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, 2004
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
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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 3, 2004).
Class A Common Stock, $.01 par value: 12,207,426 shares
Class B Common Stock, $.01 par value: 2,350,000 shares
Page 1
PART I
FINANCIAL INFORMATION
<Table>
Page Number
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2004 (Unaudited) and December 31, 2003 3
Consolidated Statements of Operations for the three and six months ended June 30, 4
2004 and 2003 (Unaudited)
Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003 5
(Unaudited)
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
PART II
OTHER INFORMATION
Page Number
Item 1. Legal Proceedings 26
Item 2. Changes in Securities by the Issuer and Affiliated Purchasers 26
Item 3. Not applicable 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Not applicable 27
Item 6. Exhibits and Reports on Form 8-K 27
Page 2
ITEM 1. FINANCIAL STATEMENTS
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
ASSETS June 30, 2004 December 31, 2003
------ (unaudited)
--------------------- ----------------------
Current assets:
Cash and cash equivalents $ 5,915 $ 3,306
Accounts receivable, net of allowance of $1,350 in 2004
and 2003 72,946 62,998
Drivers advances and other receivables 6,133 9,622
Inventory and supplies 3,252 3,581
Prepaid expenses 13,961 16,185
Deferred income taxes 13,042 13,462
Income taxes receivable 5,317 278
--------------------- ----------------------
Total current assets 120,566 109,432
Property and equipment, at cost 298,170 320,909
Less accumulated depreciation and amortization (90,101) (99,175)
--------------------- ----------------------
Net property and equipment 208,069 221,734
Other assets 22,988 23,115
--------------------- ----------------------
Total assets $351,623 $354,281
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt 1,309 1,300
Securitization Facility 49,153 48,353
Accounts payable 11,865 8,822
Accrued expenses 14,331 14,420
Insurance and claims accrual 29,566 27,420
--------------------- ----------------------
Total current liabilities 106,224 100,315
Long-term debt, less current maturities 10,017 12,000
Deferred income taxes 39,904 49,824
--------------------- ----------------------
Total liabilities 156,145 162,139
Commitments and contingent liabilities
Stockholders' equity:
Class A common stock, $.01 par value; 20,000,000 shares
authorized; 13,304,359 and 13,295,026 shares issued;
12,211,359 and 12,323,526 outstanding as of June 30, 2004
and December 31, 2003, respectively 132 133
Class B common stock, $.01 par value; 5,000,000 shares
authorized; 2,350,000 shares issued and outstanding as of
June 30, 2004 and December 31, 2003 24 24
Additional paid-in-capital 89,029 88,888
Treasury Stock at cost; 1,093,000 and 971,500 shares as of
June 30, 2004 and December 31, 2003, respectively (9,848) (7,935)
Retained earnings 116,141 111,032
--------------------- ----------------------
Total stockholders' equity 195,478 192,142
--------------------- ----------------------
Total liabilities and stockholders' equity $351,623 $354,281
===================== ======================
The accompanying notes are an integral part of these consolidated financial
statements.
Page 3
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(In thousands except per share data)
Three months ended June 30, Six months ended June 30,
(unaudited) (unaudited)
--------------------------------- -----------------------------
2004 2003 2004 2003
---- ---- ---- ----
Freight revenue $ 140,036 $ 139,480 $ 270,626 $ 269,833
Fuel surcharges 9,811 6,462 16,888 13,984
--------------------------------- ------------------------------
Total revenue $ 149,847 $ 145,942 $ 287,514 $ 283,817
Operating expenses:
Salaries, wages, and related expenses 56,378 55,662 108,336 109,472
Fuel expense 30,264 26,502 57,816 55,290
Operations and maintenance 7,482 10,290 15,193 20,284
Revenue equipment rentals and purchased
transportation 18,589 16,562 37,153 31,380
Operating taxes and licenses 3,674 3,745 7,153 7,176
Insurance and claims 8,999 9,558 17,264 17,597
Communications and utilities 1,535 1,731 3,316 3,439
General supplies and expenses 3,524 3,826 7,021 6,999
Depreciation and amortization, including gains
(losses) on disposition of equipment 10,677 10,617 22,480 21,217
--------------------------------- ------------------------------
Total operating expenses 141,122 138,493 275,732 272,854
--------------------------------- ------------------------------
Operating income 8,725 7,449 11,782 10,963
Other (income) expenses:
Interest expense 655 596 1,263 1,247
Interest income (69) (25) (87) (63)
Other (510) 61 (482) 46
--------------------------------- ------------------------------
Other (income) expenses, net 76 632 694 1,230
--------------------------------- ------------------------------
Income before income taxes 8,649 6,817 11,088 9,733
Income tax expense 4,261 3,653 5,981 5,730
--------------------------------- ------------------------------
Net income $ 4,388 $ 3,164 $ 5,107 $ 4,003
================================= ==============================
Net income per share:
Basic earnings per share: $ 0.30 $ 0.22 $ 0.35 $ 0.28
Diluted earnings per share: $ 0.30 $ 0.22 $ 0.34 $ 0.27
Basic weighted average shares outstanding 14,643 14,397 14,660 14,389
Diluted weighted average shares outstanding 14,787 14,664 14,823 14,637
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, 2004 AND 2003
(In thousands)
Six months ended June 30,
(unaudited)
--------------------------------------------
2004 2003
---- ----
Cash flows from operating activities:
Net income $ 5,107 $ 4,003
Adjustments to reconcile net income to net cash
provided by operating activities:
Net provision for (reduction to) losses on accounts receivable 83 (8)
Depreciation and amortization 21,031 21,426
Deferred income taxes (benefit) (9,500) (5,504)
Income tax benefit from exercise of stock options 20 -
(Gain) loss on disposition of property and equipment 1,449 (209)
Changes in operating assets and liabilities:
Receivables and advances (6,542) 2,704
Prepaid expenses and other assets 2,224 141
Inventory and supplies 329 (147)
Insurance and claims 2,146 3,879
Accounts payable and accrued expenses (2,083) 8,829
------------------ -----------------
Net cash flows provided by operating activities 14,264 35,114
Cash flows from investing activities:
Acquisition of property and equipment (34,663) (28,324)
Proceeds from disposition of property and equipment 25,975 32,233
------------------ -----------------
Net cash flows provided by (used in) investing activities (8,688) 3,909
Cash flows from financing activities:
Exercise of stock options 120 1,116
Repurchase of company stock (1,913) -
Proceeds from issuance of debt 40,026 20,000
Repayments of long-term debt (41,200) (57,000)
Deferred costs - (318)
------------------ -----------------
Net cash used in financing activities (2,967) (36,202)
------------------ -----------------
Net change in cash and cash equivalents 2,609 2,821
Cash and cash equivalents at beginning of period 3,306 42
Cash and cash equivalents at end of period $ 5,915 $ 2,863
================== =================
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, 2003 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, 2003. Results of operations in interim periods are
not necessarily indicative of results to be expected for a full year.
Note 2. Comprehensive Earnings
Comprehensive earnings generally include all changes in equity during a
period except those resulting from investments by owners and distributions
to owners. Comprehensive earnings for the three and six-month periods ended
June 30, 2004 and 2003 equaled net income.
Note 3. 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,
2004 2003 2004 2003
---- ---- ---- ----
Numerator:
Net earnings $4,388 $3,164 $5,107 $4,003
Denominator:
Denominator for basic earnings
per share - weighted-average shares 14,643 14,397 14,660 14,389
Effect of dilutive securities:
Employee stock options 144 267 163 248
---------- ---------- ---------- ----------
Denominator for diluted earnings per share -
adjusted weighted-average shares and assumed
conversions 14,787 14,664 14,823 14,637
========== ========== ========== ==========
Net income per share:
Basic earnings per share: $0.30 $0.22 $0.35 $0.28
Diluted earnings per share: $0.30 $0.22 $0.34 $0.27
Dilutive common stock options are included in the diluted earnings per
share calculation using the treasury
Page 6
stock method. At June 30, 2004, we had one stock based employee
compensation plan. Employee stock options in the table above exclude
245,133 and 60,000 in the three month periods ended June 30, 2004 and 2003,
respectively, and 209,396 and 63,000 in the six month periods ended June
30, 2004 and 2003, respectively, from the computation of diluted earnings
per share because their effect would have been anti-dilutive. 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, Accounting for Stock-Based Compensation, ("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
3.7%; expected life of 5 years; dividend rate of zero percent; and expected
volatility of 51.6% for the 2004 period, and 52.8% for the 2003 period.
