed a few weeks ago for last year and then for the first 6 months, you'll see that, that's really nice growth and above what the rest of the business is growing our legacy business. .

Got you. No, that's very helpful. As we think about your dedicated business, I think you said dedicated now was like 50% of your fleet, seeing tremendous growth there. Your shippers continue to look for dedicated capacity as a way to lock in capacity.

Do you anticipate your dedicated business to continue to grow from these levels? And maybe, I don't know, at the expense of one-way trucking, if that makes sense, but I'd imagine dedicated will continue to grow. And it's also a way for you guys to keep your drivers home at night more often and give them a scheduled service.

But as we think about the next couple of years, do you have an idea in mind what percent dedicated could be of your fleet? Is there a limit on it where you'd like to get to or... .

Yes, I'd tell you, when you put the lead question at CTG that says how do we get deeper in the supply chain, so we never become or we at least eliminate as much as you can, "you call, we haul." A customer calls, I got a load. Okay, I'm going to go pick it up.

How do you get deeper? How are you going to make sure you're bringing value to that customer, that you are truly a partner with them. And that's the reason for the Landair acquisition was because of that. And we're going to continue to go in that direction. We're going to continue to get deeper into the supply chain.

And one of the areas is the dedicated. And to make sure that we've got nice long-term contracts and we're doing a great job on that side and we will continue to grow that. I mean, we've got internal targets that we're just in the process of meeting with our companies as we speak right now to make sure that we're all on the same thought process.

But I expect next year to be another couple of hundred trucks on the dedicated side of our business. And again, it's to get deeper. So as we look at ours and the kind of the segmentation that we've got out there, and that is capacity, contract management, the Landair, warehousing. TMS is a big portion that is going to be there.

The dedicated side, then our expedited side where our customers are really needing us on the expedited, because we're performing a service that not everybody can perform. And then lastly, the refrigerated side of the business. And I would say that we're probably up to 70% of that freight is freight that if a recession hit.

It's not going to be hurt as dramatically as what we were a year ago and definitely what we were 2 years ago. And so we're going to continue doing that and continue to grow that at the sake of just the OTR, "you call, we haul" mentality. .

Got you, got you. The "you call, we haul" landscape is littered with companies where that didn't work, as you know. .

Yes. .

Yes.

So lastly on dedicated, how do you feel about those contracts now you're signing? Are they pretty staggered throughout the next couple of years, so not all rolling over at once? How should we think about the duration and kind of how these contracts are staggered?.

Yes, yes, that is something that we've absolutely -- because of the growth that we've been working on and we've been doing at -- we've got 2, 3 folks from the Landair side as well as the CTG side that is running with that effort, and it's in pretty good shape.

I mean, we've got to go internally by the end of the first quarter that we've got about -- out of 1,500 trucks, we've got about 300 trucks that we want to shore up a little bit better.

And actually I was in Detroit last week, and about half of those trucks are ones that -- we don't have nothing signed yet, but I'm 98% that we're going to be there that are kind of on a bid-by-bid transaction that will become a minimum of a 3-year contract. So most of our accounts are owned 3 or longer year contracts.

We do have one that our Star company has had for 25 years. They've had it for 25 years, but the contract is not as good as what we want. So we've already talked to them. We're going to visit them again. I think we will have to accept getting there. So -- but it's in pretty good shape.

And I think by the end of the first quarter, that we're all thinking that we're in excellent shape. And it's kind of about a 25% a year kind of number that over the next 3 years that -- 3 or 4 years it comes due on negotiations. And our goal was to put positions in there, out clauses.

I mean, because at the end of the day, if you give them 70% on time [ performance ] , you need to be kicked out. And so the contract allows that you've got to make sure that you're giving the service or they can tell you goodbye tomorrow.

So assuming that then they're late because of business purpose is to get out of it then there's either penalties or those clauses in the contracts that say, over the next quarter, you're can reduce, whatever, 20%, 25%, the next quarter, 25%, the next quarter, that kind of way.

At least it gives us an opportunity to find a home for those trucks that were not hit with 400 trucks, just because we entered into a recession. .

And Kevin, the majority of those contracts do have either significant financial or operational or both penalties related to them. And the staggering effect of the contract maturities is over 60% would not be -- would not mature next year, 70% would mature next year or have the opportunity to without some significant penalties. .

Your next question comes from Scott Group with Wolfe Research. .

I wanted to just start off on sort of the first question just about the environment.

Maybe can you talk, David, just sort of more monthly trends and sort of what you're seeing so far in October from a demand and capacity standpoint?.

Yes. We came out of June, the end of the second quarter and everybody was on fire. And to be honest with you, an unhealthy fire. I mean, when your customers cannot get their freight delivered, that is not good. That's not good for me and you. Eventually it's going to bite us all in the bottom and you can't make anybody happy and those kind of things.

