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 June 30, 2003
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 TRANSPORT, INC.
(Exact name of registrant as specified in its charter)
Nevada 88-0320154
- ----------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
400 Birmingham Hwy.
Chattanooga, TN 37419 37419
- ----------------------------------- ------------------------------------
(Address of principal executive (Zip Code)
offices)
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 is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date (August 5, 2003).
Class A Common Stock, $.01 par value: 12,108,173 shares
Class B Common Stock, $.01 par value: 2,350,000 shares
Page 1
PART I
FINANCIAL INFORMATION
Page Number
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2003 (Unaudited) and
December 31, 2002 3
Condensed Consolidated Statements of Operations for the three and six months ended
June 30, 2003 and 2002 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 2003 and 2002 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
Item 4. Controls and Procedures 24
PART II
OTHER INFORMATION
Page Number
Item 1. Legal Proceedings 25
Items 2 and 3. Not applicable 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Not applicable 25
Item 6. Exhibits and reports on Form 8-K 25
Page 2
ITEM 1. FINANCIAL STATEMENTS
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
June 30, 2003 December 31, 2002
ASSETS (unaudited)
------ ---------------------- ----------------------
Current assets:
Cash and cash equivalents $ 2,863 $ 42
Accounts receivable, net of allowance of $1,500 in 2003
and $1,800 in 2002 60,805 65,041
Drivers advances and other receivables 5,019 3,480
Inventory and supplies 3,373 3,226
Prepaid expenses 14,309 14,450
Deferred income taxes 11,109 11,105
Income taxes receivable 2,186 2,585
--------------------- ----------------------
Total current assets 99,664 99,929
Property and equipment, at cost 354,300 392,498
Less accumulated depreciation and amortization (140,772) (154,010)
--------------------- ----------------------
Net property and equipment 213,527 238,488
Other assets 23,276 23,124
--------------------- ----------------------
Total assets $ 336,467 $ 361,541
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt - 43,000
Securitization facility 45,230 39,230
Accounts payable 13,594 6,921
Accrued expenses 18,975 17,220
Insurance and claims accrual 25,089 21,210
--------------------- ----------------------
Total current liabilities 102,888 127,581
Long-term debt, less current maturities 1,300 1,300
Deferred income taxes 51,572 57,072
--------------------- ----------------------
Total liabilities 155,760 185,953
Commitments and contingent liabilities
Stockholders' equity:
Class A common stock, $.01 par value; 20,000,000 shares
authorized; 13,075,423 and 12,999,315 shares issued and 12,103,923
and 12,027,815 outstanding as of June 30, 2003 and December 31,
2002, respectively 131 130
Class B common stock, $.01 par value; 5,000,000 shares authorized;
2,350,000 shares issued and outstanding as of June 30, 2003 and
December 31, 2002 24 24
Additional paid-in-capital 85,608 84,492
Treasury Stock at cost; 971,500 shares as of June 30, 2003 and
December 31, 2002 (7,935) (7,935)
Retained earnings 102,879 98,877
--------------------- ----------------------
Total stockholders' equity 180,707 175,588
--------------------- ----------------------
Total liabilities and stockholders' equity $ 336,467 $ 361,541
===================== ======================
See accompanying notes to consolidated financial statements.
Page 3
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(In thousands except per share data)
Three months ended June 30, Six months ended June 30,
(unaudited) (unaudited)
--------------------------------- -----------------------------
2003 2002 2003 2002
---- ---- ---- ----
Freight revenue $ 137,439 $ 138,840 $ 265,463 $ 267,860
Fuel surcharge and other accessorial revenue 8,503 5,472 18,354 8,671
--------------------------------- ------------------------------
Total revenue $ 145,942 $ 144,312 $ 283,817 $ 276,531
Operating expenses:
Salaries, wages, and related expenses 55,662 58,576 109,472 114,332
Fuel expense 26,502 24,061 55,290 46,146
Operations and maintenance 10,290 10,264 20,284 19,127
Revenue equipment rentals and purchased
transportation 16,562 14,855 31,380 29,657
Operating taxes and licenses 3,745 3,915 7,176 7,192
Insurance and claims 9,558 7,836 17,597 15,004
Communications and utilities 1,731 1,690 3,439 3,536
General supplies and expenses 3,826 3,637 6,999 7,148
Depreciation, amortization and impairment
charge, including gains (losses) on
disposition of equipment (1) 10,617 11,915 21,217 25,974
--------------------------------- ------------------------------
Total operating expenses 138,493 136,749 272,854 268,116
--------------------------------- ------------------------------
Operating income 7,449 7,563 10,963 8,415
Other (income) expenses:
Interest expense 596 870 1,247 1,934
Interest income (25) (11) (63) (34)
Other 61 434 46 211
Early extinguishment of debt (2) - - - 1,434
--------------------------------- ------------------------------
Other (income) expenses, net 632 1,293 1,230 3,545
--------------------------------- ------------------------------
Income before income taxes 6,817 6,270 9,733 4,870
Income tax expense 3,653 3,288 5,730 3,557
--------------------------------- ------------------------------
Net income $ 3,164 $ 2,982 $ 4,003 $ 1,313
================================= ==============================
Net income per share:
Basic earnings per share: $ 0.22 $ 0.21 $ 0.28 $ 0.09
Diluted earnings per share: $ 0.22 $ 0.21 $ 0.27 $ 0.09
Weighted average shares outstanding 14,397 14,108 14,389 14,096
Weighted average shares outstanding adjusted for 14,664 14,399 14,637 14,380
assumed conversions
(1) Includes a $3.3 million pre-tax impairment charge in the six month period ending June 30, 2002.
(2) Reflects the reclassification of early extinguishment of debt due to the adoption of SFAS 145 in the six month period ending
June 30, 2002.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 4
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
(In thousands)
Six months ended June 30,
(unaudited)
--------------------------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income $ 4,003 $ 1,313
Adjustments to reconcile net income to net cash
provided by operating activities:
Net provision for (reduction to) losses on accounts receivables (8) 600
Loss on early extinguishment of debt - 890
Depreciation, amortization and impairment of assets (1) 21,426 24,593
Provision for losses on guaranteed residuals - 324
Deferred income tax expense (benefit) (5,504) 602
(Gain)/loss on disposition of property and equipment (209) 1,381
Changes in operating assets and liabilities:
Receivables and advances 2,704 (7,644)
Prepaid expenses 141 2,583
Tire and parts inventory (147) 547
Accounts payable and accrued expenses 12,708 5,501
------------------ -----------------
Net cash flows provided by operating activities 35,114 30,690
Cash flows from investing activities:
Acquisition of property and equipment (28,324) (29,118)
Proceeds from disposition of property and equipment 32,233 829
------------------ -----------------
Net cash flows provided by (used in) investing activities 3,909 (28,289)
Cash flows from financing activities:
Checks in excess of bank balances - 3,368
Deferred costs (318) -
Exercise of stock options 1,116 2,391
Proceeds from issuance of long-term debt 20,000 49,000
Repayments of long-term debt (57,000) (56,388)
------------------ -----------------
Net cash flows used in financing activities (36,202) (1,629)
------------------ -----------------
Net change in cash and cash equivalents 2,821 772
Cash and cash equivalents at beginning of period 42 383
------------------ -----------------
Cash and cash equivalents at end of period $ 2,863 $ 1,155
================== =================
(1) Includes a $3.3 million pre-tax impairment charge in the six month period ending June 30, 2002.
The accompanying notes are an integral part of these consolidated financial statements.
Page 5
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned
subsidiaries ("Covenant" or the "Company"). All significant intercompany
balances and transactions have been eliminated in consolidation.
The financial statements have been prepared, without audit, in accordance
with accounting principles generally accepted in the United States of
America, pursuant to the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the accompanying
financial statements include all adjustments which are necessary for a fair
presentation of the results for the interim periods presented, such
adjustments being of a normal recurring nature. Certain information and
footnote disclosures have been condensed or omitted pursuant to such rules
and regulations. The December 31, 2002 consolidated balance sheet was
derived from the audited balance sheet of the Company for the year then
ended. It is suggested that these consolidated financial statements and
notes thereto be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Form 10-K for the
year ended December 31, 2002. Results of operations in interim periods are
not necessarily indicative of results to be expected for a full year.
Note 2. Basic and Diluted Earnings per Share
The following table sets forth for the periods indicated the calculation of
net earnings per share included in the Company's consolidated statements of
operations:
(in thousands except per share data) Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Numerator:
Net earnings $ 3,164 $ 2,982 $ 4,003 $ 1,313
Denominator:
Denominator for basic earnings
per share - weighted-average shares 14,397 14,108 14,389 14,096
Effect of dilutive securities:
Employee stock options 267 291 248 284
---------- ---------- ---------- ----------
Denominator for diluted earnings per share -
adjusted weighted-average shares and assumed
conversions 14,664 14,399 14,637 14,380
========== ========== ========== ==========
Net income per share:
Basic earnings per share: $0.22 $0.21 $0.28 $0.09
Diluted earnings per share: $0.22 $0.21 $0.27 $0.09
Dilutive common stock options are included in the diluted EPS calculation
using the treasury stock method. Employee stock options in the table above
exclude 60,000 and 376,000 in the three months ended June 30, 2003 and
2002, respectively, and 63,000 and 378,000 in the six month periods ended
June 30, 2003 and 2002, respectively, from the computation of diluted
earnings per share because their effect would have been anti-
Page 6
dilutive. At June 30, 2003, the Company had stock-based employee
compensation plans. The Company accounts for the plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting
for Stock Issued to Employees, and related Interpretations. No stock-based
employee compensation cost is reflected in net income, as all options
granted under those plans had an exercise price equal to the market value
of the underlying common stock on the date of grant. Under SFAS No. 123,
fair value of options granted are estimated as of the date of grant using
the Black-Scholes option pricing model and the following weighted average
assumptions: risk-free interest rates ranging from 2.3% to 3.5%; expected
life of 5 years; dividend rate of zero percent; and expected volatility of
52.8% for the 2003 periods, and 53.3% for the 2002 periods. Using these
assumptions, the fair value of the employee stock options granted, net of
the related tax effects, in the three months ending June 30, 2003 and 2002
periods are $0.4 million and $0.5 million respectively, and in the six
months ending June 30, 2003 and 2002 periods are $1.0 million and $0.9
million, respectively, which would be amortized as compensation expense
over the vesting period of the options. The following table illustrates the
effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation, to stock-based employee compensation.