Using these assumptions, the fair value of the employee stock options
granted, net of the related tax effects, in the three months ended June 30,
2004 and 2003 periods are $0.3 million and $0.4 million, respectively and
in the six months ended June 30, 2004 and 2003 periods are $0.6 million and
$1.0 million, respectively. The following table illustrates the effect on
net income and earnings per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee
compensation.
Three months ended June Six months ended
(in thousands except per share data) 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
Net income, as reported: $4,388 $3,164 $5,107 $4,003
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (278) (438) (613) (977)
----------- ------------ ------------ ------------
Pro forma net income $4,110 $2,726 $4,494 $3,026
Basic earnings per share:
As reported $0.30 $0.22 $0.35 $0.28
Pro forma $0.28 $0.19 $0.31 $0.21
Diluted earnings per share:
As reported $0.30 $0.22 $0.34 $0.27
Pro forma $0.28 $0.19 $0.30 $0.21
Note 4. 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 5. Derivative Instruments and Other Comprehensive Income
The FASB issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, ("SFAS No. 133"). SFAS No. 133, as amended, 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
Page 7
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 statements of operations. At June 30,
2004 and 2003, the fair value of these interest rate swap agreements was a
liability of $0.7 million and $1.7 million, respectively, which are
included in accrued expenses on the consolidated balance sheets. The
derivative activity, as reported in the Company's financial statements for
the six months ended June 30, 2004 and 2003 is summarized in the following:
Six months ended
(in thousands) June 30,
2004 2003
---- ----
Net liability for derivatives at January 1 $ (1,201) $ (1,645)
Gain (loss) in value of derivative instruments that do not
qualify as hedging instruments 481 (61)
----------- -------------
Net liability for derivatives at June 30 $ (720) $ (1,706)
=========== =============
Note 6. Property and Equipment
Depreciation is calculated using the straight-line method over the
estimated useful lives of the assets. For the six month period ended June
30, 2004, the annualized depreciation expense on tractors and trailers is
approximately $37.1 million. We depreciate revenue equipment, excluding day
cabs, over five to ten years with salvage values ranging from 9% to 33%. We
evaluate the salvage value, useful life, and annual depreciation of
tractors and trailers annually based on the current market environment and
our recent experience with disposition values. We also evaluate the
carrying value of long-lived assets for impairment 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 evaluate the need to 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 actual cash flows and salvage
values, the methods of estimation used for determining fair values and the
impact of guaranteed residuals. Any changes in management's judgments could
result in greater or lesser annual depreciation expense or additional
impairment charges in the future.
Note 7. Securitization Facility and Long-Term Debt
Outstanding debt consisted of the following at June 30, 2004 and December
31, 2003:
(in thousands) June 30, 2004 December 31, 2003
----------------------- ----------------------
Securitization Facility $ 49,153 $ 48,353
======================= ======================
Borrowings under Credit Agreement $ 10,000 $ 12,000
Note payable to former SRT shareholder, bearing
interest at 6.5% with interest payable quarterly 1,300 1,300
Equipment and vehicle obligations with commercial
lending institutions 26 -
----------------------- ----------------------
Total long-term debt 11,326 13,300
Less current maturities 1,309 1,300
----------------------- ----------------------
Long-term debt, less current portion $ 10,017 $ 12,000
======================= ======================
In December 2000, we 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, which floats daily, or LIBOR,
which accrues interest based on one, two, three or six month LIBOR rates
plus an applicable margin that is adjusted quarterly between 0.75% and
1.25% based on a Consolidated Leverage Ratio which is generally defined as
the ratio of borrowings, letters of credit, and the present value of
Page 8
operating lease obligations to our earnings before interest, income taxes,
depreciation, amortization, and rental payments under operating leases. The
applicable margin was 1.0% at June 30, 2004. As of June 30, 2004, we had
borrowings under the Credit Agreement in the amount of $10.0 million with a
weighted average interest rate of 2.46%. The Credit Agreement is guaranteed
by the Company and all of our subsidiaries except CVTI Receivables Corp.
("CRC") and Volunteer Insurance Limited.
The Credit Agreement has a maximum borrowing limit of $100.0 million, with
a 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 $70.0 million. 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 the Consolidated
Leverage Ratio, is due on the daily unused portion of the Credit Agreement.
At June 30, 2004 and December 31, 2003, we had undrawn letters of credit
outstanding of approximately $52.4 million and $51.2 million, respectively.
As of June 30, 2004, we had approximately $37.6 million of borrowing
capacity under the Credit Agreement.
In December 2000, we entered into an 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 $62.0 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, 2004 and December 31, 2003, we
had received $49.2 million and $48.4 million, respectively, in proceeds,
with a weighted average interest rate of 1.3% and 1.0%, respectively.
The Credit Agreement and Securitization Facility contain certain
restrictions and covenants relating to, among other things, dividends,
tangible net worth, Consolidated Leverage Ratio, acquisitions and
dispositions, and total indebtedness. These agreements are cross-defaulted.
We were in compliance with these agreements as of June 30, 2004.
Note 8. Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board issued FIN 46-R,
Consolidation of Variable Interest Entities, ("FIN 46-R"). This
Interpretation of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, addresses consolidation by business enterprises of
variable interest entities. For enterprises that are not small business
issuers, FIN 46-R is to be applied to all variable interest entities by the
end of the first reporting period ending after March 15, 2004. Our adoption
of FIN 46-R did not have an impact on our financial condition or results of
operations.
Note 9. Commitments and Contingencies
We are involved in certain legal proceedings arising in the normal course
of business. In the opinion of management, our potential exposure under
pending legal proceedings is adequately provided for in the accompanying
consolidated financial statements.
Page 9
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," "plans,"
"intends," 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 tractor and trailer capacity in
the trucking industry; decreased demand for our services or loss of one or more
of our major customers; surplus inventories; recessionary economic cycles and
downturns in customers' business cycles; strikes, work slow downs, or work
stoppages at our facilities, or at customer, port, or other shipping related
facilities; increases or rapid fluctuations in fuel prices as well as
fluctuations in hedging activities and surcharge collection, the volume and
terms of diesel purchase commitments, 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 independent contractors; elevated experience in
the frequency and severity of claims relating to accident, cargo, workers'
compensation, health, and other matters; high insurance premiums and deductible
amounts; 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, including
revised hours-of-service requirements for drivers; the ability to successfully
execute our initiative of improving the profitability of medium length of haul
movements; 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 with the Securities and
Exchange Commission. We do not assume, and specifically disclaim, any obligation
to update any forward looking statements in this report.
Executive Overview
We are one of the ten largest truckload carriers in the United States measured
by revenue. We focus on targeted markets where we believe our service standards
can provide a competitive advantage. We are a major carrier for transportation
companies such as freight forwarders, less-than-truckload carriers, and
third-party logistics providers that require a high level of service to support
their businesses as well as for traditional truckload customers such as
manufacturers and retailers.
We adopted several business practices in 2001 that were designed to improve our
profitability and particularly, our average revenue per tractor, our chief
measure of asset utilization. The most significant of these practices were
constraining the size of our tractor and trailer fleets until profit margins
justify expansion, increasing freight volumes within our existing traffic lanes,
replacing lower yielding freight, implementing selective rate increases, and
reinforcing our cost control efforts. We believe that a combination of these
business practices and an improved freight environment contributed to
substantial improvement in our operating performance between 2001 and 2003.
For the six months ended June 30, 2004, total revenue increased $3.7 million, or
1.3%, to $287.5 million compared to $283.8 million in the 2003 period. Net
income increased 27.6% to $5.1 million, or $.34 per diluted share, from $4.0
million or $.27 per diluted share, for the first six months of 2003. We believe
that a favorable relationship between freight demand and the industry wide
supply of tractor trailer capacity and our dedication to improving our
efficiency, consistent with the factors previously listed, contributed to our
increase in earnings for the first six months of 2004.
Page 10
Revenue
We generate substantially all of our revenue by transporting freight for our
customers. 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, the
number of tractors operating and the number of miles we generate with our
equipment. These factors relate to, among other things, 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, driver availability
and our average length of haul.
We also derive revenue from fuel surcharges, loading and unloading activities,
equipment detention, and other accessorial services. Historically, we have
measured freight revenue, before fuel and accessorial surcharges, in addition to
total revenue. After the new hours-of-service regulations that became effective
January 4, 2004, accessorial revenue, primarily for equipment detention and stop
offs, has increased significantly. Under the new regulatory requirements, we
have determined it to be appropriate to reclassify accessorial revenue,
excluding fuel surcharges, into freight revenue, and our historical financial
statements have been conformed to this presentation. We continue to report fuel
surcharge revenue separately. We measure freight revenue before fuel surcharges,
because we believe that fuel surcharges tend to be a volatile source of revenue.
The exclusion of such fuel surcharges affords a more consistent basis for
comparing the results of operations from period to period.
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. The main
constraints on our internal growth are the ability to recruit and retain a
sufficient number of qualified drivers and in times of slower economic growth,
to add profitable freight.
In addition to constraining fleet size, we reduced our number of two-person
driver teams during 2001 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.
Since the middle of 2003, we have been conducting an evaluation of the freight
in what we call "in-between" movements. We define "in-between" movements as
lengths of haul between 550 and 850 miles. They are longer than one-day regional
moves but not long enough for expedited team service or two full days with a
single driver. In many instances we believe that the revenue that we have
generated from in-between movements has been insufficient to generate the
profitability we desire based on the amount of time the tractor and driver are
committed to the load. Accordingly, we have been examining each in-between
movement and negotiating with our customers to raise rates, obtain more
favorable loads, or cease hauling the in-between loads. During the period of our
evaluation in 2003, these in-between movements represented approximately 25% of
our total loads, and we believe they have been significantly less profitable
than our longer or shorter lengths of haul. In-between movements represented 22%
of our total loads for the six months ended June 30, 2004. Based on the initial
results of these efforts, we believe that we have significant opportunities to
improve our profitability over time as we continue to focus on our in-between
loads.
Expenses and Profitability
For 2004, the key factors that we expect to affect our profitability are our
revenue per mile, our miles per tractor, our compensation of drivers, our
capital cost of revenue equipment, elevated fuel costs, our costs of maintenance
and our insurance and claims expense. We expect our costs for driver
compensation and the ownership and financing of our new equipment to increase
significantly. On March 15, 2004 we implemented a three cent per mile driver pay
increase for our employee and independent contractor drivers. We also compensate
for detention time, which was effective January 4, 2004. We also expect our
revenue equipment capital cost (whether in the form of interest and depreciation
or payments under operating leases) to increase during 2004, as we continue to
integrate new equipment into our fleet. To overcome these cost increases and
improve our margins we will need to achieve significant increases in revenue per
tractor, particularly in revenue per mile. We also expect the following to
significantly impact our profitability: maintenance costs, which we expect to
decrease because of a newer tractor fleet, insurance and claims, which can be
volatile due to our large self-insured retention; miles per tractor, which will
be affected by
Page 11
our ability to attract and retain drivers in an increasingly competitive driver
market, our success with improving the utilization of our solo driver fleet, and
our success in addressing utilization challenges imposed by hours-of-service
regulations.
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, particularly in revenue per mile, to overcome expected
additional cost increases 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.
Revenue Equipment
At June 30, 2004, we operated approximately 3,540 tractors and 8,945 trailers.
Of our tractors, approximately 2,218 were owned, 1,035 were financed under
operating leases, and 287 were provided by independent contractors, who own and
drive their own tractors. Of our trailers, approximately 1,334 were owned and
approximately 7,611 were financed under operating leases. Currently,
substantially all of our tractors are covered by arrangements under which we may
trade back or cause equipment manufacturers to repurchase the tractor for a
specified value. The trade-in or buy-back values approximate our expected
disposition values of the tractors. Our assumptions represent management's best
estimate, and actual values could differ by the time those tractors are
scheduled for trade.
Because of the increases in purchase prices and lower 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 units being replaced. The timing of
these expenses could be affected in future periods as we continue to transition
from a four year trade cycle to a three year trade cycle for tractors. We expect
to complete the upgrade of our tractor fleet by the end of 2004.
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
transitioning from approximately four years back to three 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.
Independent contractors (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
independent contractors and the financing of equipment under operating leases
are recorded in revenue equipment rentals and purchased transportation. Expenses
associated with owned equipment, such as interest and depreciation, are not
incurred, and for independent contractor tractors, driver compensation, fuel,
and other expenses are not incurred. Because obtaining equipment from
independent contractors 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.
Results of Operations
Historically, we have measured freight revenue, before fuel and accessorial
surcharges, in addition to total revenue. However with the new hours-of-service
regulations that became effective January 4, 2004, accessorial revenue,
primarily for equipment detention and stop offs, has increased significantly.
Under the new regulatory requirements, we have determined it to be appropriate
to reclassify accessorial revenue, excluding fuel surcharges, into freight
revenue, and our historical financial statements have been conformed to this
presentation. We continue to report fuel surcharge revenue separately. For
comparison purposes in the table below, we use freight revenue when discussing
changes as a percentage of revenue. We believe excluding sometimes volatile fuel
surcharge revenue affords a more consistent basis for comparing the results of
operations from period to period.
Page 12
The following table sets forth the percentage relationship of certain items to
total revenue and freight revenue:
Three Months Ended Three Months Ended
June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
Total revenue 100.0% 100.0% Freight revenue (1) 100.0% 100.0%
- ------------- --------- --------- --------------- --------- ---------
Operating expenses: Operating expenses:
Salaries, wages, and related Salaries, wages, and
expenses 37.6 38.1 related expenses 40.3 39.9
Fuel expense 20.2 18.2 Fuel expense (1) 14.6 14.4
Operations and maintenance 5.0 7.1 Operations and maintenance 5.3 7.4
Revenue equipment rentals Revenue equipment rentals
and purchased and purchased
transportation 12.4 11.3 transportation 13.3 11.9
Operating taxes and licenses 2.5 2.6 Operating taxes and licenses 2.6 2.7
Insurance and claims 6.0 6.5 Insurance and claims 6.4 6.9
Communications and utilities 1.0 1.2 Communications and utilities 1.2 1.2
General supplies and General supplies and
expenses 2.4 2.6 expenses 2.5 2.7
Depreciation and amortization 7.1 7.3 Depreciation and amortization 7.6 7.6
--------- --------- --------- ---------
Total operating expenses 94.2 94.9 Total operating expenses 93.8 94.7
--------- --------- --------- ---------
Operating income 5.8 5.1 Operating income 6.2 5.3
Other (income) expense, net 0.1 0.4 Other (income) expense, net 0.1 0.5
--------- --------- --------- ---------
Income before income Income before income
taxes 5.8 4.7 taxes 6.1 4.9
Income tax expense 2.8 2.5 Income tax expense 3.0 2.6
--------- --------- --------- ---------
Net Income 2.9% 2.2% Net Income 3.1% 2.3%
========= ========= ========= =========
(1) Freight revenue is total revenue less fuel surcharge revenue. In this
table, fuel surcharge revenue is shown netted against the fuel expense
category ($9.8 million and $6.5 million in the three months ended June 30,
2004, and 2003, respectively).
Six Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
---- ---- ---- ----
Total revenue 100.0% 100.0% Freight revenue (2) 100.0% 100.0%
- ------------- --------- --------- --------------- --------- ---------
Operating expenses: Operating expenses:
Salaries, wages, and related Salaries, wages, and
expenses 37.7 38.6 related expenses 40.0 40.6
Fuel expense 20.1 19.5 Fuel expense (2) 15.1 15.3
Operations and maintenance 5.3 7.1 Operations and maintenance 5.6 7.5
Revenue equipment rentals Revenue equipment rentals
and purchased and purchased
transportation 12.9 11.1 transportation 13.7 11.6
Operating taxes and licenses 2.5 2.5 Operating taxes and licenses 2.6 2.7
Insurance and claims 6.0 6.2 Insurance and claims 6.4 6.5
Communications and utilities 1.2 1.2 Communications and utilities 1.2 1.3
General supplies and General supplies and
expenses 2.4 2.5 expenses 2.6 2.6
Depreciation and amortization 7.8 7.5 Depreciation and amortization 8.3 7.9
--------- --------- --------- ---------
Total operating expenses 95.9 96.1 Total operating expenses 95.6 95.9
--------- --------- --------- ---------
Operating income 4.1 3.9 Operating income 4.4 4.1
Other (income) expense, net 0.2 0.4 Other (income) expense, net 0.3 0.5
--------- --------- --------- ---------
Income before income Income before income
taxes 3.9 3.4 taxes 4.1 3.6
Income tax expense 2.1 2.0 Income tax expense 2.2 2.1
--------- --------- --------- ---------
Net Income 1.8% 1.4% Net Income 1.9% 1.5%
========= ========= ========= =========
(2) Freight revenue is total revenue less fuel surcharge revenue. In this
table, fuel surcharge revenue is shown
Page 13
netted against the fuel expense category ($16.9 million and $14.0 million
in the six months ended June 30, 2004, and 2003, respectively).
COMPARISON OF THREE MONTHS ENDED JUNE 30, 2004 TO THREE MONTHS ENDED JUNE 30,
2003
For the quarter ended June 30, 2004, total revenue increased $3.9 million, or
2.7% to $149.8 million, compared with $145.9 million in the 2003 period. Total
revenue includes $9.8 million and $6.5 million of fuel surcharge revenue in the
2004 and 2003 periods, respectively. For comparison purposes in the discussion
below, we use freight revenue (total revenue less fuel surcharge 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 remained relatively constant at $140.0 million in the three
months ended June 30, 2004, and $139.5 million in the same period of 2003.
Revenue per tractor per week increased to $2,996 in the 2004 period from $2,892
in the 2003 period, primarily attributable to a 9.8% increase in rate per loaded
mile. The increase was partially offset by a 4.3% decrease in average miles per
tractor and an increase in non-revenue miles. Weighted average tractors
decreased to 3,578 in the 2004 period from 3,699 in the 2003 period. We have
elected to constrain the size of our tractor fleet until fleet utilization and
profitability improve.
Salaries, wages, and related expenses increased $0.7 million, or 1.3%, to $56.4
million in the 2004 period, from $55.7 million in the 2003 period. As a
percentage of freight revenue, salaries, wages, and related expenses increased
to 40.3% in the 2004 period, from 39.9% in the 2003 period. Driver pay increased
to 27.5% of freight revenue in the 2004 period from 27.3% of freight revenue in
the 2003 period. The increase was largely attributable to a pay increase that
went into effect March 15, 2004 and was partially offset by our utilizing a
larger percentage of single-driver tractors, where only one driver per tractor
is compensated. Management expects driver wages, excluding benefits, to increase
by approximately $13.0 million pre-tax on an annualized basis due to our
implementation of a three cent per mile pay increase. Our payroll expense for
employees, other than over the road drivers, remained relatively constant at
7.0% of freight revenue in the 2004 period and 7.1% of freight revenue in the
2003 period. Health insurance, employer paid taxes, workers' compensation, and
other employee benefits remained relatively constant at 5.8% of freight revenue
in the 2004 period and 5.6% of freight revenue in the 2003 period.
Fuel expense, net of fuel surcharge revenue of $9.8 million in the 2004 period
and $6.5 million in the 2003 period, increased $0.4 million, or 2.1%, to $20.5
million in the 2004 period, from $20.0 million in the 2003 period. As a
percentage of freight revenue, net fuel expense increased to 14.6% in the 2004
period from 14.4% in the 2003 period, primarily because of higher fuel prices
and lower fuel mileage due to government mandated emissions standards that have
resulted in less fuel efficient engines. Fuel prices increased sharply during
2003 and have remained at high levels into 2004. Fuel surcharges amounted to
$0.088 per revenue mile in the 2004 period and $0.054 per revenue mile in the
2003 period, which partially offset the increased fuel expense. Higher fuel
prices will increase our operating expenses. Fuel costs may be affected in the
future by volume purchase commitments, the collectibility of fuel surcharges,
the percentage of miles driven by independent contractors, and lower fuel
mileage due to government mandated emissions standards that have resulted in
less fuel efficient engines.
Operations and maintenance, consisting primarily of vehicle maintenance, repairs
and driver recruitment expenses, decreased $2.8 million to $7.5 million in the
2004 period from $10.3 million in the 2003 period. As a percentage of freight
revenue, operations and maintenance decreased to 5.3% in the 2004 period from
7.4% in the 2003 period. The decrease resulted in part from the implementation
of our equipment plan. Over the past twelve months, we have accepted delivery of
approximately 1,700 tractors and 3,800 trailers and have disposed of
approximately 1,700 tractors and 2,900 trailers. We are changing our four year
tractor trade cycle back to a period of approximately three years, which has
reduced the average age of our tractor fleet. Accordingly, maintenance costs
have decreased. The average age of our tractor and trailer fleets decreased to
18 and 30 months at June 30, 2004, from 27 and 57 months as of June 30, 2003,
respectively. The maintenance savings are expected to be partially offset by
increased driver recruiting expense due to the greater demand for trucking
services and a tighter supply of drivers.
Revenue equipment rentals and purchased transportation increased $2.0 million,
or 12.2%, to $18.6 million in the 2004 period, from $16.6 million in the 2003
period. As a percentage of freight revenue, revenue equipment rentals
Page 14
and purchased transportation expense increased to 13.3% in the 2004 period from
11.9% in the 2003 period. The increase is due principally to an increase in
revenue equipment rental payments slightly offset by a decrease in the amount of
independent contractor fleet compensation. Tractor and trailer equipment rental
expense increased $3.0 million to $8.8 million in the three months ended June
30, 2004 compared to $5.8 million in the same period of 2003. As of June 30,
2004, we had financed approximately 1,035 tractors and 7,611 trailers under
operating leases as compared to 890 tractors and 3,835 trailers under operating
leases as of June 30, 2003. Payments to independent contractors decreased $1.1
million to $9.5 million in the 2004 period from $10.6 million in the 2003
period, mainly due to a decrease in the independent contractor fleet to an
average of 320 during the 2004 period versus an average of 354 in the 2003
period.
Operating taxes and licenses remained essentially constant at $3.7 million in
the 2004 and 2003 periods. As a percentage of freight revenue, operating taxes
and licenses also remained essentially constant at 2.6% in the 2004 period and
2.7% in the 2003 period.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, decreased
$0.6 million, or 5.8%, to $9.0 million in the 2004 period from $9.6 million in
the 2003 period. This decrease is predominantly the result of fewer and less
severe incidents during the second quarter of 2004 partially offset by an
industry-wide increase in insurance rates, which we addressed by adopting an
insurance program with significantly higher deductible exposure. As a percentage
of freight revenue, insurance and claims decreased to 6.4% in the 2004 period
from 6.9% in the 2003 period. During the first quarter of 2004, we renewed our
casualty program through February 2005. We are self-insured for personal injury
and property damage claims for amounts up to $2.0 million per occurrence for the
first $5.0 million of exposure. Insurance and claims expense will vary based on
the frequency and severity of claims, the premium expense, and the level of
self-insured retention and may cause our insurance and claims expense to be
higher or more volatile in future periods than in historical periods.
Communications and utilities expense remained essentially constant at $1.5
million in the 2004 period and $1.7 million in the 2003 period. As a percentage
of freight revenue, communications and utilities also remained essentially
constant at 1.2% in the 2004 and 2003 periods.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses, decreased $0.3 million, or 7.9%, to $3.5 million
in the 2004 period, from $3.8 million in the 2003 period. As a percentage of
freight revenue, general supplies and expenses decreased to 2.5% in the 2004
period from 2.7% in the 2003 period.
Depreciation and amortization, consisting primarily of depreciation of revenue
equipment, remained relatively constant at $10.7 million in the 2004 period and
$10.6 million in the 2003 period. As a percentage of freight revenue,
depreciation and amortization remained relatively constant at 7.6% in the 2004
and 2003 periods. 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 $0.5 million in the 2004 period and approximately
$25,000 in the 2003 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, Goodwill and Other Intangible
Assets, and we evaluate goodwill and certain intangibles for impairment,
annually. During the second quarter of 2004, we tested our goodwill ($11.5
million) for impairment and found no impairment.
Our ownership/lease costs of revenue equipment were unusually high during the
three month period ending June 30, 2004 as we traded a substantial amount of
equipment. The majority of the increase related to trade-in equipment
preparation costs and increased depreciation associated with the fleet upgrade
that was completed during the period. Our ownership/lease costs include both
leased and owned equipment and are reflected in the combined cost of revenue
equipment rentals, depreciation and interest. Excluding the unusually high
trade-in equipment preparation costs, we expect an increase in our
ownership/lease costs of approximately one-half cent per mile going forward, due
to the increased prices and decreased residual values of new tractors and the
cost relating to our decision to increase the size of our trailer fleet in
response to a shorter length of haul and to improve customer service. 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
Page 15
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.
Other expense, net, decreased $0.6 million, or 88.0%, to $76,000 in the 2004
period from $0.6 million in the 2003 period. The decrease is due to a $0.5
million pre-tax, non-cash gain in the 2004 period related to the accounting for
interest rate derivatives under SFAS No. 133, compared to a loss of
approximately $81,000 in the 2003 period. As a percentage of freight revenue,
other expense, net, decreased to 0.1% in the 2004 period from 0.5% in the 2003
period. The other expense category includes interest expense, interest income,
and pre-tax non-cash gains or losses related to the accounting for interest rate
derivatives under SFAS No. 133.
Our income tax expense was $4.3 million and $3.7 million in the 2004 and 2003
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
approximately $1.2 million to $4.4 million in the 2004 period from $3.2 million
in the 2003 period. We believe that a favorable relationship between freight
demand and the industry wide supply of tractor trailer capacity and our
dedication to improving our efficiency, consistent with the factors previously
listed, contributed to our increase in earnings. As a result of the foregoing,
our net margin increased to 3.1% in the 2004 period from 2.3% in the 2003
period.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 2004 TO SIX MONTHS ENDED JUNE 30, 2003
For the six months ended June 30, 2004, total revenue increased $3.7 million, or
1.3% to $287.5 million, compared with $283.8 million in the 2003 period. Total
revenue includes $16.9 million and $14.0 million of fuel surcharge revenue in
the 2004 and 2003 periods, respectively. For comparison purposes in the
discussion below, we use freight revenue (total revenue less fuel surcharge
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 remained relatively constant at $270.6 million in the six months
ended June 30, 2004, and $269.8 million in the same period of 2003. Revenue per
tractor per week increased to $2,871 in the 2004 period from $2,792 in the 2003
period, primarily attributable to a 7.6% increase in rate per loaded mile
partially offset by a 3.1% decrease in average miles per tractor and an increase
in non-revenue miles. Weighted average tractors decreased to 3,612 in the 2004
period from 3,706 in the 2003 period. We have elected to constrain the size of
our tractor fleet until fleet utilization and profitability improve.
Salaries, wages, and related expenses decreased $1.1 million, or 1.0%, to $108.3
million in the 2004 period, from $109.5 million in the 2003 period. As a
percentage of freight revenue, salaries, wages, and related expenses decreased
to 40.0% in the 2004 period, from 40.6% in the 2003 period. Driver pay decreased
to 27.0% of freight revenue in the 2004 period from 27.2% of freight revenue in
the 2003 period. The decrease was largely attributable to our utilizing a larger
percentage of single-driver tractors, where only one driver per tractor is
compensated. This decrease was offset by a pay increase that went into effect
March 15, 2004. Management expects driver wages, excluding benefits, to increase
by approximately $13.0 million pre-tax on an annualized basis due to our
implementation of a three cent per mile pay increase. Our payroll expense for
employees, other than over the road drivers, remained relatively constant at
7.1% of freight revenue in the 2004 period and 7.2% of freight revenue in the
2003 period. Health insurance, employer paid taxes, workers' compensation, and
other employee benefits remained relatively constant at 5.9% of freight revenue
in the 2004 period and 6.1% of freight revenue in the 2003 period.
Fuel expense, net of fuel surcharge revenue of $16.9 million in the 2004 period
and $14.0 million in the 2003 period, decreased $0.4 million, or 0.9%, to $40.9
million in the 2004 period, from $41.3 million in the 2003 period. As a
percentage of freight revenue, net fuel expense decreased to 15.1% in the 2004
period from 15.3% in the 2003 period, primarily because of higher freight rates
and lower miles per tractor partially offset by higher fuel prices and lower
fuel mileage due to government mandated emissions standards that have resulted
in less fuel efficient engines. Fuel prices increased sharply during 2003 and
have remained at high levels into 2004. Fuel surcharges amounted to
Page 16
$0.077 per revenue mile in the 2004 period and $0.060 per revenue mile in the
2003 period, which partially offset the increased fuel expense. Higher fuel
prices will increase our operating expenses. Fuel costs may be affected in the
future by volume purchase commitments, the collectibility of fuel surcharges,
the percentage of miles driven by independent contractors, and lower fuel
mileage due to government mandated emissions standards that have resulted in
less fuel efficient engines.
Operations and maintenance, consisting primarily of vehicle maintenance, repairs
and driver recruitment expenses, decreased $5.1 million to $15.2 million in the
2004 period from $20.3 million in the 2003 period. As a percentage of freight
revenue, operations and maintenance decreased to 5.6% in the 2004 period from
7.5% in the 2003 period. The decrease resulted in part from the implementation
of our equipment plan. Over the past twelve months, we have accepted delivery of
approximately 1,700 tractors and 3,800 trailers and have disposed of
approximately 1,700 tractors and 2,900 trailers. We are changing our four year
tractor trade cycle back to a period of approximately three years, which has
reduced the average age of our tractor fleet. Accordingly, maintenance costs
have decreased. The average age of our tractor and trailer fleets decreased to
18 and 30 months at June 30, 2004, from 27 and 57 months as of June 30, 2003,
respectively. The maintenance savings are expected to be partially offset by
increased driver recruiting expense due to the greater demand for trucking
services and a tighter supply of drivers.
Revenue equipment rentals and purchased transportation increased $5.8 million,
or 18.4%, to $37.2 million in the 2004 period, from $31.4 million in the 2003
period. As a percentage of freight revenue, revenue equipment rentals and
purchased transportation expense increased to 13.7% in the 2004 period from
11.6% in the 2003 period. The increase is due principally to an increase in
revenue equipment rental payments. Tractor and trailer equipment rental expense
increased $5.9 million to $16.6 million in the six months ended June 30, 2004
compared to $10.7 million in the same period of 2003. As of June 30, 2004, we
had financed approximately 1,035 tractors and 7,611 trailers under operating
leases as compared to 890 tractors and 3,835 trailers under operating leases as
of June 30, 2003. Payments to independent contractors decreased $0.2 million to
$20.1 million in the 2004 period from $20.3 million in the 2003 period. We
utilized an average of 357 independent contractors during the 2004 period versus
an average of 354 in the 2003 period. However, the independent contractors
averaged fewer miles in the 2004 period as compared to the 2003 period.
Operating taxes and licenses remained essentially constant at $7.2 million in
the 2004 and 2003 periods. As a percentage of freight revenue, operating taxes
and licenses also remained essentially constant at 2.6% in the 2004 period and
2.7% in the 2003 period.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, decreased
$0.3 million, or 1.9%, to $17.3 million in the 2004 period from $17.6 million in
the 2003 period. This decrease is predominantly the result of fewer and less
severe incidents during the six month period ending June 30, 2004 partially
offset by an industry-wide increase in insurance rates, which we addressed by
adopting an insurance program with significantly higher deductible exposure. As
a percentage of freight revenue, insurance and claims remained essentially
constant at 6.4% in the 2004 period and 6.5% in the 2003 period. During the
first quarter of 2004, we renewed our casualty program through February 2005. We
are self-insured for personal injury and property damage claims for amounts up
to $2.0 million per occurrence for the first $5.0 million of exposure. Insurance
and claims expense will vary based on the frequency and severity of claims, the
premium expense, and the level of self-insured retention and may cause our
insurance and claims expense to be higher or more volatile in future periods
than in historical periods.
Communications and utilities expense remained essentially constant at $3.3
million in the 2004 period and $3.4 million in the 2003 period. As a percentage
of freight revenue, communications and utilities also remained essentially
constant at 1.2% in the 2004 period and 1.3% in the 2003 period.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses remained essentially constant at $7.0 million in
the 2004 and 2003 periods. As a percentage of freight revenue, general supplies
and expenses also remained essentially constant at 2.6% in the 2004 and 2003
periods.
Depreciation and amortization, consisting primarily of depreciation of revenue
equipment, increased $1.3 million or 6.0% to $22.5 million in the 2004 period
from $21.2 million in the 2003 period. As a percentage of freight revenue,
depreciation and amortization expense increased to 8.3% in the 2004 period from
7.9% in the 2003 period.
Page 17
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 $1.4 million in the 2004 period compared to a gain of $209,000 in
the 2003 period.
Our ownership/lease costs of revenue equipment were unusually high during the
six month period ending June 30, 2004 as we traded a substantial amount of
equipment. The majority of the increase related to trade-in equipment
preparation costs and increased depreciation associated with the fleet upgrade
that was completed during the period. Our ownership/lease costs include both
leased and owned equipment and are reflected in the combined cost of revenue
equipment rentals, depreciation and interest. With the majority of our trade-in
equipment preparation costs completed, we expect our ownership/lease costs of
revenue equipment to decrease by approximately one cent per mile by the end of
the year as compared to the first six months of 2004. Excluding the unusually
high trade-in equipment preparation costs, we expect an increase in our
ownership/lease costs of approximately one-half cent per mile going forward, due
to the increased prices and decreased residual values of new tractors and the
cost relating to our decision to increase the size of our trailer fleet in
response to a shorter length of haul and to improve customer service. 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.
Other expense, net, decreased $0.5 million, or 43.6%, to $0.7 million in the
2004 period from $1.2 million in the 2003 period. The decrease is due to a $0.5
million pre-tax, non-cash gain in the 2004 period related to the accounting for
interest rate derivatives under SFAS No. 133, compared to a loss of
approximately $60,000 in the 2003 period. The other expense category includes
interest expense, interest income, and pre-tax non-cash gains or losses related
to the accounting for interest rate derivatives under SFAS No. 133.
Our income tax expense was $6.0 million and $5.7 million in the 2004 and 2003
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
approximately $1.1 million to $5.1 million in the 2004 period from $4.0 million
in the 2003 period. We believe that a favorable relationship between freight
demand and the industry wide supply of tractor trailer capacity and our
dedication to improving our efficiency, consistent with the factors previously
listed, contributed to our increase in earnings. As a result of the foregoing,
our net margin increased to 1.9% in the 2004 period from 1.5% in the 2003
period.
LIQUIDITY AND CAPITAL RESOURCES
Our business requires significant capital investments. We historically have
financed our capital 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, 2004, were funds provided by operations, proceeds under
the Securitization Facility, borrowings under our Credit Agreement, each as
defined in Note 7 to our consolidated financial statements contained herein, and
operating leases of revenue equipment.
Over the past several years, we have financed a large and increasing percentage
of our revenue equipment through operating leases. This has reduced the net
value of revenue equipment reflected on our balance sheet, reduced our
borrowings and increased our net cash flows compared to purchasing all of our
revenue equipment. Certain items could fluctuate depending on whether we finance
our revenue equipment through borrowings or through operating leases. We expect
capital expenditures, primarily for revenue equipment (net of trade-ins), to be
approximately $55.0 to $60.0 million in 2004, exclusive of acquisitions of
companies, and including assets financed with leases, as we transition back to a
three-year trade cycle for tractors and a seven year trade cycle on dry van
trailers. We believe our sources of liquidity are adequate to meet our current
and projected needs for at least the next twelve months. On a longer term basis,
based on anticipated future cash flows, current availability under our credit
Facility, and sources of equipment lease financing that we expect will be
available to us, we do not expect to experience significant liquidity
constraints in the foreseeable future.
Page 18
Net cash provided by operating activities was $14.3 million in the 2004 period
and $35.1 million in the 2003 period. Our primary sources of cash flow from
operations in the 2004 period were net income and depreciation and amortization.
Net cash used in investing activities was $8.7 million in the 2004 period
related to the purchase of tractors. Net cash provided by investing activities
was $3.9 million in the first six months of 2003 and was derived from the sale
of revenue equipment during the period.
Net cash used in financing activities was $3.0 million in the 2004 period, and
$36.2 million in the 2003 period. During the six month period ended June 30,
2004, we reduced outstanding balance sheet debt by $1.2 million and repurchased
$1.9 million of company stock, using proceeds from the Credit Agreement. At June
30, 2004, we had outstanding debt of $60.5 million, consisting of $49.2 million
in the Securitization Facility, $10.0 million drawn under the Credit Agreement
and a $1.3 million interest bearing note to the former primary stockholder of
SRT. Interest rates on this debt range from 1.3% to 6.5%.
In May 2004, the Board of Directors authorized a stock repurchase plan for up to
1.0 million company shares to be purchased in the open market or through
negotiated transactions subject to criteria established by the board. During the
second quarter of 2004, the Company purchased a total of 121,500 shares with an
average price of $15.75. The stock repurchase plan referenced herein expires May
31, 2005 and cancels and replaced the Company's stock repurchase program adopted
by the Board of Directors in 2000.
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 $15.6 million in cash and leased the trailers back under three
year walk away leases. The resulting gain was approximately $0.3 million and is
being 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. We sold the trailers, which consisted of model year 1991
to model year 1997 dry van trailers, to the finance company for approximately
$20.5 million in cash and leased the 3,600 dry van trailers back under seven
year walk away leases. 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. The transaction was completed in the
first quarter of 2004 and the leases begin to expire in June 2010.
Contractual Obligations and Commitments - We had commitments outstanding related
to equipment, debt obligations, and diesel fuel purchases as of January 1, 2004.
The following table sets forth our contractual cash obligations and commitments
as of January 1, 2004.
There-
Payments Due By Period Total 2004 2005 2006 2007 2008 after
(in thousands)
-------------------------------------------------------------------------------------
Long Term Debt $ 12,000 $ - $ 12,000 $ - $ - $ - $ -
Short Term Debt (1) 49,653 49,653 - - - -
-
Operating Leases 128,367 32,045 30,854 23,863 14,778 12,676 14,151
Lease residual value guarantees 42,656 - 9,486 8,462 5,590 18,151 967
Purchase Obligations:
Diesel fuel (2) 5,561 5,561 - - - - -
Equipment (3) 90,373 90,373 - - - - -
-------------------------------------------------------------------------------------
Total Contractual Cash
Obligations $328,610 $177,632 $ 52,340 $ 32,325 $ 20,368 $ 30,827 $ 15,118
=====================================================================================
Page 19
(1) Approximately $48.4 million of this amount represents proceeds drawn under
our Securitization Facility at December 31, 2003. 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 December 2004.
(2) This amount represents volume purchase commitments for the 2004 period
through our truck stop network. We estimate that this amount represents
approximately 5% of our fuel needs for the 2004 period.
(3) Amount reflects the total purchase price or lease commitment of tractors
and trailers scheduled for delivery throughout 2004. Net of estimated
trade-in values and other dispositions, the estimated amount due under
these commitments is approximately $45.0 million. These purchases are
expected to be financed by debt or operating leases, proceeds from sales of
existing equipment, and cash flows from operations. We have the option to
cancel commitments relating to equipment with 60 days prior notice.
OFF BALANCE SHEET ARRANGEMENTS
Operating leases have been an important source of financing for our revenue
equipment, computer equipment and company airplane. We lease a significant
portion of our tractor and trailer fleet using operating leases. At June 30,
2004, we had financed approximately 1,035 tractors and 7,611 trailers under
operating leases. Vehicles held under operating leases are not carried on our
balance sheet, and lease payments in respect of such vehicles are reflected in
our income statements in the line item "Revenue equipment rentals and purchased
transportation." Our revenue equipment rental expense was $16.6 million in the
2004 period, compared to $10.7 million in the 2003 period. The total amount of
remaining payments under operating leases as of June 30, 2004, was approximately
$144.6 million. In connection with the leases of a majority of the value of the
equipment we finance with operating leases, we issued residual value guarantees,
which provide that if we do not purchase the leased equipment from the lessor at
the end of the lease term, then we are liable to the lessor for an amount equal
to the shortage (if any) between the proceeds from the sale of the equipment and
an agreed value. As of June 30, 2004, the maximum amount of the residual value
guarantees was approximately $47.8 million. To the extent the expected value at
the lease termination date is lower than the residual value guarantee, we would
accrue for the difference over the remaining lease term. We believe that
proceeds from the sale of equipment under operating leases would exceed the
payment obligation on all operating leases.
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 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 for the fiscal year ended
December 31, 2003. The following discussion addresses our most critical
accounting policies, which are those that are both important to the portrayal of
our financial condition and results of operations and that require significant
judgment or use of complex estimates.
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 excluding day cabs over five to ten years with salvage values ranging
from 9% to 33%. We evaluate the salvage value, useful life, and annual
depreciation of tractors and trailers annually based on the current market
environment and 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
Page 20
depreciation in the statements of operations. We also evaluate the carrying
value of long-lived assets for impairment 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 evaluate the need to 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
actual cash flows and salvage values, the methods of estimation used for
determining fair values and the impact of guaranteed residuals. Any changes in
management's judgments could result in greater or lesser annual depreciation
expense or additional impairment charges in the future.
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 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, as well as the legal and other costs to settle or defend the
claims. Because of our significant self-insured retention amounts, we have
significant exposure to fluctuations in the number and severity of claims. If
there is an increase in the frequency and severity of claims, or we are required
to accrue or pay additional amounts if the claims prove to be more severe than
originally assessed, our profitability would be adversely affected.
In addition to estimates within our self-insured retention layers, we also must
make judgments concerning our aggregate coverage limits. 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, although for the
period from July through November 2002, our aggregate coverage limit was $2.0
million because of a fraudulently issued binder for our excess coverage. If any
claim occurrence were to exceed our aggregate coverage limits, we would have to
accrue for the excess amount, and our critical estimates include evaluating
whether a claim may exceed such limits and, if so, by how much. Currently, we
are not aware of any such claims. If one or more claims from this period were to
exceed the then effective coverage limits, our financial condition and results
of operations could be materially and adversely affected.
Lease Accounting and Off-Balance Sheet Transactions - Operating leases have been
an important source of financing for our revenue equipment, computer equipment
and company airplane. We lease a significant portion of our tractor and trailer
fleet using operating leases. In connection with the leases of a majority of the
value of the equipment we finance with operating leases, we issued residual
value guarantees, which provide that if we do not purchase the leased equipment
from the lessor at the end of the lease term, then we are liable to the lessor
for an amount equal to the shortage (if any) between the proceeds from the sale
of the equipment and an agreed value. As of June 30, 2004, the maximum amount of
the residual value guarantees was approximately $47.8 million. To the extent the
expected value at the lease termination date is lower than the residual value
guarantee, we would accrue for the difference over the remaining lease term. We
believe that proceeds from the sale of equipment under operating leases would
exceed the payment obligation on all operating leases. The estimated values at
lease termination involve management judgments. As leases are entered into,
determination as to the classification as an operating or capital lease involves
management judgments on residual values and useful lives.
Accounting for Income Taxes - In this area, we make important judgments
concerning a variety of factors, including, the appropriateness of tax
strategies, expected future tax consequences based on future company
performance, and to the extent tax strategies are challenged by taxing
authorities, our likelihood of success. The Company utilizes certain income tax
planning strategies to reduce its overall cost of income taxes. These strategies
have been examined by the IRS in an audit of our 2001 and 2002 income tax
returns. It is possible that certain strategies might be disallowed resulting in
an increased liability for income taxes. We have received an IRS Notice of
Proposed Assessment, which asserts that three of our tax planning strategies
have been disallowed, and as a result, we have filed an appeal in the matter. We
have not yet been contacted by the IRS Appeals Division to schedule a hearing to
resolve this issue. In April 2004, we submitted a $5.0 million cash bond to the
Internal Revenue Service to mitigate any future interest expense. We have
accrued amounts that we believe are appropriate given our expectations
concerning the ultimate resolution of the strategies. Significant management
judgments are involved in assessing the likelihood of sustaining the strategies
and in determining the likely range of defense and settlement costs.
Deferred income taxes represent a substantial liability on our consolidated
balance sheet and are determined in accordance with SFAS No. 109, Accounting for
Income Taxes. Deferred tax assets (tax benefits expected to be
Page 21
realized in the future) and liabilities are recognized for the expected future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, and operating loss and tax credit carry forwards. We evaluate our
deferred tax assets and liabilities on a periodic basis and adjust these
balances as appropriate. We believe that we have adequately provided for our
future tax consequences based upon current facts and circumstances and current
tax law. During the six months ended June 30, 2004, we made no material changes
in our assumptions regarding the determination of deferred income taxes.
However, should these tax positions be challenged and not prevail, different
outcomes could result and have a significant impact on the amounts reported
through our Consolidated Statement of Operations.
The carrying value of our deferred tax assets assumes that we will be able to
generate, based on certain estimates and assumptions, sufficient future taxable
income in certain tax jurisdictions to utilize these deferred tax benefits. If
these estimates and related assumptions change in the future, we may be required
to reduce the value of the deferred tax assets resulting in additional income
tax expense. We believe that it is more likely than not that the deferred tax
assets, net of valuation allowance, will be realized, based on forecasted
income. However, there can be no assurance that we will meet our forecasts of
future income. We evaluate the deferred tax assets on a periodic basis and
assess the need for additional valuation allowances.
INFLATION, NEW EMISSIONS CONTROL REGULATIONS 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. New emissions control regulations have
resulted in higher tractor prices, and there has been an industry-wide increase
in wages paid to attract and retain qualified drivers. The cost of fuel also has
risen substantially over the past three years. We believe this increase
primarily reflects world events rather than underlying inflationary pressure. We
attempt to limit the effects of inflation through increases in freight rates,
certain cost control efforts and the effects of fuel prices through fuel
surcharges.
The engines used in our newer tractors are subject to new emissions control
regulations, which may substantially increase our operating expense. The Federal
Environmental Protection Agency ("EPA") recently adopted new emissions control
regulations, which require progressive reductions in exhaust emissions from
diesel engines through 2007, for engines manufactured in October 2002, and
thereafter. The new regulations decrease the amount of emissions that can be
released by truck engines and affect tractors produced after the effective date
of the regulations. Compliance with such regulations has increased the cost of
our new tractors and could impair equipment productivity, lower fuel mileage,
and increase our operating expenses. Some manufacturers have significantly
increased new equipment prices, in part to meet new engine design requirements,
and have eliminated or sharply reduced the price of repurchase commitments.
These adverse effects combined with the uncertainty as to the reliability of the
vehicles equipped with the newly designed diesel engines and the residual values
that will be realized from the disposition of these vehicles could increase our
costs or otherwise adversely affect our business or operations.
Fluctuations in the price or availability of fuel, as well as hedging
activities, surcharge collection, and the volume and terms of diesel fuel
purchase commitments, may increase our cost of operation, which could materially
and adversely affect our profitability. We impose fuel surcharges on
substantially all accounts. These arrangements may not fully protect us from
fuel price increases and also may result in us not receiving the full benefit of
any fuel price decreases. We currently do not have any fuel hedging contracts in
place. If we do hedge, we may be forced to make cash payments under the hedging
arrangements. A small portion of our fuel requirements for 2004 are covered by
volume purchase commitments. Based on current market conditions, we have decided
to limit our hedging and purchase commitments, but we continue to evaluate such
measures. The absence of meaningful fuel price protection through these measures
could adversely affect our profitability.
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.
Page 22
<Page>
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.
Page 23
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 ended June 30, 2004, diesel fuel expenses net of fuel surcharge
represented 15.8% of our total operating expenses and 15.1% of freight revenue.
At June 30, 2004, 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
Our market risk is also affected by changes in interest rates. Historically, we
have used a combination of fixed rate and variable rate obligations to manage
our interest rate exposure. Fixed rate obligations expose us to the risk that
interest rates might fall. Variable rate obligations expose us to the risk that
interest rates might rise.
Our variable rate obligations consist of our Credit Agreement and our
Securitization Facility. Borrowings under the Credit Agreement, provided there
has been no default, are based on the banks' base rate, which floats daily, or
LIBOR, which accrues interest based on one, two, three or six month LIBOR rates
plus an applicable margin that is adjusted quarterly between 0.75% and 1.25%
based on a Consolidated Leverage Ratio which is generally defined as the ratio
of borrowings, letters of credit, and the present value of operating lease
obligations to our earnings before interest, income taxes, depreciation,
amortization, and rental payments under operating leases. The applicable margin
was 1.0% at June 30, 2004.
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. Due to the counter-parties' embedded options to cancel, 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, 2004, the fair value of these
interest rate swap agreements was a liability of $0.7 million. At June 30, 2004,
we had variable, base rate borrowings of $10.0 million outstanding under the
Credit Agreement.
Our Securitization Facility carries a variable interest rate based on the
commercial paper rate plus an applicable margin of 0.41% per annum. At June 30,
2004, borrowings of $49.2 million had been drawn on the Securitization Facility.
Assuming variable rate borrowings under the Credit Agreement and Securitization
Facility at June 30, 2004 levels, a one percentage point increase in interest
rates could increase our annual interest expense by approximately $392,000.
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.
Page 24
ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended
(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 25
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time we are a party to ordinary, routine litigation
arising in the ordinary course of business, most of which involves
claims for personal injury and property damage incurred in connection
with the transportation of freight. The Company maintains insurance to
cover liabilities arising from the transportation of freight for
amounts in excess of certain self-insured retentions.
On October 26, 2003, a pickup truck collided with a trailer being
operating by Southern Refrigerated Transport, Inc. ("SRT"), one of our
subsidiaries. A lawsuit was filed in the United States District Court
for the Southern District of Mississippi (the "Court") on February 4,
2004 on behalf of Donald J. Byrd, an injured passenger in the pickup
truck, and an amended complaint was filed on February 18, 2004 on
behalf of Mr. Byrd and Marilyn S. Byrd, his wife. The relief sought in
the lawsuit is judgment against SRT and the driver of the SRT truck in
excess of one million dollars. In addition, the Company has received
demands in the form of letters seeking a total of $27.0 million from
attorneys representing potential beneficiaries of two decedents who
occupied the pickup truck. One of the demand letters is seeking $15.0
million and a second demand letter is seeking $12.0 million. A
memorandum of settlement with the beneficiaries of one of the
decedents was entered into on June 28, 2004. A formal agreement for
full and final settlement has recently been entered into with those
beneficiaries. As to the claims arising from that decedent, an Agreed
Order providing for dismissal of the Company has been signed by
counsel for the parties and filed with the Court. It is anticipated
that the Court will issue a Judgment of Dismissal with Prejudice as to
those claims. The $12.0 million demand letter referenced above is
rendered moot by this settlement effectively reducing the outstanding
demands against the Company from $27.0 million to $15.0 million. We
continue to defend the case and expect all matters involving the
occurrence to be resolved at a level substantially below our aggregate
coverage limits of our insurance policies.
Item 2. Changes in Securities and Use of Proceeds.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers(1)
Total Number of Maximum Number (or
Total Average Shares Purchased Approx. Dollar Value)
Period Number of Price Paid as Part of Publicly of Shares that May Yet
Shares Per Share Announced Plans Be Purchased Under
Purchased or Programs the Plans or Programs
------------------- ------------- ------------- --------------------- --------------------------
April 1, 2004 -
April 30, 2004 0 N/A 0 1,000,000
------------------- ------------- ------------- --------------------- --------------------------
May 1, 2004 -
May 31, 2004 43,200 $15.56 43,200 956,800
------------------- ------------- ------------- --------------------- --------------------------
June 1, 2004 -
June 30, 2004 78,300 $15.85 78,300 878,500
------------------- ------------- ------------- --------------------- --------------------------
Total 121,500 $15.75 121,500 878,500
------------------- ------------- ------------- --------------------- --------------------------
(1) On May 21, 2004, the Company announced that the Board of Directors
authorized the Company to repurchase up to one million (1,000,000) shares
of its Class A common stock, subject to criteria established by the Board
of Directors. The stock may be purchased on the open market or in privately
negotiated transactions at any time until May 31, 2005, at which time, or
prior thereto, the board may elect to extend the repurchase program. This
program canceled and replaced the program adopted by the Board of Directors
in 2000.
Page 26
Item 3. Defaults Upon Senior Securities.
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 27, 2004, for the purpose of electing seven directors for
one-year terms. Proxies for the meeting were solicited pursuant to
Section 14(a) of the Exchange Act, 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 13,593,710 - 3,054,983
Mark A. Scudder 13,511,198 - 3,137,495
William T. Alt 13,478,498 - 3,170,195
Hugh O. Maclellan, Jr. 15,779,008 - 869,685
Robert E. Bosworth 15,779,108 - 869,585
Bradley A. Moline 13,506,092 - 3,142,601
Niel B. Nielson 16,199,862 - 448,831
Item 5. Other Information.
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. 6 to Loan Agreement dated July 8, 2004 among Three Pillars Funding, LLC
(f/k/a Three Pillars Funding Corporation), SunTrust Capital Markets, Inc. (f/k/a
SunTrust Equitable Securities Corporation), CVTI Receivables Corporation, and
Covenant Transport, Inc. effective June 1, 2004.
10.2 # Form of Indemnification Agreement between Covenant Transport, Inc. and each officer
and director, effective May 1, 2004.
31.1 # Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, by David R. Parker, the Company's
Chief Executive Officer.
31.2 # Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, by Joey B. Hogan, the Company's Chief
Financial Officer.
32 # Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, by David R. Parker, the Company's Chief Executive
Officer, and Joey B. Hogan, the Company's Chief Financial Officer.
- ------------------------------------------------------------------------------------------------------------------------
References:
(1) Incorporated by reference from Form S-1, Registration No. 33-82978,
effective October 28, 1994.
# Filed herewith.
(b) Reports on Form 8-K
Page 27
On April 21, 2004, the Company furnished a Form 8-K with the SEC under Item
12 (Results of Operations and Financial Condition) a press release
announcing its financial and operating results for the quarter ended March
31, 2004.
On June 1, 2004, the Company filed a Form 8-K with the SEC to provide
notice to the SEC of the Company's change in 401(k) provider and the black
out period that resulted due to the change.
Page 28
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 4, 2004 /s/ Joey B. Hogan
-------------------
Joey B. Hogan
Executive Vice President and Chief Financial Officer,
in his capacity as such and on behalf of the issuer.