From a service standpoint, when they've got 20 loads and you've got 1 truck and they have put all their eggs in your basket. And that's the way the trucking industry was in the second quarter. We definitely started seeing in -- as of the July 4 and around the July 10, there definitely was a moderation.

I don't want to use the word slowdown, because I already used 4.2% to 3.5%, and I think anybody on this call would say that's a great quarter, we'll take it, give it to me right now, and tell me that is what I'm going to have for the next 4 quarters and we'll all be happy with that.

But we definitely saw that say those 20 loads I used as an example plus 20 with 1 truck, it became a plus 10 with 1 truck in the month of July. And in the month of August, that number probably became kind of a plus 5 for 1 truck.

So it's still healthy, and we were still moving our trucks in pretty good shape but there will be days in the week that, oh, I need 3 more loads in Dallas today or I need 5 more loads in New Jersey today. But tomorrow, I am overbooked. So that's the way that the month of August and actually probably until the middle of September was going.

And then we started seeing the middle of September starting to come back, and we started seeing early, early peak. But I don't want to say it's material, but good. Some good numbers that peak started for us, say, in latter part of the month of September. Of course, then you had the hurricanes that hit South Carolina and Florida.

And the hurricanes produced for us about 50% of what it produced last year to give you an idea in terms of revenue. So I mean, it helps, but -- I mean, from a financial standpoint, excuse me, I'm not taking death lightly, but just strictly trucking, it definitely has no comparison to what it was last September, last October.

And since then, as to the middle of September, it just continues to ratchet up, continues to get strong. And I'm very, very, very pleased with the way I'm seeing the freight environment. And we're just now starting -- I mean, I'll now say that we're 10% in the peak, to give you an idea.

And over -- between now and Black Friday, Cyber Monday is really when peak will start at that time. So we're just at the beginning stages of it, and I'm very, very pleased with the freight environment. .

So if we went from a 20 to a 10 to a 5, where are we now? And then just as I think about the cycle broadly, what's a number that would concern you in that sort of example you're giving?.

Yes, that's a good question. I would say using that number, I would say that we're back up to the 10 kind of number. But we're very quickly here about the first week of November, I think our number will be back to 20. And that number will proceed to go to about 50 until about 20th of December.

And what does concern me, when it becomes negative, I mean, which is a January, February event that we all live with and we all know that, that happens. But that's where it starts, you're really having to work. .

Okay, that's really helpful. I think last quarter, you talked about 7 to 8% sort of as an initial guess or gut for 2019 pricing.

What would be your sort of updated views today?.

Yes, and I'm -- and talking just on the truckload, because one of the things that, Scott, that we got -- I got to get my hands around and we're playing with numbers, because we're just now starting to process a quarter into the Landair acquisition.

And from the truckload environment, from the Covenant, SRT, the Star, the OTR, Landair, I said 7% to 8% and I'm more probably that 6% to 7% kind of number, I've dropped it down about 1% because of July and August and the business starting getting stronger, et cetera, but 6% to 7%.

And again, that has nothing to do with all this managed freight and all that kind of stuff. So actually I'll have to defer that to Richard to see if that's going to be separated or all thrown into the bucket together. .

Yes, and that will be separate from what we're reporting on... .

Okay. Yes. 6% to 7% for '19. .

Okay, that's helpful. And then just last question, I think when you did the Landair announcement, there were 430 trucks.

How many trucks are there today? And anything changing in terms of -- is the seated count going higher, lower post the deal?.

The number ended at 413 for the end of the quarter. And some of that is they have some trucks that run over in the warehousing area and doing shuttling and those kinds of things. And they get real low miles, they're running around the warehouses and they're not included in that count.

This is just -- the 413 is what we consider in our Truckload segment that has reported utilization and the rates are comparative there. And so some of that's just kind of transitioning where they're needed. And so it's still probably -- we would expect kind of 420 to 430 for the fourth quarter.

And then next year, just depending on what kind of dedicated growth we have and the -- because there Landair's dedicated would be included in the Truckload side. .

Okay.

So you're not seeing any sort of turnover issues or driver issues there?.

It's been excellent. Matter of fact, the -- they've done a great job at Landair. They were in good shape. I mean, their numbers were -- they're kind of running that 2.5% to 3.5% open. And it's more since we've had them. And of course, we've had [ issues ] to deal with it. It's just -- they've been very blessed on their team.

But they're at that 1.5% to 2% open. So it's better than the rest of our companies. And so they've done a great job on filling already a low number open percentage, to even a lower number.

And so one of the things that we're working on now is to make sure that all of CTG drivers realize some of the job openings that are throughout the company just to make sure that if we got even the team expedited, the entire running the team expedited, market or refrigerated market, and they want to be home on a nightly or weekly basis, those kind of things, there's a lot of Landair opportunities there.

