Attached files

file filename
EX-10.1 - EXHIBIT 10.1 (SIXTEENTH AMENDMENT TO THIRD AMENDED AND RESTATED CREDIT AGREEMENT - COVENANT TRANSPORTATION GROUP INCexhibit101.htm
EX-32.2 - EXHIBIT 32.2 (SECTION 906 CERTIFICATION - RICHARD B. CRIBBS) - COVENANT TRANSPORTATION GROUP INCexhibit322.htm
EX-32.1 - EXHIBIT 32.1 (SECTION 906 CERTIFICATION - DAVID R. PARKER) - COVENANT TRANSPORTATION GROUP INCexhibit321.htm
EX-31.2 - EXHIBIT 31.2 (SECTION 302 CERTIFICATION - RICHARD B. CRIBBS) - COVENANT TRANSPORTATION GROUP INCexhibit312.htm
EX-31.1 - EXHIBIT 31.1 (SECTION 302 CERTIFICATION - DAVID R. PARKER) - COVENANT TRANSPORTATION GROUP INCexhibit311.htm
EX-2.1 - EXHIBIT 2.1 (LANDAIR STOCK PURCHASE AGREEMENT) - COVENANT TRANSPORTATION GROUP INCexhibit21.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018
or

[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                       to

Commission File Number:  0-24960


COVENANT TRANSPORTATION GROUP, INC.
(Exact name of registrant as specified in its charter)
Nevada
 
88-0320154
(State or other jurisdiction of incorporation
 
(I.R.S. Employer Identification No.)
or organization)
   
     
400 Birmingham Hwy.
   
Chattanooga, TN
 
37419
(Address of principal executive offices)
 
(Zip Code)

423-821-1212
(Registrant's telephone number, including area code)

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 whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes [X]
No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [   ]
 
Accelerated filer [X]
Non-accelerated filer   [   ]
Smaller reporting company [   ]
 
Emerging growth company [   ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   [   ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [   ]
No [X]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date (November 6, 2018).
Class A Common Stock, $.01 par value: 15,996,066 shares
Class B Common Stock, $.01 par value:   2,350,000 shares

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION
   
Page
Number
Item 1.
Financial Statements
 
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8
     
Item 2.
24
     
Item 3.
40
     
Item 4.
41
     
 
PART II
OTHER INFORMATION
   
Page
Number
     
Item 1.
42
     
Item 1A.
42
     
Item 2.
42
     
Item 3.
42
     
Item 4.
42
     
Item 5.
42
     
Item 6.
43
 
 
 
PART I          FINANCIAL INFORMATION

ITEM 1.          FINANCIAL STATEMENTS

COVENANT TRANSPORTATION GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
 
ASSETS
 
September 30, 2018
(unaudited)
   
December 31, 2017
(unaudited)
 
Current assets:
           
Cash and cash equivalents
 
$
19,612
   
$
15,356
 
Accounts receivable, net of allowance of $1,817 in 2018 and $1,460 in 2017
   
134,957
     
104,153
 
Drivers' advances and other receivables, net of allowance of $672 in 2018 and $496 in 2017
   
15,340
     
15,062
 
Inventory and supplies
   
4,337
     
4,232
 
Prepaid expenses
   
12,045
     
8,699
 
Assets held for sale
   
1,325
     
1,444
 
Income taxes receivable
   
1,585
     
11,551
 
Other short-term assets
   
2,333
     
1,817
 
Total current assets
   
191,534
     
162,314
 
                 
Property and equipment, at cost
   
635,909
     
650,988
 
Less: accumulated depreciation and amortization
   
(187,144
)
   
(186,916
)
Net property and equipment
   
448,765
     
464,072
 
                 
Goodwill
   
41,086
     
-
 
Other intangibles, net
   
33,269
     
-
 
Other assets, net
   
32,828
     
23,282
 
Total assets
 
$
747,482
   
$
649,668
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Checks outstanding in excess of bank balances
   
605
     
-
 
Accounts payable
   
21,488
     
11,857
 
Accrued expenses
   
47,797
     
26,520
 
Current maturities of long-term debt
   
27,643
     
24,596
 
Current portion of capital lease obligations
   
5,074
     
2,962
 
Current portion of insurance and claims accrual
   
24,785
     
15,042
 
Other short-term liabilities
   
-
     
243
 
Total current liabilities
   
127,392
     
81,220
 
                 
Long-term debt
   
169,037
     
164,465
 
Long-term portion of capital lease obligations
   
33,877
     
21,777
 
Insurance and claims accrual
   
16,291
     
21,836
 
Deferred income taxes
   
73,347
     
63,344
 
Other long-term liabilities
   
1,388
     
1,825
 
Total liabilities
   
421,332
     
354,467
 
Commitments and contingent liabilities
   
-
     
-
 
Stockholders' equity:
               
Class A common stock, $.01 par value; 20,000,000 shares authorized; 15,996,066 shares issued and outstanding as of September 30, 2018 and 15,979,703 shares issued and outstanding as of December 31, 2017
   
171
     
171
 
Class B common stock, $.01 par value; 5,000,000 shares authorized; 2,350,000 shares issued and outstanding
   
24
     
24
 
Additional paid-in-capital
   
140,404
     
137,242
 
Accumulated other comprehensive income
   
1,487
     
293
 
Retained earnings
   
184,064
     
157,471
 
Total stockholders' equity
   
326,150
     
295,201
 
Total liabilities and stockholders' equity
 
$
747,482
   
$
649,668
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
COVENANT TRANSPORTATION GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(In thousands, except per share data)

   
Three months ended
September 30,
(unaudited)
   
Nine months ended
September 30,
(unaudited)
 
   
2018
   
2017
   
2018
   
2017
 
Revenue:
                       
Freight revenue
 
$
214,623
   
$
159,500
   
$
535,721
   
$
445,212
 
Fuel surcharge revenue
   
28,680
     
19,131
     
77,466
     
56,489
 
Total revenue
 
$
243,303
   
$
178,631
   
$
613,187
   
$
501,701
 
                                 
Operating expenses:
                               
Salaries, wages, and related expenses
   
86,249
     
60,732
     
211,621
     
178,639
 
Fuel expense
   
33,428
     
25,998
     
89,817
     
76,310
 
Operations and maintenance
   
16,457
     
13,046
     
40,783
     
37,504
 
Revenue equipment rentals and purchased transportation
   
47,445
     
36,361
     
115,525
     
90,719
 
Operating taxes and licenses
   
3,377
     
2,364
     
8,649
     
7,197
 
Insurance and claims
   
12,675
     
7,681
     
31,269
     
24,313
 
Communications and utilities
   
1,810
     
1,747
     
5,216
     
5,081
 
General supplies and expenses
   
6,391
     
3,729
     
16,833
     
10,919
 
Depreciation and amortization, including gains and losses on disposition of property and equipment
   
19,290
     
17,932
     
56,803
     
57,707
 
Total operating expenses
   
227,122
     
169,590
     
576,516
     
488,389
 
Operating income
   
16,181
     
9,041
     
36,671
     
13,312
 
Interest expense, net
   
2,460
     
2,174
     
6,360
     
6,216
 
Income from equity method investment
   
(2,142
)
   
(750
)
   
(5,407
)
   
(2,575
)
Income before income taxes
   
15,863
     
7,617
     
35,718
     
9,671
 
Income tax expense
   
4,249
     
2,985
     
9,716
     
3,530
 
Net income
 
$
11,614
   
$
4,632
   
$
26,002
   
$
6,141
 
                                 
Income per share:
                               
Basic net income per share
 
$
0.63
   
$
0.25
   
$
1.42
   
$
0.34
 
Diluted net income per share
 
$
0.63
   
$
0.25
   
1.41
   
$
0.33
 
Basic weighted average shares outstanding
   
18,343
     
18,288
     
18,337
     
18,275
 
Diluted weighted average shares outstanding
   
18,497
     
18,404
     
18,448
     
18,366
 

The accompanying notes are an integral part of these condensed consolidated financial statements.


COVENANT TRANSPORTATION GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(In thousands)

   
Three months ended
September 30,
(unaudited)
   
Nine months ended
September 30,
(unaudited)
 
   
2018
   
2017
   
2018
   
2017
 
                         
Net income
 
$
11,614
   
$
4,632
   
$
26,002
   
$
6,141
 
                                 
Other comprehensive income (loss):
                               
                                 
Unrealized gain (loss) on effective portion of cash flow hedges, net of tax of $133 and $782 in 2018 and $1,050 and $796 in 2017, respectively
   
353
     
1,678
     
2,065
     
(1,271
)
                                 
Reclassification of cash flow hedges (gain) loss into statement of operations, net of tax of $155 and $330  in 2018 and $424 and $1,546 in 2017, respectively
   
(406
)
   
677
     
(868
)
   
2,469
 
                                 
Unrealized holding loss on investments classified as available-for-sale
   
(3
)
   
-
     
(3
)
   
-
 
                                 
Total other comprehensive income (loss)
   
(56
)
   
2,355
     
1,194
     
1,198
 
                                 
Comprehensive income
 
$
11,558
   
$
6,987
   
$
27,196
   
$
7,339
 

The accompanying notes are an integral part of these condensed consolidated financial statements.


COVENANT TRANSPORTATION GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018
(Unaudited and in thousands)

         
Additional
   
Accumulated
Other
         
Total
 
   
Common Stock
   
Paid-In
Capital
   
Comprehensive
Income
   
Retained
Earnings
   
Stockholders'
Equity
 
 
Class A
   
Class B
 
                                     
Balances at December 31, 2017
 
$
171
   
$
24
   
$
137,242
   
$
293
   
$
157,471
   
$
295,201
 
                                                 
Net income
   
-
     
-
     
-
     
-
     
26,002
     
26,002
 
                                                 
Effect of adoption of ASU 2014-09
   
-
     
-
     
-
     
-
     
591
     
591
 
                                                 
Other comprehensive income
   
-
     
-
     
-
     
1,194
     
-
     
1,194
 
                                                 
Stock-based employee compensation expense
   
-
     
-
     
2,868
     
-
     
-
     
2,868
 
                                                 
Issuance of restricted shares
   
-
     
-
     
294
     
-
     
-
     
294
 
                                                 
Balances at September 30, 2018
 
$
171
   
$
24
   
$
140,404
   
$
1,487
   
$
184,064
   
$
326,150
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
COVENANT TRANSPORTATION GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017
(In thousands)

   
Nine months ended September 30,
(unaudited)
 
   
2018
   
2017
 
Cash flows from operating activities:
           
Net income
 
$
26,002
   
$
6,141
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for losses on accounts receivable
   
168
     
241
 
Reversal of gain on sales to equity method investee
   
(185
)
   
(153
)
Depreciation and amortization
   
56,370
     
54,489
 
Amortization of deferred financing fees
   
111
     
206
 
Deferred income tax expense
   
9,172
     
16,437
 
Income tax benefit arising from restricted share vesting
   
19
     
96
 
Stock-based compensation expense
   
3,243
     
896
 
Equity in income of affiliate
   
(5,407
)
   
(2,575
)
Return on investment in affiliated company
   
-
     
1,960
 
Loss on disposition of property and equipment
   
433
     
3,217
 
Loss on investment in available-for-sale securities
   
(6
)
   
-
 
Changes in operating assets and liabilities:
               
Receivables and advances
   
(4,717
)
   
(19,975
)
Prepaid expenses and other assets
   
(2,763
)
   
1,439
 
Inventory and supplies
   
(102
)
   
(69
)
Insurance and claims accrual
   
1,553
     
837
 
Accounts payable and accrued expenses
   
17,723
     
(400
)
Net cash flows provided by operating activities
   
101,614
     
62,787
 
                 
Cash flows from investing activities:
               
Acquisition of Landair Holdings, Inc., net of cash acquired
   
(106,060
)
   
-
 
Purchase of available-for-sale securities
   
(1,496
)
   
-
 
Acquisition of property and equipment
   
(44,528
)
   
(89,917
)
Proceeds from disposition of property and equipment
   
49,302
     
32,739
 
Net cash flows used in investing activities
   
(102,782
)
   
(57,178
)
                 
Cash flows from financing activities:
               
Change in checks outstanding in excess of bank balances
   
605
     
1,325
 
Proceeds from issuance of notes payable
   
83,746
     
110,762
 
Repayments of  notes payable
   
(73,376
)
   
(101,717
)
Repayments of capital lease obligations
   
(2,608
)
   
(6,689
)
Proceeds under revolving credit facility
   
1,153,310
     
930,161
 
Repayments under revolving credit facility
   
(1,156,162
)
   
(938,667
)
Payment of minimum tax withholdings on stock compensation
   
(81
)
   
(257
)
Debt refinancing costs
   
(10
)
   
-
 
Net cash provided by (used in) financing activities
   
5,424
     
(5,082
)
                 
Net change in cash and cash equivalents
   
4,256
     
527
 
                 
Cash and cash equivalents at beginning of period
   
15,356
     
7,750
 
                 
Cash and cash equivalents at end of period
 
$
19,612
   
$
8,277
 
                 
Supplemental disclosure of cash flow information:
               
Cash paid during the year for:
               
Equipment purchased under capital leases
 
$
16,820
   
$
9,953
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
COVENANT TRANSPORTATION GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1.   Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements include the accounts of Covenant Transportation Group, Inc., a Nevada holding company, and its wholly owned subsidiaries. References in this report to "we," "us," "our," the "Company," and similar expressions refer to Covenant Transportation Group, Inc. and its wholly owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated under the Securities Act of 1933.  In preparing financial statements, it is necessary for management to make assumptions and estimates affecting the amounts reported in the condensed consolidated financial statements and related notes.  These estimates and assumptions are developed based upon all information available.  Actual results could differ from estimated amounts.  In the opinion of management, the accompanying financial statements include all adjustments that are necessary for a fair presentation of the results for the interim periods presented, such adjustments being of a normal recurring nature.

Certain information and footnote disclosures have been condensed or omitted pursuant to such rules and regulations.  The December 31, 2017, condensed consolidated balance sheet was derived from our audited balance sheet as of that date.  The Company’s operating results are subject to seasonal trends when measured on a quarterly basis; therefore operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.  These condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in our Form 10-K for the year ended December 31, 2017.  Results of operations in interim periods are not necessarily indicative of results to be expected for a full year.

Recent Accounting Pronouncements

Accounting Standards adopted

In May 2014 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2014-09, which supersedes virtually all existing revenue guidance. The new standard introduces a five-step model to determine when and how revenue is recognized.  The premise of the new model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The guidance also requires enhanced disclosures regarding the nature, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers.  The new standard became effective for us for our annual and interim reporting periods beginning January 1, 2018.  The guidance permits the use of either a full retrospective or modified retrospective adoption approach with a cumulative effect adjustment recorded in either scenario as necessary upon transition.

As permitted by the guidance, we elected the modified retrospective approach and thus recognized the cumulative effect of adoption of $0.6 million, net of tax, as a positive adjustment to retained earnings in the first quarter of 2018 as a result of the initial recording of in process revenue and associated direct expenses.

Based on our review of our customer shipping arrangements and the related guidance, we have concluded that we will recognize revenue from loads proportionally as the transportation service is performed based on the percentage of miles completed as of the period end, as opposed to recognizing revenue upon the completion of the load, which was our historic practice. Revenue will be recognized on a gross basis at amounts charged to our customers because we control and are primarily responsible for the fulfillment of the promised service. Our recognition of revenue under the new standard approximates our recognition of revenue under the prior standard, as there will generally be a consistent amount of freight in process at the beginning and end of the period; however, seasonality and the day on which the period ends may cause minor differences.
 

The following tables summarize the impacts of adopting ASU 606 on the Company’s consolidated condensed financial statements for the three and nine months ended September 30, 2018.

   
Three Months Ended September 30, 2018
 
Financial Statement Line Item (in thousands)
 
As reported
   
Adjustments
   
Balances without adoption of Topic 606
 
Consolidated Balance Sheet
 
     Accounts receivable, net of allowances
 
$
134,957
   
$
(1,276
)
 
$
133,681
 
     Total assets
   
747,482
     
(1,276
)
   
746,206
 
     Accrued expenses
   
47,797
     
(236
)
   
47,561
 
     Deferred income taxes
   
73,347
     
(286
)
   
73,061
 
     Total liabilities
   
421,332
     
(522
)
   
420,810
 
     Retained earnings
   
184,064
     
(754
)
   
183,310
 
     Total stockholders’ equity
   
326,150
     
(754
)
   
325,396
 
     Total liabilities and stockholders’ equity
   
747,482
     
(1,276
)
   
746,206
 
Consolidated Statement of Operations
 
     Freight revenue
   
214,623
     
49
     
214,672
 
     Total revenue
   
243,303
     
49
     
243,352
 
     Salaries, wages and related expenses
   
86,249
     
(1
)
   
86,248
 
     Revenue equipment rentals and purchased transportation
   
47,445
     
(95
)
   
47,350
 
     Total operating expenses
   
227,122
     
(96
)
   
227,026
 
     Income tax expense
   
4,249
     
40
     
4,289
 
     Net income
   
11,614
     
105
     
11,719
 
Consolidated Statement of Comprehensive Income
 
     Net income
   
11,614
     
105
     
11,719
 
     Comprehensive income
   
11,558
     
105
     
11,663
 
Consolidated Statement of Cash Flows
 
Operating Cash Flows
                       
     Net income
   
11,614
     
105
     
11,719
 
     Deferred income tax expense
   
2,676
     
40
     
2,716
 
     Change in: Receivables and advances
   
(16,537
)
   
(49
)
   
(16,586
)
     Change in: Accounts payable and accrued expenses
   
16,087
     
(96
)
   
15,991
 
     Net cash flows provided by operating activities
   
38,981
     
-
     
38,981
 


   
Nine Months Ended September 30, 2018
 
Financial Statement Line Item (in thousands)
 
As reported
   
Adjustments
   
Balances without adoption of Topic 606
 
Consolidated Balance Sheet
 
     Accounts receivable, net of allowances
 
$
134,957
   
$
(1,276
)
 
$
133,681
 
     Total assets
   
747,482
     
(1,276
)
   
746,206
 
     Accrued expenses
   
47,797
     
(236
)
   
47,561
 
     Deferred income taxes
   
73,347
     
(286
)
   
73,061
 
     Total liabilities
   
421,332
     
(522
)
   
420,810
 
     Retained earnings
   
184,064
     
(754
)
   
183,310
 
     Total stockholders’ equity
   
326,150
     
(754
)
   
325,396
 
     Total liabilities and stockholders’ equity
   
747,482
     
(1,276
)
   
746,206
 
Consolidated Statement of Operations
 
     Freight revenue
   
535,721
     
(266
)
   
535,455
 
     Total revenue
   
613,187
     
(266
)
   
612,921
 
     Salaries, wages and related expenses
   
211,621
     
13
     
211,634
 
     Revenue equipment rentals and purchased transportation
   
115,525
     
(54
)
   
115,471
 
     Total operating expenses
   
576,516
     
(41
)
   
576,475
 
     Income tax expense
   
9,716
     
(62
)
   
9,654
 
     Net income
   
26,002
     
(164
)
   
25,838
 
Consolidated Statement of Comprehensive Income
 
     Net income
   
26,002
     
(163
)
   
25,838
 
     Comprehensive income
   
27,196
     
(163
)
   
27,032
 
Consolidated Statement of Cash Flows
 
Operating Cash Flows
                       
     Net income
   
26,002
     
(163
)
   
25,838
 
     Deferred income tax expense
   
9,172
     
(62
)
   
9,110
 
     Change in: Receivables and advances
   
(4,717
)
   
266
     
(4,451
)
     Change in: Accounts payable and accrued expenses
   
17,723
     
(41
)
   
17,682
 
     Net cash flows provided by operating activities
   
101,613
     
-
     
101,612
 

We have two reportable segments, Truckload, which is comprised of our truckload services, and Managed Freight, which provides freight brokerage and logistics services.

The Truckload segment consists of four operating fleets that are aggregated because they have similar economic characteristics and meet the aggregation criteria.  The four operating fleets that comprise our Truckload segment are as follows: (i) Covenant Transport, our historical flagship operation, which provides expedited long haul, dedicated, temperature-controlled, and regional solo-driver service; (ii) SRT, which provides primarily long-haul, regional, and dedicated service; (iii) Star Transportation, Inc., which provides regional solo-driver and dedicated services, primarily in the southeastern United States; and (iv) Landair’s trucking operations, which provides primarily dedicated service.

Managed Freight is comprised primarily of freight brokerage, logistics, and transportation management services. Included in Managed Freight are our accounts receivable factoring and warehousing businesses, which do not meet the aggregation criteria, but only accounted for $3.4 million and $11.7 million of our  revenue, respectively, during the nine months ended September 30, 2018.
 
The following table summarizes our revenue by our two reportable segments, Truckload and Managed Freight, disaggregated to the operating fleet level as used by our chief operating decision maker in making decisions regarding allocation of resources, etc., organized first by reportable segment (i.e. Truckload and Managed Freight) and then by operating fleet for the three and nine months ended September 30, 2018:

(in thousands)
 
Three Months ended
September 30,
   
Nine Months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Total Revenues:
                       
Truckload: Covenant Transport
 
$
108,223
   
$
95,100
   
$
309,583
   
$
272,387
 
Truckload: SRT
   
47,866
     
41,382
     
134,163
     
123,905
 
Truckload: Star Transportation
   
19,887
     
16,584
     
57,489
     
50,030
 
Truckload: Landair
   
21,077
     
-
     
21,077
     
-
 
Managed Freight
   
46,250
     
25,565
     
90,875
     
55,379
 
Total
 
$
243,303
   
$
178,631
   
$
613,187
   
$
501,701
 

Accounting Standards not yet adopted

In February 2016, FASB issued ASU 2016-02, which requires lessees to recognize a right-to-use asset and a lease obligation for all leases.  Lessees are permitted to make an accounting policy election to not recognize an asset and liability for leases with a term of twelve months or less.  Lessor accounting under the new standard is substantially unchanged.  Additional qualitative and quantitative disclosures, including significant judgments made by management, will be required.  This new standard will become effective for us in our annual reporting period beginning January 1, 2019, including interim periods within that reporting period and requires a modified retrospective transition approach.  We have engaged a third party to assist with our implementation of the standard and are currently evaluating the impacts the adoption of this standard will have on the consolidated financial statements.

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation. Depreciation for book purposes is determined using the straight-line method over the estimated useful lives of the assets, while depreciation for tax purposes is generally recorded using an accelerated method. Depreciation of revenue equipment is our largest item of depreciation. We have historically depreciated new tractors (excluding day cabs) over five years to salvage values of approximately 15% of their cost.  We generally depreciate new trailers over seven years for refrigerated trailers and ten years for dry van trailers to salvage values of approximately 25% of their cost. We annually review the reasonableness of our estimates regarding useful lives and salvage values of our revenue equipment and other long-lived assets based upon, among other things, our experience with similar assets, conditions in the used revenue equipment market, and prevailing industry practice.  Changes in the useful life or salvage value estimates, or fluctuations in market values that are not reflected in our estimates, could have a material effect on our results of operations. Gains and losses on the disposal of revenue equipment are included in depreciation expense in the consolidated statements of operations.

Note 2.
Income Per Share

Basic income per share excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding for the period.  Diluted income per share reflects the dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in our earnings.  There were no anti-dilutive shares for the three and nine months ended September 30, 2018.  There were no outstanding stock options at September 30, 2018.  Income per share is the same for both Class A and Class B shares.


The following table sets forth for the periods indicated the calculation of net income per share included in the condensed consolidated statements of operations:

(in thousands except per share data)
 
Three Months ended
September 30,
   
Nine Months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Numerator:
                       
Net income
 
$
11,614
   
$
4,632
   
$
26,002
   
$
6,141
 
Denominator:
                               
Denominator for basic earnings per share – weighted-average shares
   
18,343
     
18,288
     
18,337
     
18,275
 
Effect of dilutive securities:
                               
Equivalent shares issuable upon conversion of unvested restricted stock
   
154
     
116
     
111
     
91
 
Denominator for diluted earnings per share – adjusted weighted-average shares and assumed conversions
   
18,497
     
18,404
     
18,448
     
18,366
 
                                 
Basic income per share:
 
$
0.63
   
$
0.25
   
$
1.42
   
$
0.34
 
Diluted income per share:   $ 0.63     0.25     1.41     0.33  

Note 3.
Segment Information

We have two reportable segments, our truckload services or Truckload and Managed Freight, which provides freight brokerage, logistics, and transportation management services. Our Managed Freight consists of several operating segments, which are aggregated due to similar margins and customers.  Included in Managed Freight are our accounts receivable factoring and warehousing businesses, which do not meet the aggregation criteria, but only accounted for $3.4 million and $11.7 million of our revenue, respectively, during the nine months ended September 30, 2018.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies in our 2017 Annual Report on Form 10-K.  Substantially all intersegment sales prices are market based.  We evaluate performance based on operating income of the respective business units.

The following table summarizes our segment information used by our chief operating decision maker of the Company in making decisions regarding allocation of resources, etc., as of and for the three and nine months ended September 30, 2018:

(in thousands)
 
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Total Revenues:
                       
Truckload
 
$
197,053
   
$
153,066
   
$
522,312
   
$
446,322
 
Managed Freight
   
46,250
     
25,565
     
90,875
     
55,379
 
Total
 
$
243,303
   
$
178,631
   
$
613,187
   
$
501,701
 
                                 
Operating Income:
                               
Truckload
 
$
11,960
   
$
6,573
   
$
29,055
   
$
7,812
 
Managed Freight
   
4,221
     
2,468
     
7,616
     
5,500
 
Total
 
$
16,181
   
$
9,041
   
$
36,671
   
$
13,312
 

Note 4.
Income Taxes

Income tax expense varies from the amount computed by applying the federal corporate income tax rates of 21% and 35% in 2018 and 2017, respectively, to income before income taxes, primarily due to state income taxes, net of federal income tax effect, adjusted for permanent differences, the most significant of which is the effect of the per diem pay structure for drivers.  Drivers who meet the requirements and elect to receive per diem generally receive non-taxable per diem pay in lieu of a portion of their taxable wages.  This per diem program increases our drivers' net pay per mile, after taxes, while decreasing gross pay, before taxes.  As a result, salaries, wages, and related expenses are slightly lower and our effective income tax rate is higher than the statutory rate.  Generally, as pre-tax income or loss increases, the impact of the driver per diem program on our effective tax rate decreases, because aggregate per diem pay becomes smaller in relation to pre-tax income or loss, while in periods where earnings are at or near breakeven the impact of the per diem program on our effective tax rate is significant.  Due to the partially nondeductible effect of per diem pay, our tax rate will fluctuate in future periods based on fluctuations in earnings.

Our liability recorded for uncertain tax positions as of September 30, 2018 has decreased by $0.1 million since December 31, 2017.

The net deferred tax liability of $73.3 million primarily relates to differences in cumulative book versus tax depreciation of property and equipment, partially off-set by net operating loss carryovers and insurance claims that have been reserved but not paid. The carrying value of our deferred tax assets assumes that we will be able to generate, based on certain estimates and assumptions, sufficient future taxable income in certain tax jurisdictions to utilize these deferred tax benefits.  If these estimates and related assumptions change in the future, we may be required to establish a valuation allowance against the carrying value of the deferred tax assets, which would result in additional income tax expense.  On a periodic basis, we assess the need for adjustment of the valuation allowance.  Based on forecasted taxable income resulting from the reversal of deferred tax liabilities, primarily generated by accelerated depreciation for tax purposes in prior periods, and tax planning strategies available to us, a valuation allowance has been established at September 30, 2018, for $0.1 million related to certain state net operating loss carry-forwards.  If these estimates and related assumptions change in the future, we may be required to modify our valuation allowance against the carrying value of the deferred tax assets.

Provisional Amounts in the Effective Rate

The Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017.  We are applying the Securities and Exchange Commission’s guidance in Staff Accounting Bulletin No. 118 when accounting for the enactment-date effects of the Act.  At September 30, 2018, we have not completed our accounting for all of the tax effects of the Act; however, as described below, we have made a reasonable estimate of the effects.  During the three and nine months ended September 30, 2018, we recognized no adjustments to the provisional amounts recorded at December 31, 2017.  We will continue to make and refine our calculations as additional analysis is completed, and as the states determine how they will coordinate and we receive the results of the federal carryback claim.  Our estimates may also be affected as we gain a more thorough understanding of the tax law on a federal and state basis.

Deferred tax assets and liabilities:  We remeasured certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%.  We also analyzed the future deductibility of restricted stock awards for executives and computed the effects of a net operating loss carryback to benefit the loss at 35% in prior years.  We recorded a provisional benefit amount of $40.1 million as of December 31, 2017 related to the remeasurement of certain deferred tax balances.  For the three and nine months ended September 30, 2018, we have made no change to our analysis.  We are still analyzing certain aspects of the Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts.  The provisional amount is also subject to change based on how states conform to the Act, as that information is not readily available for many states at this time.

Note 5.          Fair Value of Financial Instruments

Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Accordingly, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. The fair value of the hedge derivative liability was determined based on quotes from the counterparty which were verified by comparing them to the exchange on which the related futures are traded, adjusted for counterparty credit risk. The fair value of our interest rate swap agreements is determined using the market-standard methodology of netting the discounted future fixed-cash payments and the discounted expected variable-cash receipts. The variable-cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. These analyses reflect the contractual terms of the swap, including the period to maturity, and use observable market-based inputs, including interest rate curves and implied volatilities. The fair value of available-for-sale securities is based upon quoted prices in active markets. The fair value calculation also includes an amount for risk of non-performance of our counterparties using "significant unobservable inputs" such as estimates of current credit spreads to evaluate the likelihood of default, which we have determined to be insignificant to the overall fair value of our interest rate swap agreements.  A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:

Level 1. Observable inputs such as quoted prices in active markets;
Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Financial Instruments Measured at Fair Value on a Recurring Basis

(in thousands)
     
Hedge derivatives
 
September 30, 2018
   
December 31, 2017(1)
 
Net Fair Value of Derivatives
 
$
2,055
   
$
393
 
Quoted Prices in Active Markets (Level 1)
  $
-
    $
-
 
Significant Other Observable Inputs (Level 2)
 
$
2,055
   
$
393
 
Significant Unobservable Inputs (Level 3)
  $
-
    $
-
 
 
(1)
Includes derivative liabilities of $487 at December 31, 2017.
 
(in thousands)
     
Available-for-sale securities
 
September 30, 2018
   
December 31, 2017
 
Net Fair Value of Derivatives
 
$
1,493
   
$
-
 
Quoted Prices in Active Markets (Level 1)
 
$
1,493
    $
-
 
Significant Other Observable Inputs (Level 2)
  $
-
    $
-
 
Significant Unobservable Inputs (Level 3)
  $
-
    $
-
 

Our financial instruments consist primarily of cash and cash equivalents, certificates of deposit, accounts receivable, commodity contracts, accounts payable, debt, and interest rate swaps. The carrying amount of cash and cash equivalents, certificates of deposit, accounts receivable, accounts payable, and current debt approximates their fair value because of the short-term maturity of these instruments.  Included in accounts receivable is $46.2 million and $31.9 million of factoring receivables at September 30, 2018 and December 31, 2017, respectively, net of a $0.4 million and $0.2 million allowance for bad debt for each respective date. We advance approximately 85% to 95% of each receivable factored and retain the remainder as collateral for collection issues that might arise.  The retained amounts are returned to the clients after the related receivable has been collected, net of accrued interest. At September 30, 2018 and December 31, 2017, the retained amounts related to factored receivables totaled $2.4 million and $0.6 million, respectively, and were included in accounts payable in the condensed consolidated balance sheets.  Our clients are smaller trucking companies that factor their receivables to us for a fee to facilitate faster cash flow.  We evaluate each client's customer base under predefined criteria.  The carrying value of the factored receivables approximates the fair value, as the receivables are generally repaid directly to us by the client's customer within 30-40 days due to the combination of the short-term nature of the financing transaction and the underlying quality of the receivables.

Interest rates that are currently available to us for issuance of long-term debt with similar terms and remaining maturities are used to estimate the fair value of our long-term debt, which primarily consists of revenue equipment installment notes.  The fair value of our revenue equipment installment notes approximated the carrying value at September 30, 2018, as the weighted average interest rate on these notes approximates the market rate for similar debt. Borrowings under our revolving Credit Facility (as defined herein) approximate fair value due to the variable interest rate on that facility.  Additionally, commodity contracts, which are accounted for as hedge derivatives, as discussed in Note 6, are valued based on the forward rate of the specific indices upon which the contract is being settled and adjusted for counterparty credit risk using available market information and valuation methodologies. The fair value of our interest rate swap agreements is determined using the market-standard methodology of netting the discounted future fixed-cash payments and the discounted expected variable-cash receipts. The variable-cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. These analyses reflect the contractual terms of the swap, including the period to maturity and use observable market-based inputs, including interest rate curves and implied volatilities. The fair value calculation also includes an amount for risk of non-performance of our counterparties using "significant unobservable inputs" such as estimates of current credit spreads to evaluate the likelihood of default, which we have determined to be insignificant to the overall fair value of our interest rate swap agreements.

Note 6.    Derivative Instruments

We engage in activities that expose us to market risks, including the effects of changes in fuel prices and in interest rates.  Financial exposures are evaluated as an integral part of our risk management program, which seeks, from time-to-time, to reduce the potentially adverse effects that the volatility of fuel markets and interest rate risk may have on operating results.

In an effort to seek to reduce the variability of the ultimate cash flows associated with fluctuations in diesel fuel prices, we periodically enter into various derivative instruments, including forward futures swap contracts.  Specifically, we enter into hedging contracts with respect to ultra-low sulfur diesel ("ULSD"). Under these contracts, we pay a fixed rate per gallon of ULSD and receive the monthly average price of Gulf Coast ULSD. The retrospective and prospective regression analyses provided that changes in the prices of diesel fuel and ULSD were deemed to be highly effective based on the relevant authoritative guidance. We do not engage in speculative transactions, nor do we hold or issue financial instruments for trading purposes.

In August 2015, we entered into an interest rate swap agreement with a notional amount of $28.0 million, which was designated as a hedge against the variability in future interest payments due on the debt associated with the purchase of our corporate headquarters as described in Note 7. The terms of the swap agreement effectively convert the variable rate interest payments on this note to a fixed rate of 4.2% through maturity on August 1, 2035.  In 2016 and 2017, we also entered into several interest rate swaps, which were designated to hedge against the variability in future interest rate payments associated with the purchase of certain trailers.  Because the critical terms of the swaps and hedged items coincide, in accordance with the requirements of ASC 815, the change in the fair value of the derivative is expected to exactly offset changes in the expected cash flows due to fluctuations in the LIBOR rate over the term of the debt instrument, and therefore no ongoing assessment of effectiveness is required. The fair value of all interest rate swap agreements that were in effect at September 30, 2018, of approximately $1.2 million, is included in other short and long-term assets in the condensed consolidated balance sheet and is included in accumulated other comprehensive income, net of tax. Additionally, less than $0.1 million was reclassified from accumulated other comprehensive income into our results of operations as additional interest expense for the three months ended September 30, 2018, related to changes in interest rates during such period. Based on the amounts in accumulated other comprehensive income as of September 30, 2018, we expect to reclassify gains of approximately $0.1 million, net of tax, on derivative instruments from accumulated other comprehensive income into our results of operations during the next twelve months due to changes in interest rates. The amounts actually realized will depend on the fair values as of the date of settlement.

We recognize all derivative instruments at fair value on our condensed consolidated balance sheets.  Our derivative instruments are designated as cash flow hedges, thus the gain or loss on the derivatives is reported as a component of accumulated other comprehensive income and will be reclassified into earnings in the same period during which the hedged transaction affects earnings.  The change in fair value of the hedge offsets the change in fair value of the hedged item.

At September 30, 2018, we had fuel hedge contracts on approximately 1.9 million gallons for the remainder of 2018, or approximately 17.1% of our projected remaining 2018 fuel requirements.

The fair value of the fuel hedge contracts that were in effect at September 30, 2018, of approximately $0.9 million is included in other short-term assets in the consolidated balance sheet and is included in accumulated other comprehensive income, net of tax.  Changes in the fair values of these instruments can vary dramatically based on changes in the underlying commodity prices. For example, during the third quarter in 2018, market "spot" prices for ULSD peaked at a high of approximately $2.31 per gallon and hit a low price of approximately $2.02 per gallon. During the same 2017 quarter, market "spot" prices ranged from a high of $1.83 per gallon to a low of $1.41 per gallon. Market price changes can be driven by factors such as supply and demand, inventory levels, weather events, refinery capacity, political agendas, the value of the U.S. dollar, geopolitical events, and general economic conditions, among other items.
 

Additionally, $0.6 million and $1.3 million were reclassified from accumulated other comprehensive income into our results of operations as a reduction to fuel expense for the three and nine months ended September 30, 2018, respectively, related to gains on contracts that expired.  Based on the amounts in accumulated other comprehensive income as of September 30, 2018, and the expected timing of the purchases of the diesel hedged, we expect to reclassify gains of approximately $0.6 million, net of tax, on derivative instruments from accumulated other comprehensive income into our results of operations during the next twelve months due to actual diesel fuel purchases.  The amounts actually realized will be dependent on the fair values as of the date of settlement.

We perform both a prospective and retrospective assessment of the effectiveness of our fuel hedge contracts at inception and quarterly, including assessing the possibility of counterparty default.  If we determine that a derivative is no longer expected to be highly effective, we discontinue hedge accounting prospectively and recognize subsequent changes in the fair value of the hedge in earnings.  As a result of our effectiveness assessment at inception and at September 30, 2018, we believe our hedge contracts have been and will continue to be highly effective in offsetting changes in cash flows attributable to the hedged risk.

Outstanding financial derivative instruments expose us to credit loss in the event of nonperformance by the counterparties to the agreements. We do not expect any of the counterparties to fail to meet their obligations.  Our credit exposure related to these financial instruments is represented by the fair value of contracts reported as assets.  To manage credit risk, we review each counterparty's audited financial statements, credit ratings, and obtain references as we deem necessary.

Note 7.   Debt

Current and long-term debt consisted of the following at September 30, 2018 and December 31, 2017:

(in thousands)
 
September 30, 2018
   
December 31, 2017
 
   
Current
   
Long-Term
   
Current
   
Long-Term
 
Borrowings under Credit Facility; interest rate of 5.8% at September 30, 2018
 
$
-
   
$
6,155
   
$
-
   
$
-
 
Revenue equipment installment notes with finance companies; weighted average interest rate of 3.6% and 3.3% at September 30, 2018 and December 31, 2017, respectively, due in monthly installments with final maturities at various dates ranging from October 2018 to July 2023, secured by related revenue equipment
   
26,752
     
139,044
     
23,732
     
130,946
 
Real estate note; interest rate of 3.8% and 3.1% at September 30, 2018 and December 31, 2017, respectively, due in monthly installments with a fixed maturity at August 2035, secured by related real estate
   
1,037
     
24,029
     
1,004
     
24,810
 
Deferred loan costs
   
(146
)
   
(191
)
   
(140
)
   
(298
)
Total debt
   
27,643
     
169,037
     
24,596
     
164,465
 
Principal portion of capital lease obligations, secured by related revenue equipment
   
5,074
     
33,877
     
2,962
     
21,777
 
Total debt and capital lease obligations
 
$
32,717
   
$
202,914
   
$
27,558
   
$
186,242
 
 
We and substantially all of our subsidiaries are parties to a Third Amended and Restated Credit Facility (the "Credit Facility") with Bank of America, N.A., as agent (the "Agent") and JPMorgan Chase Bank, N.A. (together with the Agent, the "Lenders").

The Credit Facility is a $95.0 million revolving credit facility, with an uncommitted accordion feature that, so long as no event of default exists, allows us to request an increase in the revolving credit facility of up to $50.0 million subject to Lender acceptance of the additional funding commitment.  The Credit Facility includes, within our $95.0 million revolving credit facility, a letter of credit sub facility in an aggregate amount of $95.0 million and a swing line sub facility in an aggregate amount equal to the greater of $10.0 million or 10% of the Lenders' aggregate commitments under the Credit Facility from time-to-time.  The Credit Facility matures in September 2021.

Borrowings under the Credit Facility are classified as either "base rate loans" or "LIBOR loans."  Base rate loans accrue interest at a base rate equal to the greater of the Agent's prime rate, the federal funds rate plus 0.5%, or LIBOR plus 1.0%, plus an applicable margin ranging from 0.5% to 1.0%; while LIBOR loans accrue interest at LIBOR, plus an applicable margin ranging from 1.5% to 2.0%.  The applicable rates are adjusted quarterly based on average pricing availability.  The unused line fee is the product of 0.25% times the average daily amount by which the Lenders' aggregate revolving commitments under the Credit Facility exceed the outstanding principal amount of revolver loans and the aggregate undrawn amount of all outstanding letters of credit issued under the Credit Facility.  The obligations under the Credit Facility are guaranteed by us and secured by a pledge of substantially all of our assets, with the notable exclusion of any real estate or revenue equipment pledged under other financing agreements, including revenue equipment installment notes and capital leases.

Borrowings under the Credit Facility are subject to a borrowing base limited to the lesser of (A) $95.0 million, minus the sum of the stated amount of all outstanding letters of credit; or (B) the sum of (i) 85% of eligible accounts receivable, plus (ii) the lesser of (a) 85% of the appraised net orderly liquidation value of eligible revenue equipment, (b) 95% of the net book value of eligible revenue equipment, or (c) 35% of the Lenders' aggregate revolving commitments under the Credit Facility, plus (iii) the lesser of (a) $25.0 million or (b) 75% of the appraised fair market value of eligible real estate, as reduced by a periodic amortization amount.  As of September 30, 2018, there were undrawn letters of credit outstanding of approximately $35.1 million, available borrowing capacity was $59.9 million, and $6.2 million in outstanding borrowings under the Credit Facility. The interest rate on outstanding borrowings under the Credit Facility as of September 30, 2018, was 5.8% on $6.2 million of base rate loans, and there were no outstanding LIBOR loans. Based on availability as of September 30, 2018 and December 31, 2017, there was no fixed charge coverage requirement.

The Credit Facility includes usual and customary events of default for a facility of this nature and provides that, upon the occurrence and continuation of an event of default, payment of all amounts payable under the Credit Facility may be accelerated, and the Lenders' commitments may be terminated.  If an event of default occurs under the Credit Facility and the Lenders cause or have the ability to cause all of the outstanding debt obligations under the Credit Facility to become due and payable, this could result in a default under other debt instruments that contain acceleration or cross-default provisions. The Credit Facility contains certain restrictions and covenants relating to, among other things, debt, dividends, liens, acquisitions and dispositions outside of the ordinary course of business, and affiliate transactions.  Failure to comply with the covenants and restrictions set forth in the Credit Facility could result in an event of default.

Capital lease obligations are utilized to finance a portion of our revenue equipment and are entered into with certain finance companies who are not parties to our Credit Facility.  The leases in effect at September 30, 2018 terminate in October 2018 through September 2023 and contain guarantees of the residual value of the related equipment by us. As such, the residual guarantees are included in the related debt balance as a balloon payment at the end of the related term as well as included in the future minimum capital lease payments. These lease agreements require us to pay personal property taxes, maintenance, and operating expenses.

Pricing for the revenue equipment installment notes is quoted by the respective financial affiliates of our primary revenue equipment suppliers and other lenders at the funding of each group of equipment acquired and include fixed annual rates for new equipment under retail installment contracts. The notes included in the funding are due in monthly installments with final maturities at various dates ranging from October 2018 to July 2023. The notes contain certain requirements regarding payment, insuring of collateral, and other matters, but do not have any financial or other material covenants or events of default except certain notes totaling $133.0 million are cross-defaulted with the Credit Facility. Additionally, the abovementioned fuel hedge contracts totaling $0.9 million at September 30, 2018, are cross-defaulted with the Credit Facility.  Additional borrowings from the financial affiliates of our primary revenue equipment suppliers and other lenders are expected to be available to fund new tractors expected to be delivered for the remainder of 2018, while any other property and equipment purchases, including trailers, are expected to be funded with a combination of available cash, notes, operating leases, capital leases, and/or from the Credit Facility.

Note 8.    Stock-Based Compensation

Our 2006 Omnibus Incentive Plan, as amended (the "Incentive Plan") governs the issuance of equity awards and other incentive compensation to management and members of the board of directors.  In February 2013, the Compensation Committee re-approved, subject to stockholder re-approval, the material terms of the performance-based goals under the Incentive Plan so that certain incentive awards granted thereunder would continue to qualify as exempt "performance-based compensation" under Internal Revenue Code Section 162(m).  Our stockholders re-approved the material terms of the performance-based goals under the Incentive Plan at our 2013 Annual Meeting held on May 29, 2013.

The Incentive Plan permits annual awards of shares of our Class A common stock to executives, other key employees, consultants, non-employee directors, and eligible participants under various types of options, restricted stock awards, or other equity instruments.  At September 30, 2018, 49,405 of the abovementioned 1,550,000 shares were available for award under the Incentive Plan.  No participant in the Incentive Plan may receive awards of any type of equity instruments in any calendar-year that relates to more than 200,000 shares of our Class A common stock.  No awards may be made under the Incentive Plan after March 31, 2023. To the extent available, we have issued treasury stock to satisfy all share-based incentive plans.

Included in salaries, wages, and related expenses within the condensed consolidated statements of operations is $1.1 million and $0.3 million of stock-based compensation expense for the three months ended September 30, 2018 and 2017, and $2.9 million and $0.6 million of stock-based compensation expense for the nine months ended September 30, 2018 and 2017, respectively. All stock compensation expense recorded in 2018 and 2017 relates to restricted shares.  An additional $0.4 million and $0.3 million of stock-based compensation was recorded in general supplies and expenses in the condensed consolidated statements of operations for each of the three- and nine-month periods ended September 30, 2018 and 2017, respectively, as this amount relates to the issuance of restricted stock to non-employee directors.

The Incentive Plan allows participants to pay the federal and state minimum statutory tax withholding requirements related to awards that vest or allows participants to deliver to us shares of Class A common stock having a fair market value equal to the minimum amount of such required withholding taxes. To satisfy withholding requirements for shares that vested through September 30, 2018, certain participants elected to forfeit receipt of an aggregate of 2,753 shares of Class A common stock at a weighted average per share price of $29.57 based on the closing price of our Class A common stock on the dates the shares vested in 2018, in lieu of the federal and state minimum statutory tax withholding requirements. We remitted less than $0.1 million to the proper taxing authorities in satisfaction of the employees' minimum statutory withholding requirements.

Note 9.    Equity Method Investment

We own a minority investment in Transport Enterprise Leasing, LLC ("TEL"). TEL is a tractor and trailer equipment leasing company and used equipment reseller. We have not guaranteed any of TEL's debt and have no obligation to provide funding, services, or assets. In May 2016, the operating agreement with TEL was amended to, among other things, remove the previously agreed to fixed date purchase options.  TEL’s majority owners are generally restricted from transferring their interests in TEL, other than to certain permitted transferees, without our consent.  We sold approximately $0.1 million of tractors or trailers to TEL during each of the nine months ended September 30, 2018 and 2017, and we received $5.9 million and $4.2 million respectively, for providing various maintenance services, certain back-office functions, and for miscellaneous equipment.  We recognized a net reversal of previously deferred gains totaling approximately $0.2 million for each of the nine months ended September 30, 2018 and 2017, representing 49% of the gains on units sold to TEL less any gains previously deferred and recognized when the equipment was subsequently sold to a third party.  Deferred gains, totaling $0.2 million at September 30, 2018, are being carried as a reduction in our investment in TEL.  At September 30, 2018 and December 31, 2017, we had accounts receivable from TEL of $5.7 million and $7.8 million, respectively, related to cash disbursements made pursuant to our performance of certain back-office and maintenance functions on TEL’s behalf.
 

We have accounted for our investment in TEL using the equity method of accounting and thus our financial results include our proportionate share of TEL's 2018 net income through September 30, 2018, or $5.4 million. Our investment in TEL, totaling $25.7 million and $20.1 million at September 30, 2018 and December 31, 2017, respectively, is included in other assets in the accompanying condensed consolidated balance sheets.

See TEL’s summarized financial information below:

(in thousands)
 
As of September 30, 2018
   
As of December 31, 2017
 
Current Assets
 
$
23,276
   
$
19,660
 
Non-current Assets
   
255,352
     
183,905
 
Current Liabilities
   
15,451
     
53,981
 
Non-current Liabilities
   
219,878
     
117,135
 
Total Equity
 
$
43,299
   
$
32,449
 

   
For the three months ended
September 30, 2018
   
For the three months ended
September 30, 2017
   
For the nine
months ended
September 30, 2018
   
For the nine
months ended
September 30, 2017
 
Revenue
 
$
25,437
   
$
18,299
   
$
74,152
   
$
64,543
 
Operating Expenses
   
19,061
     
15,439
     
58,060
     
55,753
 
Operating Income
   
6,376
     
2,860
     
16,092
     
8,790
 
Net Income
 
$
4,369
   
$
1,499
   
$
10,850
   
$
5,188
 

Note 10.  Commitments and Contingencies

From time-to-time, we are a party to ordinary, routine litigation arising in the ordinary course of business, most of which involves claims for personal injury and property damage incurred in connection with the transportation of freight.

We maintain insurance to cover liabilities arising from the transportation of freight for amounts in excess of certain self-insured retentions. In management's opinion, our potential exposure under pending legal proceedings is adequately provided for in the accompanying condensed consolidated financial statements.

On May 8, 2017, the U.S. District Court for the Southern District of Ohio issued a pre-trial decision against our Southern Refrigerated Transport, Inc. ("SRT") subsidiary relating to a cargo claim incurred in 2008. The court had previously ruled in favor of the plaintiff in 2014, and the prior decision was reversed in part by the Sixth Circuit Court of Appeals and remanded for further proceedings in 2015.  As a result of this decision, we increased the reserve in respect of this case by $0.9 million in the first quarter of 2017 in order to accrue additional legal fees and pre-judgment interest since the time of the previously noted appeal.  On September 25, 2018, the Sixth Circuit Court of Appeals ruled in favor of the plaintiff and against SRT.  While considering its further appeal to the U.S. Supreme Court, SRT will likely pay this claim, related accrued interest and legal fees totaling approximately $6.8 million within the next six months.

Our SRT subsidiary is a defendant in a lawsuit filed on December 16, 2016 in the Superior Court of San Bernardino County, California.  The lawsuit was filed on behalf of David Bass (a California resident and former driver), who is seeking to have the lawsuit certified as a class action case wherein he alleges violation of multiple California wage and hour statutes over a four year period of time, including failure to pay wages for all hours worked, failure to provide meal periods and paid rest breaks, failure to pay for rest and recovery periods, failure to reimburse certain business expenses, failure to pay vested vacation, unlawful deduction of wages, failure to timely pay final wages, failure to provide accurate itemized wage statements, and unfair and unlawful competition as well as various state claims.  The case was removed from state court in February, 2017 to the U.S. District Court in the Central District of California, and subsequently, SRT moved the District Court to transfer venue of the case to the U.S. District Court sitting in the Western District of Arkansas.  The motion to transfer was approved by the California District Court in July, 2017, and the case will now be heard in the U.S. District court in the Western District of Arkansas.

Based on our present knowledge of the facts and, in certain cases, advice of outside counsel, management believes the resolution of open claims and pending litigation, taking into account existing reserves, is not reasonably possible to have a materially adverse effect on our consolidated financial statements.

We had $35.1 million and $32.9 million of outstanding and undrawn letters of credit as of September 30, 2018 and December 31, 2017, respectively. The letters of credit are maintained primarily to support our insurance programs.

See Note 12 for a discussion of contingencies related to our acquisition of Landair Holdings, Inc.

Note 11. Other comprehensive income (loss) ("OCI")

OCI is comprised of net income and other adjustments, including changes in the fair value of certain derivative financial instruments qualifying as cash flow hedges.

The following table summarizes the change in the components of our OCI balance for the periods presented (in thousands; presented net of tax):

Details about OCI Components
 
Amount Reclassified from OCI for the three months ended September 30, 2018
   
Amount Reclassified from OCI for the nine months ended September 30, 2018
 
Affected Line Item in the Statement of Operations
Losses (gains) on cash flow hedges
               
Commodity derivative contracts
 
$
(580
)
 
$
(1,312
)
Fuel expense
     
160
     
361
 
Income tax expense
   
$
(420
)
 
$
(951
)
Net of tax
                      
Interest rate swap contract
 
$
19
   
$
114
 
Interest expense
     
(5
)
   
(31
)
Income tax benefit
   
$
14
   
$
83
 
Net of tax

Note 12.  Acquisition of Landair Holdings, Inc.

On July 3, 2018, we acquired 100% of the outstanding stock of Landair Holdings, Inc., a Tennessee corporation (“Landair”). The total cash paid was $106.7 million, including (i) $83.0 million in cash to Landair's former owners, (ii) $3.2 million reimbursement to Landair's former owners and $5.0 million in state taxes paid by Landair after the acquisition related to our Internal Revenue Code Section 338(h)(10) election, which is still subject to finalization, and (iii) approximately $15.5 million for the debt of Landair, which we have paid in full, but not considering approximately $0.8 million of cash balances acquired.  The Stock Purchase Agreement contains customary representations, warranties, covenants, and indemnification provisions.

Landair is a leading dedicated and for-hire truckload carrier, as well as a supplier of transportation management, warehousing and logistics inventory management services. Landair’s results have been included in the condensed consolidated financial statements since the date of acquisition. Landair’s trucking operations’ results are reported within our Truckload segment, while Landair’s logistics operations’ results are reported within our Managed Freight segment.

The allocation of the preliminary purchase price detailed below is subject to change based on finalization of the valuation of long-lived and intangible assets, as well as our ongoing evaluation of Landair’s accounting principles for consistency with ours.

(in thousands)  
 
 
Cash paid
       
$
106,700
 
               
Allocated to:
             
Historical book value of Landair’s assets and liabilities
 
$
25,589
         
Adjustments to recognize assets and liabilities at acquisition-date fair value:
               
Property, plant, and equipment
   
(7,450
)
       
Other assets
   
(1,094
)
       
Liabilities
   
(829
)
       
Fair value of tangible net assets acquired
           
16,216
 
Post-acquisition goodwill adjustments
           
(114
)
Identifiable intangibles at acquisition-date fair value
           
34,000
 
Debt paid at closing
           
15,512
 
Excess of consideration transferred over the net amount of assets and liabilities recognized
         
$
41,086
 
                 
Cash paid pursuant to Stock Purchase Agreement
   
$
106,700
 
Cash acquired included in historical book value of Landair assets and liabilities
     
(754
)
Net purchase price
   
$
105,946
 
               

Deferred income taxes arising from the acquisition are immaterial because of our 338(h)(10) election.

The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed at the acquisition date.

(in thousands)
     
   
July 3, 2018
 
Cash and cash equivalents
 
$
754
 
Accounts receivable
   
12,610
 
Driver advances and other receivables
   
4,295
 
Inventory and supplies
   
3
 
Prepaid expenses
   
1,010
 
Assets held for sale
   
128
 
Net property and equipment
   
26,164
 
Other assets, net
   
22
 
Other intangibles, net
   
34,000
 
Total identifiable assets acquired
   
78,986
 
         
Accounts payable
   
(5,475
)
Accrued expenses
   
(5,015
)
Insurance and claims accrual
   
(2,645
)
Other short-term liabilities
   
(123
)
Total liabilities assumed
   
(13,258
)
Net identifiable assets acquired
   
65,728
 
Goodwill
   
40,972
 
Net assets acquired
   
106,700
 
         

The goodwill recognized is attributable primarily to expected cost synergies in the areas of insurance and claims, workers compensation, fuel, and purchases of revenue equipment. Additionally, Landair and the historical Company have limited customer overlap, and as such we expect to be able to cross-sell services between historical customers and those of Landair.

The amounts of revenue and earnings of Landair included in the Company’s consolidated results of operations from the acquisition date to the period ended September 30, 2018 are as follows:

(in thousands)
 
Three months ended
 
   
September 30, 2018
 
Total revenue
 
$
41,490
 
Net income
 
$
1,956
 

 
The following unaudited pro forma consolidated results of operations for the three and nine months ended September 30, 2018 and 2017 assume that the acquisition of Landair occurred as of January 1, 2017:

(in thousands)
 
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Total revenue
 
$
243,303
   
$
208,842
   
$
687,937
   
$
592,333
 
Net income
 
$
11,614
   
$
4,882
   
$
28,886
   
$
6,892
 
Basic net income per share
 
$
0.63
   
$
0.27
   
$
1.58
   
$
0.38
 
Diluted net income per share
 
$
0.63
   
$
0.27
   
$
1.57
   
$
0.38
 

For the nine months ended September 30, 2018, the pro forma results include an immaterial amount of adjustments to conform Landair to the accounting policies of the Company related to operations and maintenance and insurance and claims. In addition, salaries, wages, and related expenses decreased by a net of $2.1 million related to sale bonuses and non-recurring compensation paid to a prior owner of Landair, partially offset by restricted shares granted to key retained employees. General supplies and expenses decreased by $3.4 million related to non-recurring acquisition-related expenses. Depreciation and amortization increased by $1.1 million due to the amortization of intangible assets as detailed in Note 13, partially offset by a net decrease resulting from the depreciation of property, plant, and equipment using useful lives consistent with those utilized by the Company. Interest expense, net increased by approximately $2.0 million as a result of the financing obtained by the Company to fund the Landair acquisition. Income tax expense was adjusted by approximately $0.1 million for the effect of each of the aforementioned adjustments. Results for the three and nine months ended September 30, 2018 exclude two days of Landair’s operations that occurred between the period ended June 30, 2018 and our acquisition on July 3, 2018, but this effect is immaterial.

For the three and nine months ended September 30, 2017, the pro forma results include an immaterial amount of adjustments to conform Landair to the accounting policies of the Company related to operations and maintenance and insurance and claims. Depreciation and amortization increased by approximately $0.6 million and $1.7 million for the quarter and nine months, respectively, due to the amortization of intangible assets as detailed in Note 13, partially offset by a net decrease resulting from the depreciation of property, plant, and equipment using useful lives consistent with those utilized by the Company. Interest expense, net increased $1.0 million and $3.0 million for the quarter and nine months, respectively, as a result of the financing obtained by the Company to fund the Landair acquisition. Income tax expense was adjusted by an immaterial amount for the effect of each of the aforementioned adjustments.

The pro forma adjustments have been made solely for informational purposes. The actual results reported by the consolidated company in periods following the acquisition may differ significantly from that reflected in the unaudited pro forma consolidated results of operations for a number of reasons, including but not limited to cost savings from operating efficiencies, synergies and the impact of the incremental costs incurred in integrating the two companies. As a result, the unaudited pro forma consolidated results of operations are not intended to represent and does not purport to be indicative of what the combined company’s results of operations would have been had the acquisition been completed on the applicable dates of this unaudited pro forma consolidated results of operations. In addition, the unaudited pro forma consolidated results of operations do not purport to project the future results of operations of the consolidated company.

Note 13.  Intangible Assets

Based on the preliminary allocation of the purchase price for Landair, the following amounts have been allocated to identifiable intangible assets along with the respective amortization periods:

(in thousands)
 
September 30, 2018
       
   
Gross intangible assets
   
Accumulated amortization
   
Net intangible assets
   
Life (months)
 
Trade name
 
$
4,400
   
$
(73
)
 
$
4,327
     
180
 
Non-Compete agreement
   
1,400
     
(70
)
   
1,330
     
60
 
Customer relationships
   
28,200
     
(588
)
   
27,612
     
144
 
Total
 
$
34,000
   
$
(731
)
 
$
33,269
         
 
The above intangible assets have a weighted average life of 145 months. The expected amortization of these assets for the next five successive years is as follows:

   
(In thousands)
 
2018
 
$
731
 
2019
   
2,923
 
2020
   
2,923
 
2021
   
2,923
 
2022
   
2,923
 
2023
   
2,783
 
Thereafter
   
18,063
 
 
Note 14.  Available-for-sale Securities

We have purchased certain investments to meet dual objectives of capital preservation and maintenance of sufficient resources to fund insurance losses. As such, the investments are not held for the purpose of trading. Furthermore, due to the uncertain nature of insurance losses, the investments are not held-to-maturity, and are thus classified as available-for-sale securities. Unrealized holding gains and losses on these investments are excluded from earnings and reported in other comprehensive income until realized. Unrealized holding losses below, which are comprised of ten investments in an unrealized loss position, are not considered other-than-temporary, as both the duration and amount of unrealized losses have been insignificant.

(in thousands)
 
September 30, 2018
 
   
Amortized cost basis
   
Gross unrealized losses (less than 12 months)
   
Fair value
 
US corporate securities, maturing within one to five years
 
$
396
   
$
(2
)
 
$
394
 
Certificates of deposit, maturing in less than one year
   
600
     
(0
)
   
600
 
Certificates of deposit, maturing within one to five years
   
500
     
(1
)
   
499
 
Total available-for-sale securities
 
$
1,496
   
$
(3
)
 
$
1,493
 


ITEM 2.          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The condensed consolidated financial statements include the accounts of Covenant Transportation Group, Inc., a Nevada holding company, and its wholly owned subsidiaries. References in this report to "we," "us," "our," the "Company," and similar expressions refer to Covenant Transportation Group, Inc. and its wholly owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.

This report contains certain statements that may be considered forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and such statements are subject to the safe harbor created by those sections and the Private Securities Litigation Reform Act of 1995, as amended.  All statements, other than statements of historical or current fact, are statements that could be deemed forward-looking statements, including without limitation: any projections of earnings, revenues, or other financial items; any statement of plans, strategies, and objectives of management for future operations; any statements concerning proposed new services or developments; any statements regarding future economic conditions or performance; and any statements of belief and any statements of assumptions underlying any of the foregoing.  In this Form 10-Q, statements relating to future reclassification of gains arising from derivative instruments and the performance of counterparties to such instruments, future impact of new accounting standards, future results of SRT, future third-party transportation provider expenses, future tax rates, expenses, and deductions, expected freight demand and volumes, potential results of a default and testing of our fixed charge covenant under the Credit Facility or other debt agreements, expected sources of working capital and liquidity (including our mix of debt, capital leases, and operating leases as means of financing revenue equipment), expected capital expenditures, future customer relationships, future use of dedicated contracts,  future mix of team versus solo drivers, expected debt reduction, future driver market conditions, expected cash flows, expected operating income and earnings per share improvements, future trucking capacity, future rates and prices, future utilization, future depreciation and amortization, future salaries, wages, and related expenses, including driver compensation and management bonuses, expected net fuel costs, strategies for managing fuel costs, the effectiveness and impact of, and cash flows relating to, our fuel hedging contracts and fuel surcharge programs, future fluctuations in operations and maintenance expenses, future fleet size and management, the market value of used equipment, including equipment subject to operating or capital leases relative to our payment obligations under such operating leases (including residual value guarantees and the proceeds from the sale thereof), the anticipated impact of our investment in Transport Enterprise Leasing, LLC, the anticipated impact of our acquisition of Landair, and anticipated levels of and fluctuations relating to insurance, claims, and litigation expenses, including with respect to the 2008 cargo claim and the California wage and hour claim, among others, are forward-looking statements. Forward-looking statements may be identified by the use of terms or phrases such as "believe," "may," "could," "expects," "estimates," "projects," "anticipates," "plans," "intends," and similar terms and phrases.  Such statements are based on currently available operating, financial, and competitive information.  Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, which could cause future events and actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled "Item 1A. Risk Factors," set forth in our Form 10-K for the year ended December 31, 2017.  Readers should review and consider the factors discussed in "Item 1A. Risk Factors," set forth in our Form 10-K for the year ended December 31, 2017, along with various disclosures in our press releases, stockholder reports, and other filings with the Securities and Exchange Commission.

All such forward-looking statements speak only as of the date of this Form 10-Q.  You are cautioned not to place undue reliance on such forward-looking statements.  We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in the events, conditions, or circumstances on which any such statement is based.

Executive Overview

With continued economic growth in the U.S. we are encouraged by the year-over-year improvement in our operating margins for the third quarter of 2018. The main positives in the third quarter were 1) 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, 2) improvement in the operating profitability at each of our Truckload segment operating fleets, 3) an approximate 10% increase in average freight revenue per tractor for our Truckload segment, excluding Landair’s truckload operations, versus the same quarter of 2017, and 4) improved year-over-year earnings from our investment in TEL. The main negative in the quarter was the increased Truckload operating costs on a per mile basis, most notably the unfavorable employee wages and casualty insurance claims costs, partially offset by lower net fuel costs and improved net depreciation expense.

Additional items of note for the third quarter of 2018 include the following:

Total revenue of $243.3 million, an increase of 36.2% compared with the third quarter of 2017 and freight revenue (which excludes revenue from fuel surcharges) of $214.6 million, an increase of 34.6% compared with the third quarter of 2017;
   
Operating income of $16.2 million, an operating ratio of 93.3%, and an adjusted operating ratio of 92.1%, compared with operating income of $9.0 million, an operating ratio of 94.9%, and an adjusted operating ratio of 94.3% in the third quarter of 2017;
   
Net income of $16.2 million, or $0.63 per diluted share, compared with net income of $4.6 million, or $0.25 per diluted share, in the third quarter of 2017;
   
With available borrowing capacity of $59.9 million under our Credit Facility as of September 30, 2018, we do not expect to be required to test our fixed charge covenant in the foreseeable future;
   
Our Managed Freight segment’s total revenue increased by 80.9% to $46.3 million, compared to $25.6 million for the third quarter of 2017, and their operating income increased to $4.2 million compared to the 2017 quarter at $2.5 million;
   
Our equity investment in TEL provided $2.1 million of pre-tax earnings compared to $0.8 million in the third quarter of 2017;
   
Since December 31, 2017, aggregate lease-adjusted indebtedness (which includes the present value of off-balance sheet lease obligations), net of cash, increased by $22.2 million to $242.4 million; and
   
Stockholders’ equity at September 30, 2018 was $326.2 million, and tangible book value was $251.8 million, or $13.72 per basic share.

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 season customers indicate robust expectations for the fourth quarter.  From a capacity perspective, attracting and retaining highly qualified, over the road professional truck drivers remains our largest challenge.  Low unemployment, alternative careers, and an aging driver population are creating an increasingly competitive environment. In this environment, we continue to work actively with our customers to improve driver compensation, 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 have increased our capital allocation to organically grow our dedicated truckload, transportation management services, and other managed freight solutions. As of September 30, 2018, we had 1,535 tractors from our truckload fleet operating under dedicated contracts, representing 50% of the fleet. This compares to a year ago when only approximately 827 of our tractors, 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 seasonally-manageable freight volumes, reduces earnings volatility of the cyclical freight economy, and provides a favorable drivers’ experience for professional drivers who desire greater consistency.

For the fourth quarter, we will remain a major participant in the holiday peak shipping season and anticipate our consolidated adjusted operating ratio and consolidated adjusted 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 are not offering more specific earnings guidance.

In addition to operating ratio, we use "adjusted operating ratio" as a key measure of profitability.  Adjusted operating ratio is not a substitute for operating ratio measured in accordance with GAAP. There are limitations to using non-GAAP financial measures.  Adjusted operating ratio means operating expenses, net of fuel surcharge revenue and amortization of intangibles, expressed as a percentage of revenue, excluding fuel surcharge revenue. We believe the use of adjusted operating ratio allows us to more effectively compare periods, while excluding the potentially volatile effect of changes in fuel prices. Our Board and management focus on our adjusted operating ratio as an indicator of our performance from period to period. We believe our presentation of adjusted operating ratio is useful because it provides investors and securities analysts the same information that we use internally to assess our core operating performance. Although we believe that adjusted operating ratio improves comparability in analyzing our period-to-period performance, it could limit comparability to other companies in our industry, if those companies define adjusted operating ratio differently. Because of these limitations, adjusted operating ratio should not be considered a measure of income generated by our business or discretionary cash available to us to invest in the growth of our business. Management compensates for these limitations by primarily relying on GAAP results and using non-GAAP financial measures on a supplemental basis.

Operating Ratio

Operating Ratio ("OR") For Three and Nine Months Ended September 30, 2017 and 2018, respectively
 
             
   
Three months ended
September 30,
   
Nine months ended
September 30,
 
GAAP Operating Ratio:
 
2018(1)(2)
   
OR %
   
2017(2)
   
OR %
   
2018(1)(2)
   
OR %
   
2017(2)
   
OR %
 
Total revenue
 
$
243,303
         
$
178,631
         
$
613,187
         
$
501,701
       
Total operating expenses
   
227,122
     
93.3
%
   
169,590
     
94.9
%
   
576,516
     
94.0
%
   
488,389
     
97.3
%
Operating income
 
$
16,181
           
$
9,041
           
$
36,671
           
$
13,312
         
                                                                 
Adjusted Operating Ratio:
   
2018
   
Adj.
OR %
     
2017
   
Adj.
OR %
     
2018
   
Adj.
OR %
     
2017
   
Adj.
OR %
 
Total revenue
 
$
243,303
           
$
178,631
           
$
613,187
           
$
501,701
         
Less: Fuel surcharge revenue:
   
(28,680
)
           
19,131
             
(77,466
)
           
56,489
         
Revenue (excluding fuel surcharge revenue)
   
214,623
             
159,500
             
535,721
             
445,212
         
                                                                 
Total operating expenses
   
227,122
             
169,590
             
576,516
             
488,389
         
Less: Fuel surcharge revenue
   
(28,680
)
           
19,131
             
(77,466
)
           
56,489
         
Less: Amortization of intangibles(3)
   
(731
)
           
-
             
(731
)
           
-
         
Total operating expenses (net of fuel surcharge revenue)
   
197,711
     
92.1
%
   
150,459
     
94.3
%
   
498,319
     
93.0
%
   
431,900
     
97.0
%
Operating income
 
$
16,912
           
$
9,041
           
$
37,402
           
$
13,312
         
   
(1) Includes impact of adoption of ASU 2014-09. See Note 1. for the related impact to total revenue and operating expenses.
(2) The reported results do not include the results of operations of Landair on and prior to its acquisition by the Company on July 3, 2018 in accordance with the
accounting treatment applicable to the transaction.
(3) “Amortization of intangibles” reflects the non-cash amortization expense relating to intangible assets identified in the July 3, 2018 acquisition of Landair.
 

Revenue and Expenses

We focus on targeted markets throughout the United States where we believe our service standards can provide a competitive advantage.  We are a major carrier for transportation companies such as parcel freight forwarders, less-than-truckload carriers, and third-party logistics providers that require a high level of service to support their businesses, as well as for traditional truckload customers such as manufacturers, retailers, and food and beverage shippers.  We also generate revenue through providing ancillary services, including freight brokerage and accounts receivable factoring.

We have two reportable segments, Truckload, which is comprised of our truckload services, and Managed Freight, which provides freight brokerage, logistics, and transportation management services.

The Truckload segment at September 30, 2018 consisted of four operating fleets that are aggregated because they have similar economic characteristics and meet the aggregation criteria.  The four operating fleets that comprise our Truckload segment are as follows: (i) Covenant Transport, our historical flagship operation, which provides expedited long haul, dedicated, temperature-controlled, and regional solo-driver service; (ii) SRT, which provides primarily long-haul, regional, and dedicated service; (iii) Star Transportation, Inc., which provides regional solo-driver and dedicated services, primarily in the southeastern United States; and (iv) Landair trucking operations, which provides primarily dedicated service.

In our Truckload segment, we primarily generate revenue by transporting freight for our customers.  Generally, we are paid a predetermined rate per mile for our truckload services.  We enhance our truckload revenue by charging for tractor and trailer detention, loading and unloading activities, and other specialized services, as well as through the collection of fuel surcharges to mitigate the impact of increases in the cost of fuel.  The main factors that affect our Truckload revenue are the revenue per mile we receive from our customers, the percentage of miles for which we are compensated, and the number of shipments and miles we generate.  These factors relate, among other things, to the general level of economic activity in the United States, inventory levels, specific customer demand, the level of capacity in the trucking industry, and driver availability.

Our Truckload segment also derives revenue from fuel surcharges, loading and unloading activities, equipment detention, and other accessorial services.  We measure revenue before fuel surcharges, or "freight revenue," because we believe that fuel surcharges tend to be a volatile source of revenue.  We believe the exclusion of fuel surcharges affords a more consistent basis for comparing the results of operations from period-to-period.  Nonetheless, freight revenue represents a non-GAAP financial measure.  Accordingly, undue reliance should not be placed on the discussion of freight revenue, and discussions of freight revenue should be considered in combination with discussions of total revenue.  For each expense item discussed below, we have provided a table setting forth the relevant expense first as a percentage of total revenue, and then as a percentage of freight revenue.

The main expenses that impact the profitability of our Truckload segment are the variable costs of transporting freight for our customers.  These costs include fuel expenses, driver-related expenses, such as wages, benefits, training, and recruitment, and purchased transportation expenses, which primarily include compensating independent contractors.  Expenses that have both fixed and variable components include maintenance and tire expense and our total cost of insurance and claims.  These expenses generally vary with the miles we travel, but also have a controllable component based on safety, self-insured retention versus insurance premiums, fleet age, efficiency, and other factors.  Our main fixed costs include rentals and depreciation of long-term assets, such as revenue equipment and terminal facilities, and the compensation of non-driver personnel.

Our main measures of profitability are operating ratio and adjusted operating ratio, which we define as operating expenses, net of fuel surcharge revenue and amortization of intangibles, divided by total revenue, less fuel surcharge revenue, or freight revenue. See page 28 for the uses and limitations associated with adjusted operating ratio.

We operate tractors driven by a single driver and also tractors assigned to two-person driver teams.  Our single driver tractors generally operate in shorter lengths-of-haul, generate fewer miles per tractor, and experience more non-revenue miles, but the lower productive miles are expected to be offset by generally higher revenue per loaded mile and the reduced employee expense of compensating only one driver.  In contrast, our two-person driver tractors generally operate in longer lengths-of-haul, generate greater miles per tractor, and experience fewer non-revenue miles, but we typically receive lower revenue per loaded mile and incur higher employee expenses of compensating both drivers.  We expect operating statistics and expenses to shift with the mix of single and team operations.

In addition, our Managed Freight segment has service offerings ancillary to our Truckload services, including: freight brokerage service directly and through freight brokerage agents, who are paid a commission for the freight they provide, and transportation management services.  The operations consist of several operating segments, which are aggregated due to similar margins and customers.  Included in Managed Freight are our accounts receivable factoring and warehousing businesses, which do not meet the aggregation criteria, but only account for $3.4 million and $11.7 million of our revenue, respectively, during the nine months ended September 30, 2018.
 

Revenue Equipment

At September 30, 2018, we operated 3,077 tractors and 6,849 trailers. Of such tractors, 2,417 were owned, 345 were financed under operating leases, and 315 were provided by independent contractors, who provide and drive their own tractors.  Of such trailers, 5,121 were owned, 570 were financed under operating leases, and 1,158 were financed under capital leases.  We finance a small portion of our tractor fleet and larger portion of our trailer fleet with off-balance sheet operating leases. These leases generally run for a period of three to five years for tractors and five to seven years for trailers.  At September 30, 2018, our fleet had an average tractor age of 2.3 years and an average trailer age of 3.8 years.

Independent contractors provide a tractor and a driver and are responsible for all operating expenses in exchange for a fixed payment per mile.  We do not have the capital outlay of purchasing or leasing the tractor.  The payments to independent contractors and the financing of equipment under operating leases are recorded in revenue equipment rentals and purchased transportation.  Expenses associated with owned equipment, such as interest and depreciation, and expenses associated with employee drivers, including driver compensation, fuel, and other expenses, are not incurred with respect to independent contractors.  Obtaining equipment from independent contractors and under operating leases effectively shifts financing expenses from interest to "above the line" operating expenses, and as such, we evaluate our efficiency using net margin as well as operating ratio.

RESULTS OF CONSOLIDATED OPERATIONS

COMPARISON OF THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2018 TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2017

The following tables set forth the percentage relationship of certain items to total revenue and freight revenue, where applicable (dollars in thousands):

Revenue

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Revenue:
                       
Freight revenue
 
$
214,623
   
$
159,500
   
$
535,721
   
$
445,212
 
Fuel surcharge revenue
   
28,680
     
19,131
     
77,466
     
56,489
 
Total revenue
 
$
243,303
   
$
178,631
   
$
613,187
   
$
501,701
 

For the quarter ended September 30, 2018, total revenue increased $64.7 million, or 36.2%, to $243.3 million from $178.6 million in the 2017 quarter.  Freight revenue increased $55.1 million, or 34.6%, to $214.6 million for the quarter ended September 30, 2018, from $159.5 million in the 2017 quarter, while fuel surcharge revenue increased $9.6 million quarter-over-quarter. The increase in freight revenue resulted from a $34.4 million increase in freight revenues from our Truckload segment, as well as a $20.7 million increase in revenues from our Managed Freight segment.

The $34.4 million increase in Truckload freight revenue relates to a 547 (or 21.6%) average tractor increase and a 6.1% increase in average freight revenue per tractor per week, partially offset by a $2.7 million decrease in intermodal revenues in the 2018 quarter as compared to the 2017 quarter, as we effectively discontinued this consistently unprofitable service offering within our solo-driver refrigerated truckload unit during December 2017.  Of the 547 increased average tractors, 428 were contributed by the Landair acquisition, as Landair contributed $18.4 million of freight revenue to consolidated truckload operations in the third quarter of 2018. Average freight revenue per total mile increased by 27.7 cents per mile, or 16.4%, compared to the 2017 quarter and average miles per tractor decreased by 8.9%.  The decline in our utilization is primarily a result of the impact of the Landair operations on the combined truckload division, as well as the 9.6% decrease in the percentage of our fleet comprised of team-driven tractors, offset by a higher average seated tractor percentage. Landair's 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.

For the nine-month period ended September 30, 2018, total revenue increased $111.5 million, or 22.2%, to $613.2 million from $501.7 million in the 2017 period.  Freight revenue increased $90.5 million, or 20.3%, to $535.7 million for the nine months ended September 30, 2018, from $445.2 million in the 2017 period, while fuel surcharge revenue increased $21.0 million period-over-period. The increase in freight revenue resulted from a $55.0 million increase in freight revenues from our Truckload segment, as well as a $35.5 million increase in revenue from our Managed Freight segment.

The $55.0 million increase in Truckload freight revenue relates to a 192 (or 7.5%) average tractor increase and an 8.9% increase in average freight revenue per tractor resulting from the aforementioned contribution of the Landair acquisition, an increase in average rate per total mile of 22.8 cents, and was partially offset by a $9.2 million decrease in freight revenue from the aforementioned discontinuation of our intermodal service offering, compared to the same 2017 period. Average freight revenue per total mile increased by 22.8 cents per mile compared to the 2017 period and average miles per tractor decreased by 4.4%. The decline in our utilization is primarily a result of the impact of the Landair operations on the combined truckload division, a lower average seated tractor percentage, as well as the 11.1% decrease in the percentage of our fleet comprised of team-driven tractors, to an average of 884 for the nine-month period ended September 30, 2018 compared to an average of 994 teams during the same 2017 period.

Managed Freight revenue increased $20.7 million quarter-over-quarter and $35.5 million for the nine-month period, as a result of $20.4 million in freight revenue contributed by Landair’s managed freight operations during the third quarter of 2018, in addition to growth with existing customers and certain internal strategic growth initiatives, compared with the same 2017 periods.

For comparison purposes in the discussion below, we use total revenue and freight revenue (total revenue less fuel surcharge revenue) when discussing changes as a percentage of revenue.  As it relates to the comparison of expenses to freight revenue, we believe removing fuel surcharge revenue, which is sometimes a volatile source of revenue, affords a more consistent basis for comparing the results of operations from period-to-period.  Nonetheless, freight revenue represents a non-GAAP financial measure.  Accordingly, undue reliance should not be placed on the discussion of freight revenue, and discussions of freight revenue should be considered in combination with discussions of total revenue.  For each expense item discussed below, we have provided a table setting forth the relevant expense first as a percentage of total revenue, and then as a percentage of freight revenue.

Salaries, wages, and related expenses

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Salaries, wages, and related expenses
 
$
86,249
   
$
60,732
   
$
211,621
   
$
178,639
 
% of total revenue
   
35.4
%
   
34.0
%
   
34.5
%
   
35.6
%
% of freight revenue
   
40.2
%
   
38.1
%
   
39.5
%
   
40.1
%

Salaries, wages, and related expenses increased approximately $25.7 million, or 42.0%, for the three months ended September 30, 2018, compared with the same quarter in 2017.  As a percentage of total revenue, salaries, wages, and related expenses increased to 35.4% of total revenue for the three months ended September 30, 2018, from 34.0% in the same quarter in 2017.  As a percentage of freight revenue, salaries, wages, and related expenses increased to 40.2% of freight revenue for the three months ended September 30, 2018, from 38.1% in the same quarter in 2017.

For the nine months ended September 30, 2018, salaries, wages, and related expenses increased approximately $33.0 million, or 18.5%, compared with the same period in 2017.  As a percentage of total revenue, salaries, wages, and related expenses decreased to 34.5% of total revenue for the nine months ended September 30, 2018, from 35.6% for the nine months ended September 30, 2017.  As a percentage of freight revenue, salaries, wages, and related expenses decreased to 39.5% of freight revenue for the nine months ended September 30, 2018, from 40.1% in the same period in 2017.

The increases for the three-month period in salaries, wages, and related expenses are primarily the result of increased driver and non-driver headcount due to the Landair acquisition, which contributed $16.6 million of salaries, wages, and related expenses during the third quarter of 2018. Additionally, employee pay adjustments beginning in the third quarter of 2017 contributed to the overall increase and were partially offset by a lower percentage of our fleet comprised of team-driven tractors.

While salaries, wages, and related expenses increased approximately $33.0 million for the nine-month period as a result of both employee pay adjustments beginning in the third quarter of 2017 and increased headcount due to the Landair acquisition, it decreased as a percentage of total and freight revenue as a result of a lower percentage of our fleet comprised of team-driven tractors. Additionally, workers’ compensation decreased 0.4 cents per mile compared to the same 2017 period.

When compared to periods prior to the Landair acquisition, we expect salaries, wages, and related expenses will be higher as a result of increased headcount due to the Landair acquisition. We believe salaries, wages, and related expenses will also increase going forward as a result of a tight driver market, which continues to offer significant challenges, wage inflation, higher healthcare costs, and, in certain periods, increased incentive compensation due to better performance. In particular, we expect driver pay to increase as we look to maintain or reduce the number of unseated tractors in our fleet in a tight market for drivers. Additionally, as freight market rates continue to increase, we would expect to, as we have historically, pass a portion of those rate increases on to our professional drivers.  Salaries, wages, and related expenses will fluctuate to some extent based on the percentage of revenue generated by independent contractors and our Managed Freight segment, for which payments are reflected in the purchased transportation line item.

Fuel expense

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Total fuel expense
 
$
33,428
   
$
25,998
   
$
89,817
   
$
76,310
 
% of total revenue
   
13.7
%
   
14.6
%
   
14.6
%
   
15.2
%

We receive a fuel surcharge on our loaded miles from most shippers; however, this does not cover the entire increase in fuel prices for several reasons, including the following: surcharges cover only loaded miles we operate; surcharges do not cover miles driven out-of-route by our drivers; and surcharges typically do not cover refrigeration unit fuel usage or fuel burned by tractors while idling.  Moreover, most of our business relating to shipments obtained from freight brokers does not carry a fuel surcharge.  Finally, fuel surcharges vary in the percentage of reimbursement offered, and not all surcharges fully compensate for fuel price increases even on loaded miles.

The rate of fuel price changes also can have an impact on results.  Most fuel surcharges are based on the average fuel price as published by the Department of Energy ("DOE") for the week prior to the shipment, meaning we typically bill customers in the current week based on the previous week's applicable index.  Therefore, in times of increasing fuel prices, we do not recover as much as we are currently paying for fuel.  In periods of declining prices, the opposite is true.  Ultra-low-sulfur diesel prices as measured by the DOE averaged approximately $0.61 per gallon and $0.53 per gallon higher, respectively, for the quarter and nine-month period ended September 30, 2018 compared with the same 2017 quarter and period.

Additionally, $0.6 million and $1.3 million, respectively, were reclassified from accumulated other comprehensive income into our results of operations as a reduction to fuel expense for the three and nine months ended September 30, 2018, related to gains on fuel hedge contracts that expired. At September 30, 2018, all the fuel hedge contracts were deemed to be effective and thus continue to qualify as cash flow hedges. To measure the effectiveness of our fuel surcharge program, we subtract fuel surcharge revenue (other than the fuel surcharge revenue we reimburse to independent contractors and other third parties which is included in purchased transportation) from our fuel expense.  The result is referred to as net fuel expense.  Our net fuel expense as a percentage of freight revenue is affected by the cost of diesel fuel net of fuel surcharge revenue, the percentage of miles driven by company tractors, our fuel economy, our percentage of deadhead miles, for which we do not receive material fuel surcharge revenues, and the net impact of fuel hedging gains and losses.  Net fuel expense is shown below:

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Total fuel surcharge
 
$
28,680
   
$
19,131
   
$
77,466
   
$
56,489
 
Less: Fuel surcharge revenue reimbursed to independent contractors and other third parties
   
3,388
     
2,002
     
9,214
     
5,586
 
Company fuel surcharge revenue
 
$
25,292
   
$
17,129
   
$
68,252
   
$
50,903
 
Total fuel expense
 
$
33,428
   
$
25,998
   
$
89,817
   
$
76,310
 
Less: Company fuel surcharge revenue
   
25,292
     
17,129
     
68,252
     
50,903
 
Net fuel expense
 
$
8,136
   
$
8,869
   
$
21,565
   
$
25,407
 
% of freight revenue
   
3.8
%
   
5.6
%
   
4.0
%
   
5.7
%
 
 
Total fuel expense increased approximately $7.4 million, or 28.6%, for the three months ended September 30, 2018, compared with the same quarter in 2017.  As a percentage of total revenue, total fuel expense decreased to 13.7% of total revenue for the three months ended September 30, 2018, from 14.6% in the same quarter in 2017. As a percentage of freight revenue, total fuel expense decreased to 15.6% of freight revenue for the three months ended September 30, 2018, from 16.3% in the same quarter in 2017.

For the nine months ended September 30, 2018, total fuel expense increased approximately $13.5 million, or 17.7%, compared with the same period in 2017.  As a percentage of total revenue, total fuel expense decreased to 14.6% of total revenue for the nine months ended September 30, 2018, from 15.2% in the 2017 period.  As a percentage of freight revenue, total fuel expense decreased to 16.8% of freight revenue for the nine months ended September 30, 2018, from 17.1% in the 2017 period.

These changes in total fuel expense for the quarter and nine-month period ended September 30, 2018 are primarily due to the 10.8% increase in total miles for the quarter, mostly due to the Landair acquisition, as well as changes in the average price per gallon of ultra-low-sulfur diesel as measured by the DOE compared with the same periods in 2017, partially offset by the aforementioned diesel fuel hedge gains of $0.6 million and $1.3 million for the quarter and nine-month periods, respectively, compared to losses of $1.0 million and $3.7 million in those respective 2017 periods.

Net fuel expense decreased $0.7 million, or 8.3%, and $3.8 million, or 15.1%, respectively, for the quarter and nine months ended September 30, 2018, as compared to the same 2017 quarter and period.  As a percentage of freight revenue, net fuel expense decreased to 3.8% and 4.0%, respectively, for the quarter and nine months ended September 30, 2018, as compared to the same 2017 quarter and period.  The change in net fuel expense is primarily due to brokering less freight and the tiered reimbursement structure of certain fuel surcharge agreements, as well as the aforementioned gains on fuel hedging transactions. These decreases were partially offset by a greater percentage of miles driven by independent contractors, where we pay a rate that reflects then-existing fuel prices and we do not have the natural hedge created by fuel surcharge.

We expect to continue managing our idle time and tractor speeds, investing in more fuel-efficient tractors to improve our miles per gallon, locking in fuel hedges when deemed appropriate, and partnering with customers to adjust fuel surcharge programs that are inadequate to recover a fair portion of fuel costs.  Going forward, our net fuel expense is expected to fluctuate as a percentage of revenue based on factors such as diesel fuel prices, percentage recovered from fuel surcharge programs, percentage of uncompensated miles, percentage of revenue generated by team-driven tractors (which tend to generate higher miles and lower revenue per mile, thus proportionately more fuel cost as a percentage of revenue), percentage of revenue generated by refrigerated operation (which uses diesel fuel for refrigeration, but usually does not recover fuel surcharges on refrigeration fuel), percentage of revenue generated from independent contractors, the success of fuel efficiency initiatives, and gains and losses on fuel hedging contracts.

Given recent historical lows, we would expect diesel fuel prices to increase over the next few years. We are continuing our efforts to increase our ability to recover fuel surcharges under our customer contracts for fuel used in refrigeration units. If these efforts are successful, it could give rise to an increase in fuel surcharges recovered and a corresponding decrease in net fuel expense. Also, due to hedging contracts being locked in at a fixed rate on a portion of the fuel gallons we expect to use in 2018, we expect net fuel expense to decline in the fourth quarter of 2018 if fuel prices remain flat or increase. We do not currently have fuel hedging contracts for periods beyond 2018.
 
Operations and maintenance

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Operations and maintenance
 
$
16,457
   
$
13,046
   
$
40,783
   
$
37,504
 
% of total revenue
   
6.8
%
   
7.3
%
   
6.7
%
   
7.5
%
% of freight revenue
   
7.7
%
   
8.2
%
   
7.6
%
   
8.4
%

Operations and maintenance increased approximately $3.4 million, or 26.1%, for the three months ended September 30, 2018, compared with the same quarter in 2017.  As a percentage of total revenue, operations and maintenance decreased to 6.8% of total revenue for the three months ended September 30, 2018, from 7.3% in the same quarter in 2017.  As a percentage of freight revenue, operations and maintenance decreased to 7.7% of freight revenue for the three months ended September 30, 2018, from 8.2% in the same quarter in 2017.

For the nine months ended September 30, 2018, operations and maintenance increased $3.3 million, or 8.7%, compared with the same period in 2017.  As a percentage of total revenue, operations and maintenance decreased to 6.7% of total revenue for the nine months ended September 30, 2018, from 7.5% in the same period in 2017.  As a percentage of freight revenue, operations and maintenance decreased to 7.6% of freight revenue for the nine months ended September 30, 2018, from 8.4% in the same period in 2017.

The changes for the quarter and nine-month period were primarily the result of the addition of the Landair business and its comparatively older tractor fleet, as well as unloading and other operational costs associated with our increase in dedicated freight that was added since the first quarter of 2017, partially offset by extending the trade cycle of our tractors in the second half of 2017 that reduced trade preparation costs.

Going forward, we believe this category will fluctuate based on several factors, including our continued ability to maintain a relatively young fleet, accident severity and frequency, weather, and the reliability of new and untested revenue equipment models, but is expected to increase in the near term when compared to the first half of 2018.

Revenue equipment rentals and purchased transportation

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Revenue equipment rentals and purchased transportation
 
$
47,445
   
$
36,361
   
$
115,525
   
$
90,719
 
% of total revenue
   
19.5
%
   
20.4
%
   
18.8
%
   
18.1
%
% of freight revenue
   
22.1
%
   
22.8
%
   
21.6
%
   
20.4
%

Revenue equipment rentals and purchased transportation increased approximately $11.1 million, or 30.5%, for the three months ended September 30, 2018, compared with the same quarter in 2017.  As a percentage of total revenue, revenue equipment rentals and purchased transportation decreased to 19.5% of total revenue for the three months ended September 30, 2018, from 20.4% in the same quarter in 2017.  As a percentage of freight revenue, revenue equipment rentals and purchased transportation decreased to 22.1% of freight revenue for the three months ended September 30, 2018, from 22.8% in the same quarter in 2017.

For the nine months ended September 30, 2018, revenue equipment rentals and purchased transportation increased approximately $24.8 million, or 27.3%, compared with the same period in 2017.  As a percentage of total revenue, revenue equipment rentals and purchased transportation increased to 18.8% of total revenue for the nine months ended September 30, 2018, from 18.1% in the same period in 2017.  As a percentage of freight revenue, revenue equipment rentals and purchased transportation increased to 21.6% of freight revenue for the nine months ended September 30, 2018, from 20.4% in the same period in 2017.

The changes for the three and nine months ended September 30, 2018 were primarily the result of the acquisition of Landair’s managed freight business, which added to overall purchased transportation cost but is less reliant on purchased transportation to generate revenue, compared to our existing brokerage and logistics services. Additionally, we experienced increases due to a more competitive market for sourcing third-party capacity in our existing Managed Freight segment, as well as an increase in our number of independent contractors, partially offset by the late 2017 discontinuation of our temperature-controlled intermodal service offering. We expect revenue equipment rentals to decrease going forward as a result of our increase in acquisition of revenue equipment through financed purchases or capital leases rather than operating leases, particularly as we transition Landair from operating leases to owned equipment. As discussed below, this decrease may be partially or fully offset by an increase in purchased transportation, as we expect to continue to grow our Managed Freight segment, as well as a result of reduced capacity.
 

 
In addition, if fuel prices continue to increase, it would result in a further increase in what we pay third party carriers and independent contractors.  However, this expense category will fluctuate with the number and percentage of loads hauled by independent contractors and handled by Managed Freight, the percentage of our fleet financed with operating leases, and the cost to obtain third party transportation services, as well as the amount of fuel surcharge revenue passed through to the third party carriers and independent contractors.  If capacity remains tight, we believe we may need to increase the amounts we pay to third-party transportation providers and independent contractors, which would increase this expense category on an absolute basis and as a percentage of freight revenue absent an offsetting increase in revenue. We continue to actively recruit independent contractors and, if we are successful, we would expect this line item to increase as a percentage of revenue. Further, we exited the temperature-controlled intermodal business in the fourth quarter of 2017 in order to focus on our objective to continue improvements at SRT. As a result, we expect purchased transportation costs at SRT to decrease in the fourth quarter of 2018, which could partially offset any increase in consolidated purchased transportation, and to be relatively consistent thereafter.

 
Operating taxes and licenses

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Operating taxes and licenses
 
$
3,377
   
$
2,364
   
$
8,649
   
$
7,197
 
% of total revenue
   
1.4
%
   
1.3
%
   
1.4
%
   
1.4
%
% of freight revenue
   
1.6
%
   
1.5
%
   
1.6
%
   
1.6
%

For the periods presented, the change in operating taxes and licenses was not significant as either a percentage of total revenue or freight revenue.

Insurance and claims

   
Three months ended
September 30,
   
Nine months ended
September 30,
 
   
2018
   
2017
   
2018
   
2017
 
Insurance and claims
 
$
12,675
   
$
7,681
   
$
31,269
   
$
24,313
 
% of total revenue
   
5.2
%
   
4.3
%
   
5.1
%
   
4.8
%
% of freight revenue
   
5.9
%
   
4.8
%
   
5.8
%
   
5.5
%

Insurance and claims, consisting primarily of premiums and deductible amounts for liability, physical damage, and cargo damage insurance and claims increased approximately $5.0 million, or 65.0%, for the three months ended September 30, 2018, compared with the same quarter in 2017.  As a percentage of total revenue, insurance and claims increased to 5.2% of total revenue for the three months ended September 30, 2018, from 4.3% in the same quarter of 2017.  As a percentage of freight revenue, insurance and claims increased to 5.9% of freight revenue for the three months ended September 30, 2018, from 4.8% in the same quarter in 2017.  Insurance and claims cost per mile increased to 14.5 cents per mile in the third quarter of 2018 from 9.8 cents per mile in the third quarter of 2017.

For the nine months ended September 30, 2018, insurance and claims increased approximately $7.0 million, or 28.6%, compared with the same period in 2017.  As a percentage of total revenue, insurance and claims increased to 5.1% of total revenue for the nine months ended September 30, 2018, from 4.8% in the same period in 2017.  As a percentage of freight revenue, insurance and claims increased to 5.8% of freight revenue for the nine months ended September 30, 2018, from 5.5% in the same period in 2017.  Insurance and claims cost per mile increased to 13.0 cents per mile in the nine months ended September 30, 2018 from 10.5 cents per mile in the same 2017 period.

These increases primarily related to an increase in accidents with third-party injuries and adverse development on prior claims during the first nine months of 2018, as well as an increase in non-chargeable accidents per million miles, as measured by the U.S. Department of Transportation, while chargeable accidents remained relatively flat compared to the same 2017 period.
 
Our auto liability (personal injury and property damage), cargo, and general liability insurance programs include significant self-insured retention amounts.  We are also self-insured for physical damage to our equipment.  Because of these significant self-insured exposures, insurance and claims expense may fluctuate significantly from period-to-period. Any increase in frequency or severity of claims, or any increases to then-existing reserves, could adversely affect our financial condition and results of operations. 

The auto liability policy contains a feature whereby we are able to retroactively obtain a partial refund of the premium in exchange for taking on the liability for incidents that occurred during the period and releasing the insurers.  This is referred to as "commuting" the policy or "policy commutation."  In several past periods, including the policy period from April 1, 2013, through September 30, 2014, commuted in 2015, we have commuted the policy, which has lowered our insurance and claims expense. We intend to evaluate our ability to commute the policy for the three years ended March 31, 2018 and any such commutation could significantly reduce insurance and claims expense, by zero to $7.2 million, depending upon the ultimate resolution of claims during that period.

We have accrued a reserve totaling $6.8 million in connection with a judgment that was rendered against us based on a 2008 cargo claim.  We recorded an additional $0.9 million of expense in the first quarter of 2017 in order to accrue additional legal fees and pre-judgment interest since the time of our previous appeal.  On September 25, 2018, the Sixth Circuit Court of Appeals ruled in favor of the plaintiff and against SRT.  While considering its further appeal to the U.S. Supreme Court, SRT will likely pay this claim, related accrued interest and legal fees within the next six months.

Communications and utilities

<