(in thousands except per share data) Three months ended Six months ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported: $3,164 $2,982 $4,003 $1,313
Deduct: Total stock-based employee compensation
expense determined under fair value based method for all
awards, net of related tax effects (438) (472) (977) (896)
Pro forma net income 2,726 2,510 3,026 417
Basic earnings per share:
As reported $0.22 $0.21 $0.28 $0.09
Pro forma $0.19 $0.18 $0.21 $0.03
Diluted earnings per share:
As reported $0.22 $0.21 $0.27 $0.09
Pro forma $0.19 $0.17 $0.21 $0.03
Note 3. Income Taxes
Income tax expense varies from the amount computed by applying the federal
corporate income tax rate of 34% 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.
Note 4. Goodwill and Other Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets, which requires the Company to evaluate goodwill
and other intangible assets with indefinite useful lives for impairment on
an annual basis, with any resulting impairment recorded as a cumulative
effect of a change in accounting principle. Goodwill that was acquired in
purchase business combinations completed before July 1, 2001, is no longer
amortized after January 1, 2002. Furthermore, any goodwill that is acquired
in a purchase business combination completed after June 30, 2001, is not
amortized. During the second quarter of 2003 and 2002, the Company
completed its evaluations of its goodwill for impairment and determined
that there was no impairment. At June 30, 2003, the Company has $11.5
million of goodwill.
Page 7
Note 5. Derivative Instruments and Other Comprehensive Income
In 1998, the FASB issued SFAS No. 133 ("SFAS 133"), Accounting for
Derivative Instruments and Hedging Activities, as amended by SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS Statement No. 133, an amendment of SFAS
Statement No. 133, and SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities, an amendment of SFAS Statement
No. 133. SFAS No. 133 requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or in other
comprehensive income, depending on whether a derivative is designated as
part of a hedging relationship and, if it is, depending on the type of
hedging relationship.
The Company adopted SFAS No. 133 effective January 1, 2001 but had no
instruments in place on that date. In 2001, the Company entered into two
$10.0 million notional amount cancelable interest rate swap agreements to
manage the risk of variability in cash flows associated with floating-rate
debt. Due to the counter-parties' imbedded options to cancel, these
derivatives did not qualify, and are not designated as hedging instruments
under SFAS No. 133. Consequently, these derivatives are marked to fair
value through earnings, in other expense in the accompanying statement of
operations. At June 30, 2003 and June 30, 2002, the fair value of these
interest rate swap agreements was a liability of $1.7 million and $0.9
million, respectively, which are included in accrued expenses on the
consolidated balance sheet.
During the third quarter of 2001, the Company entered into two heating oil
commodity swap contracts to hedge its cash flow exposure to diesel fuel
price fluctuations. These contracts were considered highly effective in
offsetting changes in anticipated future cash flows and were designated as
cash flow hedges under SFAS No. 133. At June 30, 2002 the cumulative fair
value of these heating oil contracts was an asset of $0.2 million, which
was recorded in accrued expenses with the offset to other comprehensive
income, net of taxes. The contracts expired December 31, 2002.
The derivative activity as reported in the Company's financial statements
for the six months ended June 30, is summarized in the following:
(in thousands) Six months ended
June 30,
2003 2002
---- ----
Net liability for derivatives at January 1, $ (1,645) $ (1,932)
Gain (loss) on derivative instruments:
Loss in value of derivative instruments that do not qualify as
hedging instruments (61) (211)
Gain on fuel hedge contracts that qualify as cash
flow hedges - 1,403
----------- -------------
Net liability for derivatives at June 30, $ (1,706) $ (740)
=========== =============
The following is a summary of comprehensive income as of June 30:
Six months ended
June 30,
(in thousands) 2003 2002
---- ----
Net Income: $ 4,003 $ 1,313
Other comprehensive income:
Gain on fuel hedge contracts that qualify as cash
flow hedges - 1,403
Tax benefit - (533)
----------- -------------
Other comprehensive income:
Unrealized gain on cash flow hedging derivatives, net of tax - 870
----------- -------------
Comprehensive income $ 4,003 $ 2,183
=========== =============
Page 8
Note 6. Impairment of Equipment and Change in Estimated Useful Lives
During 2001, the market value of used tractors was significantly below both
historical levels and the carrying values on the Company's financial
statements. The Company extended the trade cycle of its tractors from three
years to four years during 2001, which delayed any significant disposals
into 2002 and later years. The market for used tractors did not improve by
the time the Company negotiated a tractor purchase and trade package with
Freightliner Corporation for calendar years 2002 and 2003 covering the sale
of model year 1998 through 2000 tractors and the purchase of an equal
number of replacement units. The significant difference between the
carrying values and the sale prices of the used tractors combined with the
Company's less profitable results during 2001 caused the Company to test
for asset impairment under SFAS No. 121, Accounting for the Impairment of
Long Lived Assets and of Long Lived Assets to be disposed of. In the test,
the Company measured the expected undiscounted future cash flows to be
generated by the tractors over the remaining useful lives and the disposal
value at the end of the useful life against the carrying values. The test
indicated impairment and the Company recognized the pre-tax charges of
approximately $15.4 million and $3.3 million in 2001 and 2002,
respectively, to reflect an impairment in tractor values. The Company
incurred a loss of approximately $324,000 on guaranteed residuals for
leased tractors in the first quarter of 2002, which was recorded in revenue
equipment rentals and purchased transportation in the accompanying
statement of operations. The Company accrued this loss from January 1,
2002, to the date the tractors were purchased off lease in February 2002.
The Company's approximately 1,400 model year 2001 tractors were not
affected by the charge. The Company adjusted the depreciation rate of these
model year 2001 tractors to approximate its recent experience with
disposition values and expectation for future disposition values. The
Company also increased the lease expense on its leased units since it
expects to have a shortfall in its guaranteed residual values of
approximately $1.4 million. The Company is recording its additional lease
expense ratably over the remaining lease term. In June 2003, the Company
entered into a trade-in agreement with an equipment manufacturer covering
the model year 2001 tractors. Management believes the additional
depreciation and lease expense will bring the carrying values of these
tractors in line with the disposition values. These assumptions represent
management's best estimate and actual values could differ by the time those
tractors are scheduled for trade. Management estimates the impact of the
change in the estimated useful lives and depreciation on the 2001 model
year tractors to be approximately $1.5 million pre-tax or $.06 per share
annually.
Note 7. Long-term Debt and Securitization Facility
Outstanding debt consisted of the following at June 30, 2003 and December
31, 2002:
(in thousands) June 30, 2003 December 31, 2002
---------------------- ----------------------
Borrowings under credit agreement $ - $ 43,000
Securitization Facility 45,230 39,230
Note payable to former SRT shareholder, bearing
interest at 6.5% with interest payable quarterly 1,300 1,300
---------------------- ----------------------
Total long-term debt 46,530 83,530
Less current maturities 45,230 82,230
---------------------- ----------------------
Long-term debt, less current portion $ 1,300 $ 1,300
====================== ======================
In December 2000, the Company entered into the Credit Agreement with a
group of banks. The facility matures in December 2005. Borrowings under the
Credit Agreement are based on the banks' base rate or LIBOR and accrue
interest based on one, two, or three month LIBOR rates plus an applicable
margin that is adjusted quarterly between 0.75% and 1.25% based on cash
flow coverage. At June 30, 2003, the margin was 0.875%. The Credit
Agreement is guaranteed by the Company and all of the Company's
subsidiaries except CVTI Receivables Corp. and Volunteer Insurance Limited.
Page 9
The Credit Agreement has a maximum borrowing limit of $100.0 million with
an accordion feature which permits an increase up to a maximum borrowing
limit of $140.0 million. Borrowings related to revenue equipment are
limited to the lesser of 90% of net book value of revenue equipment or the
maximum borrowing limit. Letters of credit are limited to an aggregate
commitment of $50.0 million. The Credit Agreement includes a "security
agreement" such that the Credit Agreement may be collateralized by
virtually all assets of the Company if a covenant violation occurs. A
commitment fee, that is adjusted quarterly between 0.15% and 0.25% per
annum based on cash flow coverage, is due on the daily unused portion of
the Credit Agreement. As of June 30, 2003, the Company had no borrowings
under the Credit Agreement.
In October 1995, the Company issued $25 million in ten-year senior notes to
an insurance company. On March 15, 2002, the Company retired the remaining
$20 million in senior notes with borrowings from the Credit Agreement and
incurred a $0.9 million after-tax extraordinary item ($1.4 million pre-tax)
to reflect the early extinguishment of this debt. Upon adoption of SFAS 145
in 2003, the Company reclassified the charge and it is no longer classified
as an extraordinary item.
At June 30, 2003 and December 31, 2002, the Company had unused letters of
credit of approximately $17.9 and $19.2 million, respectively.
In December 2000, the Company entered into a $62 million revolving accounts
receivable securitization facility (the "Securitization Facility"). On a
revolving basis, the Company sells its interests in its accounts receivable
to CVTI Receivables Corp. ("CRC"), a wholly-owned bankruptcy-remote special
purpose subsidiary incorporated in Nevada. CRC sells a percentage ownership
in such receivables to an unrelated financial entity. The transaction does
not meet the criteria for sale treatment under SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities and is reflected as a secured borrowing in the financial
statements.
The Company can receive up to $62 million of proceeds, subject to eligible
receivables and will pay a service fee recorded as interest expense, as
defined in the agreement. The Company will pay commercial paper interest
rates plus an applicable margin of 0.41% per annum and a commitment fee of
0.10% per annum on the daily unused portion of the Facility. The
Securitization Facility includes certain significant events that could
cause amounts to be immediately due and payable in the event of certain
ratios. The proceeds received are reflected as a current liability on the
consolidated financial statements because the committed term, subject to
annual renewals, is 364 days. As of June 30, 2003 and December 31, 2002,
the Company had received $45.2 million and $39.2 million, respectively, in
proceeds, with a weighted average interest rate of 1.2% and 1.5%,
respectively.
The Credit Agreement and Securitization Facility contain certain
restrictions and covenants relating to, among other things, dividends,
tangible net worth, cash flow, acquisitions and dispositions, and total
indebtedness and are cross-defaulted. As of June 30, 2003, the Company was
in compliance with the Credit Agreement and Securitization Facility.
Note 8. Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS 143 provides new guidance on the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. This
pronouncement is effective January 1, 2003. The pronouncement did not have
a material impact on the Company's consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 amends existing guidance on reporting gains and
losses on extinguishment of debt to prohibit the classification of the gain
or loss as extraordinary, as the use of such extinguishments have become
part of the risk management strategy of many companies. SFAS 145 also
amends SFAS 13 to require sale-leaseback accounting for certain lease
modifications that have economic effects similar to sale-leaseback
transactions. The provisions of the Statement related to the rescission of
Statement No. 4 is applied in fiscal years beginning after May 15, 2002.
The provisions of the
Page 10
Statement related to Statement No. 13 were effective for transactions
occurring after May 15, 2002. The Company adopted SFAS 145 effective
January 1, 2003, which resulted in the reclassification of the fiscal year
2002 loss on extinguishment of debt.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements
No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees issued. Interpretation No. 45 also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the
fair value of the obligation undertaken. The initial recognition and
measurement provisions of the Interpretation are applicable to guarantees
issued or modified after December 31, 2002, and are not expected to have a
material effect on the Company's financial statements. The disclosure
requirements are effective for financial statements of interim or annual
periods ending after December 15, 2002. The Company has guarantees among
the entities within its consolidated group, which are disclosed in the
notes to these consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation/Transition and Disclosure, an amendment of FASB Statement No.
123. SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial
statements. Certain of the disclosure modifications are required for fiscal
years and interim periods ending after December 15, 2002 and are included
in the notes to these consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51
("Interpretation 46"). Interpretation 46 addresses the consolidation by
business enterprises of variable interest entities, as defined.
Interpretation 46 applied immediately to variable interests in variable
interest entities created after January 31, 2003, and to variable interests
in variable interest entities obtained after January 31, 2003. The Company
is evaluating the impact of this interpretation on the Company's financial
statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS 149 amended and
clarified accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities. SFAS 149 amended SFAS 133 regarding implementation
issues raised in relation to the application of the definition of a
derivative, particularly regarding the meaning of an "underlying" and the
characteristics of a derivative that contains financing components. The
amendments set forth in SFAS 149 improve financial reporting by requiring
that contracts with comparable characteristics be accounted for similarly.
In particular, this Statement clarifies under what circumstances a contract
with an initial net investment meets the characteristic of a derivative as
discussed in SFAS 133. In addition, it clarifies when a derivative contains
a financing component that warrants special reporting in the statement of
cash flows. SFAS 149 was effective for contracts entered into or modified
after June 30, 2003. The Company does not anticipate this Statement will
have any significant impact on the Company's financial condition or results
of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. This Statement was
developed in response to concerns expressed about issuers' classification
in the statement of financial position of certain financial instruments
that have characteristics of both liabilities and equity, but that have
been presented either entirely as equity or between the liabilities section
and the equity section of the balance sheet. SFAS 150 was effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise was effective at the beginning of the first interim period
beginning after June 15, 2003. SFAS 150 will have no effect on the
Company's balance sheet presentation of its debt and equity financial
instruments.
Page 11
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The consolidated financial statements include the accounts of Covenant
Transport, 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 Transport, Inc. and its consolidated subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation.
Except for the historical information contained herein, the discussion in this
quarterly report contains forward-looking statements that involve risk,
assumptions, and uncertainties that are difficult to predict. Statements that
constitute forward-looking statements are usually identified by words such as
"anticipates," "believes," "estimates," "projects," "expects," or similar
expressions. These statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Such statements are based
upon the current beliefs and expectations of our management and are subject to
significant risks and uncertainties. Actual results may differ from those set
forth in the forward-looking statements. The following factors, among others,
could cause actual results to differ materially from those in forward-looking
statements: excess capacity in the trucking industry; decreased demand for our
services or loss of one or more or our major customers; surplus inventories;
recessionary economic cycles and downturns in customers' business cycles;
strikes or work stoppages; increases or rapid fluctuations in fuel prices,
interest rates, fuel taxes, tolls, and license and registration fees; increases
in the prices paid for new revenue equipment; the resale value of our used
equipment and the price of new equipment; increases in compensation for and
difficulty in attracting and retaining qualified drivers and owner-operators;
increases in insurance premiums and deductible amounts or claims relating to
accident, cargo, workers' compensation, health, and other matters; seasonal
factors such as harsh weather conditions that increase operating costs;
competition from trucking, rail, and intermodal competitors; regulatory
requirements that increase costs or decrease efficiency; and the ability to
identify acceptable acquisition candidates, consummate acquisitions, and
integrate acquired operations. Readers should review and consider these factors
along with the various disclosures we make in press releases, stockholder
reports, and public filings, as well as the factors explained in greater detail
in the Company's annual report on Form 10-K.
We generate substantially all of our revenue by transporting freight for our
customers. We also derive revenue from fuel surcharges, loading and unloading
activities, equipment detention, and other accessorial services. Generally, we
are paid by the mile or by the load for our services. The main factors that
affect our revenue are the revenue per mile we receive from our customers, the
percentage of miles for which we are compensated, and the numbers of miles we
generate with our equipment. These factors relate, among other things, to the
U.S. economy, inventory levels, the level of truck capacity in our markets,
specific customer demand, the percentage of team-driven tractors in our fleet,
and our average length of haul. Since 2000 we have held our fleet size
relatively constant. An overcapacity of trucks in our fleet and the industry
generally as the economy slowed has contributed to lower equipment utilization
and pricing pressure since 2000.
In addition to constraining fleet size, we reduced our number of two-person
driver teams during 2002 and have since held the percentage relatively constant
to better match the demand for expedited long-haul service. Our single driver
fleets generally operate in shorter lengths of haul, generate fewer miles per
tractor, and experience more non-revenue miles, but the additional expenses and
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. We
expect operating statistics and expenses to shift with the mix of single and
team operations.
The trucking industry has experienced a significant increase in operating costs
over the past three years. The main factors for the industry as well as for us
have been an increased annual cost of tractors due to higher initial prices and
lower used truck values, a higher overall cost of insurance and claims, and
elevated fuel prices. Other than those categories, our expenses have remained
relatively constant or have declined as a percentage of revenue.
Looking forward, our profitability goal is to return to an operating ratio of
approximately 90%. We expect this to require additional improvements in revenue
per tractor per week to overcome expected additional cost increases of insurance
and claims, new revenue equipment (discussed below), and other general increases
in operating costs, as
Page 12
well as to expand our margins. Because a large percentage of our costs are
variable, changes in revenue per mile affect our profitability to a greater
extent than changes in miles per tractor.
At June 30, 2003, we operated approximately 3,623 tractors and 7,133 trailers.
Of our tractors at June 30, 2003, approximately 2,379 were owned, 890 were
financed under operating leases, and 354 were provided by owner-operators, who
own and drive the tractors. Of our trailers at June 30, 2003, approximately
3,298 were owned and approximately 3,835 were financed under operating leases.
Between 1999 and 2001, the market value of used equipment deteriorated. In
recognition of this fact, we recognized pre-tax impairment charges of $15.4
million in the fourth quarter of 2001 and $3.3 million in the first quarter of
2002 in relation to the reduced value of our model year 1998 through 2000
tractors. In addition, we increased the depreciation rate/lease expense on our
remaining tractors to reflect our expectations concerning market value at
disposition. We estimate the impact of the change in the estimated useful lives
and depreciation on the 2001 model year tractors to be approximately $1.5
million pre-tax or $.06 per share annually. In June 2003, the Company entered
into a trade-in agreement with an equipment manufacturer covering the model year
2001 tractors. Management believes the additional depreciation and lease expense
will bring the carrying values of these tractors in line with the disposition
values. Our assumptions represent our best estimate, and actual values could
differ by the time those tractors are scheduled for trade.
Because of the adverse change from historical purchase prices and residual
values, the annual expense per tractor on model year 2003 and 2004 tractors is
expected to be higher than the annual expense on the model year 1999 and 2000
units being replaced. We believe the increase in depreciation expense was
approximately one-half cent per mile pre-tax during 2002 and will grow to
approximately one cent per mile pre-tax in 2003 as all of these new units are
delivered. By the time the model year 2001 tractors are traded and the entire
fleet is converted in 2004, we expect the total increase in expense to be
approximately one and one-half cent pre-tax per mile versus the cost in 2001,
excluding any effect of interest rates. The timing of these expenses could be
affected if we change our tractor trade cycle to three years, which we are
considering. If the tractors are leased instead of purchased, the references to
increased depreciation would be reflected as additional lease expense.
We finance a portion of our tractor and trailer fleet with off-balance sheet
operating leases. These leases generally run for a period of three years for
tractors and seven years for trailers. With our tractor trade cycle currently at
approximately four years, we have been purchasing the leased tractors at the
expiration of the lease term, although there is no commitment to purchase the
tractors. The first trailer leases expire in 2005, and we have not determined
whether to purchase trailers at the end of these leases. In April 2003, we
entered into a sale-leaseback arrangement covering approximately 1,266 of our
trailers. This arrangement is more fully described below.
Owner-operators 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 the tractor. The payments to owner-operators 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, are not incurred, and for
owner-operator tractors, driver compensation, fuel, and other expenses are not
incurred. Because obtaining equipment from owner-operators and under operating
leases effectively shifts financing expenses from interest to "above the line"
operating expenses, we evaluate our efficiency using net margin rather than
operating ratio.
Freight revenue excludes $8.5 million and $5.5 million of fuel and accessorial
surcharge revenue in the three months ending June 30, 2003 and 2002,
respectively. In the six months ending June 30, 2003 and 2002, freight revenue
excludes $18.4 million and $8.7 million of fuel and accessorial surcharge
revenue, respectively. For comparison purposes in the table below, we use
freight revenue when discussing changes as a percentage of revenue. We believe
removing this sometimes volatile source of revenue affords a more consistent
basis for comparing the results of operations from period to period.
Page 13
The following table sets forth the percentage relationship of certain items to
freight revenue:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2003 2002 2003 2002
---------------- ------------- -------------- --------------
Freight revenue (1) 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Salaries, wages, and related expenses (1) 39.4 40.9 40.0 41.5
Fuel expense (1) 14.6 15.0 15.6 15.6
Operations and maintenance (1) 7.1 7.0 7.3 6.8
Revenue equipment rentals and purchased
transportation 12.0 10.7 11.8 11.1
Operating taxes and licenses 2.7 2.8 2.7 2.7
Insurance and claims 7.0 5.6 6.6 5.6
Communications and utilities 1.3 1.2 1.3 1.3
General supplies and expenses 2.8 2.6 2.6 2.7
Depreciation and amortization (2) 7.7 8.6 8.0 9.7
---------------- ------------- -------------- --------------
Total operating expenses 94.6 94.6 95.9 96.9
---------------- ------------- -------------- --------------
Operating income 5.4 5.4 4.1 3.1
Other (income) expense, net 0.4 0.9 0.4 1.3
---------------- ------------- -------------- --------------
Income before income taxes 5.0 4.5 3.7 1.8
Income tax expense 2.7 2.4 2.2 1.3
---------------- ------------- -------------- --------------
Net income 2.3% 2.1% 1.5% 0.5%
================ ============= ============== ==============
(1) Freight revenue is total revenue less fuel surcharge and accessorial revenue. In this table, fuel surcharge and other
accessorial revenue are shown netted against the appropriate expense category (Salaries, wages, and related expenses, $1.5
million and $1.8 million in the three months ending June 30, 2003, and 2002, respectively; Fuel expense, $6.5 million and $3.2
million in the three months ending June 30, 2003, and 2002, respectively; Operations and maintenance, $0.5 million in the three
months ending June 30, 2003, and 2002. Salaries, wages, and related expenses, $3.3 million and $3.2 million in the six months
ending June 30, 2003, and 2002, respectively; Fuel expense, $14.0 million and $4.5 million in the six months ending June 30,
2003, and 2002, respectively; Operations and maintenance, $1.0 million in the six months ending June 30, 2003, and 2002.)
(2) Includes a $3.3 million pre-tax impairment charge or 1.2% of revenue in the six months ending June 30, 2002.
COMPARISON OF THREE MONTHS ENDED JUNE 30, 2003 TO THREE MONTHS ENDED JUNE 30,
2002
For the quarter ending June 30, 2003, revenue increased $1.6 million (1.1%), to
$145.9 million, from $144.3 million in the 2002 period. Freight revenue excludes
$8.5 million of fuel and accessorial surcharge revenue in the 2003 period and
$5.5 million in the 2002 period. For comparison purposes in the discussion
below, we use freight revenue when discussing changes as a percentage of
revenue. We believe removing this sometimes volatile source of revenue affords a
more consistent basis for comparing the results of operations from period to
period.
Freight revenue (total revenue less fuel surcharge and accessorial revenue)
decreased $1.4 million (1.0%), to $137.4 million in the three months ended June
30, 2003, from $138.8 million in the same period of 2002. Our freight revenue
was affected by a 2.5% decrease in miles per tractor and an increase in non
revenue miles, which were partially offset by a 2.3% increase in rate per loaded
mile. Revenue per tractor per week decreased to $2,850 in the 2003 period from
$2,887 in the 2002 period. Weighted average tractors increased to 3,699 in the
2003 period from 3,688 in the 2002 period. Due to a weak freight environment, we
have elected to constrain the size of our tractor fleet until fleet production
and profitability improve.
Page 14
Salaries, wages, and related expenses, net of accessorial revenue of $1.5
million in the 2003 period and $1.8 million in the 2002 period, decreased $2.7
million (4.7%), to $54.2 million in the 2003 period, from $56.8 million in the
2002 period. As a percentage of freight revenue, salaries, wages, and related
expenses decreased to 39.4% in the 2003 period, from 40.9% in the 2002 period.
The decrease was largely attributable to our utilizing a larger percentage of
single-driver tractors, with only one driver per tractor to be compensated and
implementing changes in our pay structure. Our payroll expense for employees
other than over the road drivers increased to 7.2% of freight revenue in the
2003 period from 6.9% of freight revenue in the 2002 period due to growth in
headcount and a larger number of local drivers in the dedicated fleet. Health
insurance, employer paid taxes, workers' compensation, and other employee
benefits decreased to 5.6% of freight revenue in the 2003 period from 6.7% of
freight revenue in the 2002 period, partially due to paying lower taxes due to
lower payroll amounts and improving claims experience in the Company's health
insurance plan.
Fuel expense, net of fuel surcharge revenue of $6.5 million in the 2003 period
and $3.2 million in the 2002 period, decreased $0.8 million (3.9%), to $20.0
million in the 2003 period, from $20.9 million in the 2002 period. As a
percentage of freight revenue, net fuel expense decreased to 14.6% in the 2003
period from 15.0% in the 2002 period. Fuel prices averaged approximately $0.13
per gallon higher in the 2003 period compared to the 2002 period which resulted
in approximately $2.4 million additional fuel expense. However, fuel surcharges
amounted to $0.058 per loaded mile in the 2003 period compared to $0.028 per
loaded mile in the 2002 period, which more than offset the increased fuel
expense with approximately $3.3 million more fuel surcharges in the 2003 period
as compared to the 2002 period. Fuel costs may be affected in the future by
volume purchase commitments, the collectibility of fuel surcharges, and lower
fuel mileage due to government mandated emissions standards that were effective
October 1, 2002, and will result in less fuel efficient engines. We did not have
any fuel hedging contracts at June 30, 2003.
Operations and maintenance, net of accessorial revenue of $0.5 million in the
2003 period and 2002 periods, consisting primarily of vehicle maintenance,
repairs and driver recruitment expenses, remained essentially constant at $9.8
million in the 2003 period and 2002 periods. As a percentage of freight revenue,
operations and maintenance remained essentially constant at 7.1% in the 2003
period and 7.0% in the 2002 period.
Revenue equipment rentals and purchased transportation increased $1.7 million
(11.3%), to $16.6 million in the 2003 period, from $14.9 million in the 2002
period. As a percentage of freight revenue, revenue equipment rentals and
purchased transportation expense increased to 12.0% in the 2003 period from
10.7% in the 2002 period. The owner-operators fleet remained essentially
constant at an average of 354 units in the 2003 period compared to an average of
350 units in the 2002 period. Over the past several of years, it has become more
difficult to retain owner-operators due to the challenging operating conditions.
Owner-operators are independent contractors, who provide a tractor and driver
and cover all of their operating expenses in exchange for a fixed payment per
mile. Accordingly, expenses such as driver salaries, fuel, repairs,
depreciation, and interest normally associated with Company-owned equipment are
consolidated in revenue equipment rentals and purchased transportation when
owner-operators are utilized. The revenue equipment rental expense increased
$1.7 million (39.7%), to $6.0 million in the 2003 period, from $4.3 million in
the 2002 period. As of June 30, 2003, we had financed approximately 890 tractors
and 3,835 trailers under operating leases as compared to 636 tractors and 2,564
trailers under operating leases as of June 30, 2002. On April 14, 2003, we
engaged in a sale-leaseback transaction involving approximately 1,266 dry van
trailers. We sold the trailers to a finance company for approximately $15.5
million in cash and leased the trailers back under three year walk away leases.
The resulting gain will be amortized over the life of the lease. We will no
longer recognize depreciation and interest expense with respect to these
trailers.
Operating taxes and licenses decreased $0.2 million (4.3%), to $3.7 million in
the 2003 period, from $3.9 million in the 2002 period. As a percentage of
freight revenue, operating taxes and licenses remained essentially constant at
2.7% in the 2003 period and 2.8% in the 2002 period.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, increased
$1.7 million (22.0%), to $9.6 million in the 2003 period from $7.8 million in
the 2002 period. As a percentage of freight revenue, insurance and claims
increased to 7.0% in the 2003 period from 5.6% in the 2002 period. The increase
is a result of an industry-wide increase in insurance rates, which we addressed
by adopting an insurance program with significantly higher deductible exposure,
and unfavorable accident experience. The retention level for our primary
insurance layer increased from $250,000 in 2001 to $500,000 in March of 2002, to
$1.0 million in November of 2002, and to $2.0 million on March 1, 2003. We also
Page 15
have a $2.0 million self-insured layer between $5.0 million and $7.0 million per
occurrence. Our insurance program for liability, physical damage, and cargo
damage involves self-insurance with varying risk retention levels. Claims in
excess of these risk retention levels are covered by insurance in amounts which
management considers adequate. We accrue the estimated cost of the uninsured
portion of pending claims. These accruals are based on management's evaluation
of the nature and severity of the claim and estimates of future claims
development based on historical trends. Insurance and claims expense will vary
based on the frequency and severity of claims, the premium expense, and the
level of self-insured retention. Because of higher self-insured retentions, our
future expenses of insurance and claims may be higher or more volatile than in
historical periods.
Communications and utilities expense remained essentially constant at $1.7
million in the 2003 and 2002 periods. As a percentage of freight revenue,
communications and utilities remained essentially constant at 1.3% in the 2003
period as compared to 1.2% in the 2002 period.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses, increased $0.2 million (5.2%), to $3.8 million in
the 2003 period, from $3.6 million in the 2002 period. As a percentage of
freight revenue, general supplies and expenses increased to 2.8% in the 2003
period from 2.6% in the 2002 period.
Depreciation and amortization, consisting primarily of depreciation of revenue
equipment, decreased $1.3 million (10.9%), to $10.6 million in the 2003 period
from $11.9 million in the 2002 period. As a percentage of freight revenue,
depreciation and amortization decreased to 7.7% in the 2003 period from 8.6% in
the 2002 period. The decrease is the result of the April 2003 sale-leaseback
transaction involving our trailers and improvement from the sale of equipment
partially offset by increased depreciation expense on our 2001 tractors and our
new tractors. The sale-leaseback transaction involved approximately 1,266 dry
van trailers as discussed in the revenue equipment rentals and purchased
transportation section. We sold the trailers to a finance company for
approximately $15.5 million in cash and leased the trailers back under three
year walk away leases. Our revenue equipment rental expense is expected to
increase in the future to reflect this transaction and we will no longer
recognize depreciation and interest expense with respect to these trailers. In
April 2003, we also entered into an agreement with a finance company to sell
approximately 2,585 dry van trailers and to lease an additional 3,600 model year
2004 dry van trailers over the next 12 months. We will sell the trailers, which
consist of model year 1991 to model year 1997 dry van trailers, to the finance
company for approximately $20.5 million in cash and will lease the additional
3,600 dry van trailers back under seven year walk away leases. Depending on the
delivery schedule of the trade equipment, we will recognize either additional
depreciation expense or losses on the disposal of equipment up to approximately
$2.0 million. The monthly cost of the lease payments will be higher than the
cost of the depreciation and interest expense; however there will be no residual
risk of loss at disposition. We expect our annual cost of tractor and trailer
ownership and/or leasing to increase in future periods. The increase is expected
to result from a combination of higher initial prices of new equipment, lower
resale values for used equipment, and increased depreciation/lease payments on
some of our existing equipment over their remaining lives in order to better
match expected book values or lease residual values with market values at the
equipment disposal date. To the extent equipment is leased under operating
leases, the amounts will be reflected in revenue equipment rentals and purchased
transportation. To the extent equipment is owned or obtained under capitalized
leases; the amounts will be reflected as depreciation expense and interest
expense. Those expense items will fluctuate with changes in the percentage of
our equipment obtained under operating leases versus owned and under capitalized
leases.
Depreciation and amortization expense is net of any gain or loss on the disposal
of tractors and trailers. Loss on the disposal of tractors and trailers was
approximately $25,000 in the 2003 period compared to a loss of $0.8 million in
the 2002 period. Amortization expense relates to deferred debt costs incurred
and covenants not to compete from five acquisitions. Goodwill amortization
ceased beginning January 1, 2002, in accordance with SFAS No. 142, and we
evaluate goodwill and certain intangibles for impairment, annually. During the
second quarter of 2003 and 2002, we tested our goodwill for impairment and found
no impairment.
Other expense, net, decreased $0.7 million (51.1%), to $0.6 million in the 2003
period, from $1.3 million in the 2002 period. As a percentage of freight
revenue, other expense decreased to 0.4% in the 2003 period from 0.9% in the
2002 period. Included in the other expense category are interest expense,
interest income, pre-tax non-cash gains related to the accounting for interest
rate derivatives under SFAS No. 133 which amounted to approximately $81,000 in
the 2003 period and approximately $0.4 million in the 2002 period.
Page 16
Our income tax expense was $3.7 million and $3.3 million in the 2003 and 2002
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem, our
tax rate will fluctuate in future periods as income fluctuates.
Primarily as a result of the factors described above, net income increased $0.2
million (6.1%), to $3.2 million in the 2003 period (2.3% of revenue), from $3.0
million in the 2002 period (2.1% of revenue). As a result of the foregoing, our
net margin increased to 2.3% in the 2003 period from 2.1% in the 2002 period.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 2003 TO SIX MONTHS ENDED JUNE 30, 2002
For the six months ending June 30, 2003, revenue increased $7.3 million (2.6%),
to $283.8 million, from $276.5 million in the 2002 period. Freight revenue
excludes $18.4 million of fuel and accessorial surcharge revenue in the 2003
period and $8.7 million in the 2002 period. For comparison purposes in the
discussion below, we use freight revenue when discussing changes as a percentage
of revenue. We believe removing this sometimes volatile source of revenue
affords a more consistent basis for comparing the results of operations from
period to period.
Freight revenue (total revenue less fuel surcharge and accessorial revenue)
decreased $2.4 million (0.9%), to $265.5 million in the six months ended June
30, 2003, from $267.9 million in the same period of 2002. Our freight revenue
was affected by a 2.4% decrease in miles per tractor and an increase in non
revenue miles, which were partially offset by a 2.5% increase in rate per loaded
mile. Revenue per tractor per week decreased to $2,764 in the 2003 period from
$2,784 in the 2002 period. Weighted average tractors increased to 3,706 in the
2003 period from 3,700 in the 2002 period. Due to a weak freight environment, we
have elected to constrain the size of our tractor fleet until fleet production
and profitability improve.
Salaries, wages, and related expenses, net of accessorial revenue of $3.3
million in the 2003 period and $3.2 million in the 2002 period, decreased $5.0
million (4.5%), to $106.2 million in the 2003 period, from $111.1 million in the
2002 period. As a percentage of freight revenue, salaries, wages, and related
expenses decreased to 40.0% in the 2003 period, from 41.5% in the 2002 period.
The decrease was largely attributable to our utilizing a larger percentage of
single-driver tractors, with only one driver per tractor to be compensated and
implementing changes in our pay structure. Our payroll expense for employees
other than over the road drivers increased to 7.3% of freight revenue in the
2003 period from 7.0% of freight revenue in the 2002 period due to growth in
headcount and a larger number of local drivers in the dedicated fleet. Health
insurance, employer paid taxes, workers' compensation, and other employee
benefits decreased to 6.2% of freight revenue in the 2003 period from 6.8% of
freight revenue in the 2002 period, partially due to paying lower taxes due to
lower payroll amounts and improving claims experience in the Company's health
insurance plan.
Fuel expense, net of fuel surcharge revenue of $14.0 million in the 2003 period
and $4.5 million in the 2002 period, decreased $0.4 million (0.8%), to $41.3
million in the 2003 period, from $41.7 million in the 2002 period. As a
percentage of freight revenue, net fuel expense remained essentially constant at
15.6% in the 2003 and 2002 periods. Fuel prices have on average been higher in
the 2003 period as compared to the 2002 period which resulted in approximately
$9.1 million additional fuel expense. However, fuel surcharges amounted to
$0.065 per loaded mile in the 2003 period compared to $0.020 per loaded mile in
the 2002 period, which more than offset the increased fuel expense with
approximately $9.5 million more fuel surcharges in the 2003 period as compared
to the 2002 period. Fuel costs may be affected in the future by volume purchase
commitments, the collectibility of fuel surcharges, and lower fuel mileage due
to government mandated emissions standards that were effective October 1, 2002,
and will result in less fuel efficient engines. We did not have any fuel hedging
contracts at June 30, 2003.
Operations and maintenance, net of accessorial revenue of $1.0 million in the
2003 period and 2002 periods, consisting primarily of vehicle maintenance,
repairs and driver recruitment expenses, increased $1.1 million (6.3%), to $19.3
million in the 2003 period, from $18.2 million in the 2002 period. As a
percentage of freight revenue, operations and maintenance increased to 7.3% in
the 2003 period from 6.8% in the 2002 period. We extended the trade cycle on our
tractor fleet from three years to four years, which has resulted in an increase
in the number of required repairs.
Page 17
Revenue equipment rentals and purchased transportation increased $1.7 million
(5.6%), to $31.4 million in the 2003 period, from $29.7 million in the 2002
period. As a percentage of freight revenue, revenue equipment rentals and
purchased transportation expense increased to 11.8% in the 2003 period from
11.1% in the 2002 period. The owner-operators fleet remained essentially
constant at an average of 354 units in the 2003 period compared to an average of
348 units in the 2002 period. Over the past several years, it has become more
difficult to retain owner-operators due to the challenging operating conditions.
Owner-operators are independent contractors, who provide a tractor and driver
and cover all of their operating expenses in exchange for a fixed payment per
mile. Accordingly, expenses such as driver salaries, fuel, repairs,
depreciation, and interest normally associated with Company-owned equipment are
consolidated in revenue equipment rentals and purchased transportation when
owner-operators are utilized. The revenue equipment rental expense increased
$1.7 million (17.5%), to $11.1 million in the 2003 period, from $9.5 million in
the 2002 period. As of June 30, 2003, we had financed approximately 890 tractors
and 3,835 trailers under operating leases as compared to 636 tractors and 2,564
trailers under operating leases as of June 30, 2002. On April 14, 2003, we
engaged in a sale-leaseback transaction involving approximately 1,266 dry van
trailers. We sold the trailers to a finance company for approximately $15.5
million in cash and leased the trailers back under three year walk away leases.
Our revenue equipment rental expense is expected to increase in the future to
reflect this transaction. We will no longer recognize depreciation and interest
expense with respect to these trailers.
Operating taxes and licenses remained essentially constant at $7.2 million in
the 2003 and 2002 periods. As a percentage of freight revenue, operating taxes
and licenses remained essentially constant at 2.7% in the 2003 and 2002 periods.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, increased
$2.6 million (17.3%), to $17.6 million in the 2003 period from $15.0 million in
the 2002 period. As a percentage of freight revenue, insurance and claims
increased to 6.6% in the 2003 period from 5.6% in the 2002 period. The increase
is a result of an industry-wide increase in insurance rates, which we addressed
by adopting an insurance program with significantly higher deductible exposure,
and unfavorable accident experience. The retention level for our primary
insurance layer increased from $250,000 in 2001 to $500,000 in March of 2002, to
$1.0 million in November of 2002, and to $2.0 million on March 1, 2003. We also
have a $2.0 million self-insured layer between $5.0 million and $7.0 million per
occurrence. Our insurance program for liability, physical damage, and cargo
damage involves self-insurance with varying risk retention levels. Claims in
excess of these risk retention levels are covered by insurance in amounts which
management considers adequate. We accrue the estimated cost of the uninsured
portion of pending claims. These accruals are based on management's evaluation
of the nature and severity of the claim and estimates of future claims
development based on historical trends. Insurance and claims expense will vary
based on the frequency and severity of claims, the premium expense, and the
level of self-insured retention. Because of higher self-insured retentions, our
future expenses of insurance and claims may be higher or more volatile than in
historical periods.
Communications and utilities expense remained essentially constant at $3.4
million in the 2003 period and $3.5 million in the 2002 period. As a percentage
of freight revenue, communications and utilities remained essentially constant
at 1.3% in the 2003 and 2002 periods.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses, decreased $0.1 million (2.1%), to $7.0 million in
the 2003 period, from $7.1 million in the 2002 period. As a percentage of
freight revenue, general supplies and expenses remained essentially constant at
2.6% in the 2003 period and 2.7% in the 2002 period.
Depreciation, amortization and impairment charge, consisting primarily of
depreciation of revenue equipment, decreased $4.8 million (18.3%), to $21.2
million in the 2003 period from $26.0 million in the 2002 period. As a
percentage of freight revenue, depreciation and amortization decreased to 8.0%
in the 2003 period from 9.7% in the 2002 period. The decrease in part resulted
because we did not have an impairment charge in the 2003 period, as we did in
the 2003 period. In addition, we executed the April 2003 sale-leaseback
transaction, and improved the results of our sale of equipment. These factors
were partially offset by increased depreciation expense on our 2001 tractors and
on our new tractors. In the 2002 period, we recognized a pre-tax charge of
approximately $3.3 million to reflect an impairment in tractor values. See
"Impairment of Equipment and Change in Estimated Useful Lives," in Note 6 to the
Consolidated Financial Statements, for additional information. In April 2003, we
entered into a sale-leaseback transaction which involved approximately 1,266 dry
van trailers as discussed in the revenue equipment rentals and
Page 18
purchased transportation section. We sold the trailers to a finance company for
approximately $15.5 million in cash and leased the trailers back under three
year walk away leases. Our revenue equipment rental expense is expected to
increase in the future to reflect this transaction and we will no longer
recognize depreciation and interest expense with respect to these trailers. We
expect our annual cost of tractor and trailer ownership and/or leasing to
increase in future periods. The increase is expected to result from a
combination of higher initial prices of new equipment, lower resale values for
used equipment, and increased depreciation/lease payments on some of our
existing equipment over their remaining lives in order to better match expected
book values or lease residual values with market values at the equipment
disposal date. To the extent equipment is leased under operating leases, the
amounts will be reflected in revenue equipment rentals and purchased
transportation. To the extent equipment is owned or obtained under capitalized
leases; the amounts will be reflected as depreciation expense and interest
expense. Those expense items will fluctuate with changes in the percentage of
our equipment obtained under operating leases versus owned and under capitalized
leases. Depreciation and amortization expense is net of any gain or loss on the
disposal of tractors and trailers. Gain on the disposal of tractors and trailers
was approximately $0.2 million in the 2003 period compared to a loss of $1.4
million in the 2002 period. Amortization expense relates to deferred debt costs
incurred and covenants not to compete from five acquisitions. Goodwill
amortization ceased beginning January 1, 2002, in accordance with SFAS No. 142,
and we evaluate goodwill and certain intangibles for impairment, annually.
During the second quarter of 2003 and 2002, we tested our goodwill for
impairment and found no impairment.
Other expense, net, decreased $2.3 million (65.3%), to $1.2 million in the 2003
period, from $3.5 million in the 2002 period. As a percentage of freight
revenue, other expense decreased to 0.4% in the 2003 period from 1.3% in the
2002 period. Included in the other expense category are interest expense,
interest income, pre-tax non-cash gains related to the accounting for interest
rate derivatives under SFAS No. 133 which amounted to approximately $60,000 in
the 2003 period and approximately $0.2 million in the 2002 period and an early
extinguishment of debt charge.
During the first quarter of 2002, we prepaid the remaining $20 million in
previously outstanding 7.39% ten year, private placement notes with borrowings
from the Credit Agreement. In conjunction with the prepayment of the borrowings,
we recognized an approximate $1.4 million pre-tax charge to reflect the early
extinguishment of debt. The losses related to the write off of debt issuance and
other deferred financing costs and a premium paid on the retirement of the
notes. Upon adoption of SFAS 145 in 2003, we reclassified the charge and it is
no longer classified as an extraordinary item.
Our income tax expense was $5.7 million and $3.6 million in the 2003 and 2002
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem, our
tax rate will fluctuate in future periods as income fluctuates.
Primarily as a result of the factors described above, net income increased $2.7
million (204.9%), to $4.0 million in the 2003 period (1.5% of revenue), from
$1.3 million in the 2002 period (0.5% of revenue). As a result of the foregoing,
our net margin increased to 1.5% in the 2003 period from 0.5% in the 2002
period.
LIQUIDITY AND CAPITAL RESOURCES
Historically our growth has required significant capital investments. We
historically have financed our expansion requirements with borrowings under a
line of credit, cash flows from operations and long-term operating leases. Our
primary sources of liquidity at June 30, 2003, were funds provided by
operations, proceeds under the Securitization Facility (as defined below),
borrowings under our primary credit agreement, which had maximum available
borrowing of $100.0 million at June 30, 2003 (the "Credit Agreement"), the April
2003 sale-leaseback transaction, and operating leases of revenue equipment. We
believe our sources of liquidity are adequate to meet our current and projected
needs for at least the next twelve months.
Net cash provided by operating activities was $35.1 million in the 2003 period
and $30.7 million in the 2002 period. Our primary sources of cash flow from
operations in the 2003 period were net income and depreciation and amortization.
Depreciation and amortization in the 2002 period included a $3.3 million pre-tax
impairment charge.
Net cash provided by investing activities was $3.9 million in the 2003 period
and was derived from the sale of revenue equipment. The cash used in the 2002
period, $28.3 million, related to the financing of tractors, which were
Page 19
previously financed through operating leases, using proceeds from the Credit
Agreement. Anticipated capital expenditures are expected to increase in 2003 as
the Company has agreed to purchase and trade a significant number of tractors
and trailers. We expect capital expenditures, primarily for revenue equipment
(net of trade-ins), to be approximately $50.0 million in 2003, exclusive of
acquisitions, if we remain on a four-year trade cycle for tractors. The
reduction from the first quarter estimate of $80.0 million is primarily due to
the deferral of purchasing 100 new tractors and entering into operating leases.
If we change our trade cycle back to three years, our capital expenditures could
increase significantly.
Net cash used in financing activities was $36.2 million in the 2003 period, and
$1.6 million in the 2002 period. During the six month period ended June 30,
2003, we reduced outstanding balance sheet debt by $37.0 million. Approximately
$15.5 million of this reduction was from proceeds of the April 2003
sale-leaseback transaction. At June 30, 2003, we had outstanding debt of $46.5
million, primarily consisting of $45.2 million in the Securitization Facility
and a $1.3 million interest bearing note to the former primary stockholder of
SRT. Interest rates on this debt range from 1.2% to 6.5%.
During the first quarter of 2002, we prepaid the remaining $20.0 million in
previously outstanding 7.39% ten year private placement notes with borrowings
from the Credit Agreement. In conjunction with the prepayment of the borrowings,
we recognized an approximate $0.9 million after-tax extraordinary item to
reflect the early extinguishment of debt. Upon adoption of SFAS 145 in 2003, we
reclassified the charge and it is no longer classified as an extraordinary item.
In December 2000, we entered into the Credit Agreement with a group of banks,
which expires in December, 2005. Borrowings under the Credit Agreement are based
on the banks' base rate or LIBOR and accrue interest based on one, two, or three
month LIBOR rates plus an applicable margin that is adjusted quarterly between
0.75% and 1.25% based on cash flow coverage. At June 30, 2003, the margin was
0.875%. The Credit Agreement is guaranteed by the Company and all of the
Company's subsidiaries except CVTI Receivables Corp. and Volunteer Insurance
Limited.
At December 31, 2002, the Credit Agreement had a maximum borrowing limit of
$120.0 million. When the facility was extended in February 2003, the borrowing
limit was reduced to $100.0 million with an accordion feature which permits an
increase up to a borrowing limit of $140.0 million. Borrowings related to
revenue equipment are limited to the lesser of 90% of net book value of revenue
equipment or the maximum borrowing limit. Letters of credit were limited to an
aggregate commitment of $20.0 million at December 31, 2002, and were increased
to a limit of $50.0 million in February 2003. The Credit Agreement includes a
"security agreement" such that the Credit Agreement may be collateralized by
virtually all of our assets if a covenant violation occurs. A commitment fee,
that is adjusted quarterly between 0.15% and 0.25% per annum based on cash flow
coverage, is due on the daily unused portion of the Credit Agreement. As of June
30, 2003, we had no borrowings under the Credit Agreement.
In December 2000, we entered into a $62 million revolving accounts receivable
securitization facility (the "Securitization Facility"). On a revolving basis,
we sell our interests in our accounts receivable to CRC, a wholly-owned
bankruptcy-remote special purpose subsidiary incorporated in Nevada. CRC sells a
percentage ownership in such receivables to an unrelated financial entity. We
can receive up to $62 million of proceeds, subject to eligible receivables and
will pay a service fee recorded as interest expense, based on commercial paper
interest rates plus an applicable margin of 0.41% per annum and a commitment fee
of 0.10% per annum on the daily unused portion of the Facility. The net proceeds
under the Securitization Facility are required to be shown as a current
liability because the term, subject to annual renewals, is 364 days. As of June
30, 2003, there were $45.2 million in proceeds received. The transaction did not
meet the criteria for sale treatment under Financial Accounting Standard No. 140
and is reflected as a secured borrowing in the financial statements.
The Credit Agreement and Securitization Facility contain certain restrictions
and covenants relating to, among other things, dividends, tangible net worth,
cash flow, acquisitions and dispositions, and total indebtedness. All of these
agreements are cross-defaulted. The Company is in compliance with these
agreements as of June 30, 2003.
Contractual Obligations and Commitments - In April 2003, we engaged in a
sale-leaseback transaction involving approximately 1,266 dry van trailers. We
sold the trailers to a finance company for approximately $15.5 million in cash
and leased the trailers back under three year walk away leases. The resulting
gain was approximately $0.3
Page 20
million and will be amortized over the life of the lease. The monthly cost of
the lease payments will be higher than the cost of the depreciation and interest
expense; however there will be no residual risk of loss at disposition.
In April 2003, we also entered into an agreement with a finance company to sell
approximately 2,585 dry van trailers and to lease an additional 3,600 model year
2004 dry van trailers over the next 12 months. We will sell the trailers, which
consist of model year 1991 to model year 1997 dry van trailers, to the finance
company for approximately $20.5 million in cash and will lease the additional
3,600 dry van trailers back under seven year walk away leases. Depending on the
delivery schedule of the trade equipment, we will recognize either additional
depreciation expense or losses on the disposal of equipment up to approximately
$2.0 million. The monthly cost of the lease payments will be higher than the
cost of the depreciation and interest expense; however there will be no residual
risk of loss at disposition.
We had commitments outstanding related to equipment, debt obligations, and
diesel fuel purchases as of January 1, 2003. These purchases are expected to be
financed by debt, proceeds from sales of existing equipment, and cash flows from
operations. We have the option to cancel commitments relating to equipment with
60 days notice.
The following table sets forth our contractual cash obligations and commitments
as of January 1, 2003.
Payments Due By Period There-
(in thousands) Total 2003 2004 2005 2006 2007 after
----------- ----------- ----------- ------------ ----------- ----------- ------------
Long Term Debt $ 1,300 $ - $ 1,300 $ - $ - $ - $ -
Short Term Debt (1) 82,230 82,230 - - - - -
Operating Leases 62,308 21,017 12,502 10,852 6,823 4,665 6,449
Lease residual value guarantees 56,802 25,699 - 9,910 3,553 5,590 12,050
Purchase Obligations:
Diesel fuel (2) 52,477 48,020 4,457 - - - -
Equipment (3) 85,986 85,986 - - - - -
----------- ----------- ----------- ------------ ----------- ----------- ------------
Total Contractual Cash Obligations $341,103 $262,952 $18,259 $20,762 $10,376 $10,255 $18,499
=========== =========== =========== ============ =========== =========== ============
(1) In the 2003 period, approximately $39 million of this amount represents proceeds drawn under our Securitization Facility. The
net proceeds under the Securitization Facility are required to be shown as a current liability because the term, subject to
annual renewals, is 364 days. We expect the Securitization Facility to be renewed in 2003.
(2) This amount represents volume purchase commitments for the 2003 period through our truck stop network. We estimate that this
amount represents approximately one-half of our fuel needs for the 2003 period.
(3) Amount reflects gross purchase price of obligations if all leased equipment is purchased.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make decisions
based upon estimates, assumptions, and factors we consider as relevant to the
circumstances. Such decisions include the selection of applicable accounting
principles and the use of judgment in their application, the results of which
impact reported amounts and disclosures. Changes in future economic conditions
or other business circumstances may affect the outcomes of our estimates and
assumptions. Accordingly, actual results could differ from those anticipated. A
summary of the significant accounting policies
Page 21
followed in preparation of the financial statements is contained in Note 1 of
the financial statements contained in the Company's annual report on Form 10-K.
Other footnotes describe various elements of the financial statements and the
assumptions on which specific amounts were determined.
Our critical accounting policies include the following:
Property and Equipment - Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. We depreciate revenue
equipment over five to eight years with salvage values ranging from 25% to 48%.
We continually evaluate the salvage value, useful life, and annual depreciation
of tractors and trailers based on the current market environment and on our
recent experience with disposition values. Any change could result in greater or
lesser annual expense in the future. Gains or losses on disposal of revenue
equipment are included in depreciation in the statements of income.
Impairment of Long-Lived Assets - We evaluate the carrying value of long-lived
assets by analyzing the operating performance and future cash flows for those
assets, whenever events or changes in circumstances indicate that the carrying
amounts of such assets may not be recoverable. We adjust the carrying value of
the underlying assets if the sum of the expected cash flows is less than the
carrying value. Impairment can be impacted by our projection of future cash
flows, the level of cash flows and salvage values, the methods of estimation
used for determining fair values and the impact of guaranteed residuals.
Insurance and Other Claims - Our insurance program for liability, property
damage, and cargo loss and damage, involves self- insurance with high risk
retention levels. We have increased the self-insured retention portion of our
insurance coverage from $12,500 for each claim in 2000 to $1.0 million plus an
additional layer from $4.0 million to $7.0 million for each claim at November
2002. Effective March 2003, we increased our primary coverage to $5.0 million
with a $2.0 million retention level, plus an additional layer from $5.0 million
to $7.0 million for each claim. We accrue the estimated cost of the uninsured
portion of pending claims. These accruals are based on our evaluation of the
nature and severity of the claim and estimates of future claims development
based on historical trends. The rapid and substantial increase in our
self-insured retention makes these estimates an important accounting judgment.
Insurance and claims expense will vary based on the frequency and severity of
claims, the premium expense and the lack of self-insured retention.
From 1999 to present, we carried excess coverage in amounts that have ranged
from $15.0 million to $49.0 million in addition to our primary insurance
coverage. On July 15, 2002, we received a binder for $48.0 million of excess
insurance coverage over our $2.0 million primary layer. Subsequently, we were
forced to seek replacement coverage after the insurance agent retained the
premium and failed to produce proof of insurance coverage. If one or more claims
from the period July to November 2002 exceeded $2.0 million in amount, we would
be required to accrue for the potential or actual loss and our financial
condition and results of operations could be materially and adversely affected.
We are not aware of any such claims at this time.
At December 31, 2002, we maintained a workers' compensation plan and a group
medical plan for our employees with a deductible amount of $500,000 for each
workers' compensation claim and a deductible amount of $225,000 for each group
medical claim. In the first quarter of 2003, we adopted a workers' compensation
plan with a self-insured retention level of $1.0 million per occurrence and
renewed our group medical plan with a deductible amount of $250,000.
Lease Accounting - We lease a significant portion of our tractor and trailer
fleet using operating leases. Substantially all of the leases have residual
value guarantees under which we must insure that the lessor receives a
negotiated amount for the equipment at the expiration of the lease. In
accordance with SFAS No. 13, Accounting for Leases, the rental expense under
these leases is reflected as an operating expense under "revenue equipment
rentals and purchased transportation." To the extent the expected value at the
lease termination date is lower than the residual value guarantee; we accrue for
the difference over the remaining lease term. The estimated values at lease
termination involve management judgments. Operating leases are carried off
balance sheet in accordance with SFAS No. 13.
Page 22
INFLATION AND FUEL COSTS
Most of our operating expenses are inflation-sensitive, with inflation generally
producing increased costs of operations. During the past three years, the most
significant effects of inflation have been on revenue equipment prices and the
compensation paid to the drivers. Innovations in equipment technology and
comfort have resulted in higher tractor prices, and there has been an
industry-wide increase in wages paid to attract and retain qualified drivers. We
historically have limited the effects of inflation through increases in freight
rates and certain cost control efforts.
In addition to inflation, fluctuations in fuel prices can affect profitability.
Fuel expense comprises a larger percentage of revenue for us than many other
carriers because of our long average length of haul. Most of our contracts with
customers contain fuel surcharge provisions. Although we historically have been
able to pass through most long-term increases in fuel prices and taxes to
customers in the form of surcharges and higher rates, increases usually are not
fully recovered. Fuel prices have remained high throughout most of 2000, 2001,
and 2002, which has increased our cost of operating. The elevated level of fuel
prices has continued into 2003.
SEASONALITY
In the trucking industry, revenue generally decreases as customers reduce
shipments during the winter holiday season and as inclement weather impedes
operations. At the same time, operating expenses generally increase, with fuel
efficiency declining because of engine idling and weather creating more
equipment repairs. For the reasons stated, first quarter net income historically
has been lower than net income in each of the other three quarters of the year.
Our equipment utilization typically improves substantially between May and
October of each year because of the trucking industry's seasonal shortage of
equipment on traffic originating in California and our ability to satisfy some
of that requirement. The seasonal shortage typically occurs between May and
August because California produce carriers' equipment is fully utilized for
produce during those months and does not compete for shipments hauled by our dry
van operation. During September and October, business increases as a result of
increased retail merchandise shipped in anticipation of the holidays.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks from changes in (i) certain commodity
prices and (ii) certain interest rates on its debt.
COMMODITY PRICE RISK
Prices and availability of all petroleum products are subject to political,
economic, and market factors that are generally outside our control. Because our
operations are dependent upon diesel fuel, significant increases in diesel fuel
costs could materially and adversely affect our results of operations and
financial condition. Historically, we have been able to recover a portion of
long-term fuel price increases from customers in the form of fuel surcharges.
The price and availability of diesel fuel can be unpredictable as well as the
extent to which fuel surcharges could be collected to offset such increases. For
the six months ending June 30, 2003, diesel fuel expenses net of fuel surcharge
represented 15.1% of our total operating expenses and 15.6% of freight revenue.
At June 30, 2003, we had no derivative financial instruments to reduce our
exposure to fuel price fluctuations.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
INTEREST RATE RISK
The Credit Agreement, provided there has been no default, carries a maximum
variable interest rate of LIBOR for the corresponding period plus 1.25%. During
the first quarter of 2001, we entered into two $10 million notional amount
interest rate swap agreements to manage the risk of variability in cash flows
associated with floating-rate debt. The swaps expire January 2006 and March
2006. These derivatives are not designated as hedging instruments under SFAS No.
133 and consequently are marked to fair value through earnings, in other expense
in the accompanying statement of operations. At June 30, 2003, the fair value of
these interest rate swap agreements was a
Page 23
liability of $1.7 million. At June 30, 2003, we had no borrowings under the
Credit Agreement and therefore no outstanding debt subject to variable rates. An
increase or decrease in LIBOR would not impact our pre-tax interest expense.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Exchange Act, the Company has carried out
an evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of the end of the period covered by this
report. This evaluation was carried out under the supervision and with the
participation of the Company's management, including its Chief Executive Officer
and its Chief Financial Officer. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our controls and procedures
were effective as of the end of the period covered by this report. There were no
changes in our internal control over financial reporting that occurred during
the period covered by this report that have materially affected or that are
reasonably likely to materially affect the Company's internal control over
financial reporting.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in the Company's
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include controls and procedures designed to ensure that information required to
be disclosed in Company reports filed under the Exchange Act is accumulated and
communicated to management, including the Company's Chief Executive Officer as
appropriate, to allow timely decisions regarding disclosures.
The Company has confidence in its internal controls and procedures.
Nevertheless, the Company's management, including the Chief Executive Officer
and Chief Financial Officer, does not expect that our disclosure procedures and
controls or our internal controls will prevent all errors or intentional fraud.
An internal control system, no matter how well-conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of such
internal controls are met. Further, the design of an internal control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all internal control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected.
Page 24
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
None
Items 2 and 3. Not applicable
Item 4. Submission of Matters to Vote of Security Holders.
The Annual Meeting of Stockholders of Covenant Transport, Inc. was held on
May 22, 2003, for the purpose of (a) electing eight directors for one-year
terms, (b) ratification of the selection of KPMG LLP as independent public
accountants for the Company for 2003, and (c) approving the Company's 2003
Incentive Stock Plan. Proxies for the meeting were solicited pursuant to Section
14(a) of the Securities Exchange Act of 1934, and there was no solicitation in
opposition to management's nominees. Each of management's nominees for director
as listed in the Proxy Statement was elected.
The voting tabulation on the election of directors was as follows:
Shares Voted Shares Voted Shares Voted
"FOR" "AGAINST" "ABSTAIN"
David R. Parker 13,740,740 - 1,683,710
Michael W. Miller 13,740,680 - 1,683,770
Mark A. Scudder 13,759,596 - 1,664,854
William T. Alt 13,742,180 - 1,682,270
Hugh O. Maclellan, Jr. 13,759,796 - 1,664,654
Robert E. Bosworth 13,759,796 - 1,664,654
Bradley A. Moline 13,869,967 - 1,554,483
Niel B. Nielson 15,234,106 - 190,344
The voting tabulation on the selection of accountants was "FOR" 13,855,505;
"AGAINST" 7,830,505; and "ABSTAIN"164.
The voting tabulation approving the Company's 2003 Incentive Stock Plan was
"FOR" 12,783,028, "AGAINST" 2,115,957, "ABSTAIN" 16,011 and "DELIVERED NOT
VOTED" 509,454.
Item 5. Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Reference Description
3.1 (1) Restated Articles of Incorporation
3.2 (1) Amended Bylaws dated September 27, 1994.
4.1 (1) Restated Articles of Incorporation
4.2 (1) Amended Bylaws dated September 27, 1994.
10.1 # Amendment No. 3 to Credit Agreement dated June 11, 2003, among Covenant Asset Management, Inc.,
Covenant Transport, Inc., Bank of America, N.A., and each other financial institution which is a
party to the Credit Agreement.
10.2 (2) Covenant Transport, Inc. 2003 Incentive Stock Plan, filed as Appendix B.
10.3 # Consolidating Amendment No. 1 to Loan Agreement effective May 2, 2003, among CVTI Receivables Corp.,
Covenant Transport, Inc., Three Pillars Funding Corporation, and SunTrust Capital Markets, Inc.,
(formerly SunTrust Equitable Securities Corporation).
Page 25
31.1 # Certification of David R. Parker pursuant to Securities Exchange Act Rules 13a-14(a) or 15d-14(a),
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 # Certification of Joey B. Hogan pursuant to Securities Exchange Act Rules 13a-14(a) or 15d-14(a), as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 # Certification of David R. Parker and Joey B. Hogan pursuant to Securities Exchange Act Rules
13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code.
- -----------------------------------------------------------------------------------------------------------------------------------
References:
(1) Incorporated by reference from Form S-1, Registration No. 33-82978, effective October 28, 1994.
(2) Schedule 14A, filed April 16, 2003.
# Filed herewith.
(b) A Form 8-K was filed on April 23, 2003 to report information regarding the
Company's press release announcing its first quarter financial and
operating results.
Page 26
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVENANT TRANSPORT, INC.
Date: August 8, 2003 /s/ Joey B. Hogan
-----------------
Joey B. Hogan
Senior Vice President and Chief Financial
Officer, in his capacity as such and on
behalf of the issuer.