So we've got to -- we're just now starting that process, but they're already in good shape. .

Our next question comes from Jason Seidl with Cowen. .

I wanted to touch on 2 things, one, a little bit on the cost side. I mean, you called out some casualty costs and then some driver costs.

I'm assuming the casualty costs are more onetime and nature related to some accidents? Is that the right way of looking at it?.

Well, I hope so. We've kind of been trending up a little bit versus last year anyway just on a cost basis. And then this quarter, we actually had decent frequency where our accident per million miles were kind of equal-ish to slightly down on a DOT basis versus last year quarter. So we had more accidents that involved third parties or outside parties.

And so that really did drive the cost up. I don't think that there is a root cause that, that would continue. So I am hopeful that, that's not a trend and that we should expect to see that number come back down. .

Okay. That's good to hear. On the driver side, David, you pontificated on the 6% to 7% on the pricing side for 2019.

What about the driver pay? What should we expect going forward on driver pay cost?.

It's interesting. And one of the things -- number one, it will continue to go up. But I will say, as I think about our companies and various ones did various different things. But the May, which was our second to third driver pay increase for this year, was in the month of May.

And when we raised that, it did something, it allowed us to get more drivers and seated about 1% more trucks that are seated than there was. And so it definitely assisted and helped us. So we definitely hit a number in the month of May that allowed us to get some more drivers.

So we definitely -- will probably not be the same percentage in 2019 as was done in 2018, but it will be some number. I would be safe to say that it's probably a 3%, 4%, 5% kind of number for driver pay increases. And then we'll see what happens, see what kind of success we have on that and then go from there. .

And Jason, this year, rate increases have been double digits, kind of 12 percentage, 13%, 14%, however you want to look at it. And driver pay has been similar, kind of 10% to 12% increases as well. And so I think that if our number of 6% to 7% rate increases, then that 4% to 5% could be 6% to 7%.

So maybe the range is really 4% to 7% kind of number on driver pay increases, which again is passing along probably about 40% to 50% of the margin that we get in the rate. .

Listen, that's great color, guys. I want to take it back on my last question here on SRT. It wasn't long ago where you guys were less than satisfied with some of the numbers coming out of there. And you put a new management team, changed operation.

Can you give us an update on how well that's going?.

Yes, Jason, this is Joey. I think that, a, it's come a long, long way in the last year. I think its overall margin included, what we call, [ slightly prorated, come a long way, say, over 200 basis points ] improvement versus the same quarter a year ago. We still think there's some opportunity there. Now that includes dedicated.

So all the companies have been aggressively growing its dedicated fleet. So I think the management team has done a really, really good job. I think there's still some more opportunity there. There's no question.

I think the nondriving workforce has stabilized greatly, which I think is a big part that we -- we haven't talked to a bunch about it actually internally as a key to the success for our team in Texarkana.

So that stabilized greatly, which I think is significant as we look -- work through this kind of, let's call, the last group of operating efficiencies that we need to get through. So if I look across the enterprise, there's still opportunities, but it's not what it was.

But I would say there's another, let's call it, 500 to 700 points of operating ratio -- 5% of points of ratio opportunity on the table for a good fleet. And so I think the pricing has done exceptionally well. We've closed that gap. It's just [ cost banks ] that we need to close there.

But really plays -- there's some good opportunity, and I think that 2019 will get really close to what it could be. .

5 to 7 points still seems like a decent amount of improvement left there. Well, gentlemen, listen, I appreciate the time as always and nice quarter. .

Our next question comes from Brad Delco with Stephens. .

Guys, this is actually Scott Schoenhaus on for Brad. Just wanted to follow up on any unusual merger-related costs in the quarter.

Just trying to see if there was a negative effect on the OR at all from this merger from unusual cost items perspective?.

Yes, Scott, they're very, very small, not even $0.01 a share. We basically had most of that collected in the second quarter and we called that out at that time. So other than the intangible amortization that we have now reconciled to give you a GAAP versus non-GAAP adjusted OR and EPS number, there really wasn't anything. .

So just $0.01, if that. .

Yes, if that, if that. I mean, we have some extra travel cost as we're getting to know each other and all those kind of things. But it's not -- it's nothing material at all. .

And I guess, my follow-up would be, I know Scott Group asked about your rate expectations heading into next year's bid.

Are you seeing any customers pulling their bids forward? We've heard a lot about that, and I just want to see from your end if you're seeing your shippers just trying to pull forward their bids ahead of their usual timing of next year, early?.

No, I have not seen that. .

Thank you. And I'm showing there are no further questions. .

All right. Well, we'll wrap it up then. Thank you for everyone calling in, and we'll talk to you again next quarter. Thank you. .

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect..