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: 0-24946 KNIGHT TRANSPORTATION, INC. (Exact name of registrant as specified in its charter) Arizona 86-0649974 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5601 West Buckeye Road Phoenix, Arizona 85043 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: 602-269-2000 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. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [X] Yes [ ] No The number of shares outstanding of registrant's Common Stock, par value $0.01 per share, as of July 30, 2004 was 56,380,470 shares. KNIGHT TRANSPORTATION, INC. INDEX PART I - FINANCIAL INFORMATION Page Number Item 1. Financial Statements Condensed Consolidated Balance Sheets as of June 30, 2004 1 and December 31, 2003 (Unaudited) Condensed Consolidated Statements of Income for the three months 3 and six months ended June 30, 2004 and 2003 (Unaudited) Condensed Consolidated Statements of Cash Flows for the 4 six months ended June 30, 2004 and 2003 (Unaudited) Notes to Condensed Consolidated Financial Statements (Unaudited) 6 Item 2. Management's Discussion and Analysis of Financial Condition 10 and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk 20 Item 4. Controls and Procedures 21 Part II - OTHER INFORMATION 22 Item 1. Legal Proceedings Item 2. Changes in Securities and Use of Proceeds 22 Item 3. Defaults Upon Senior Securities 22 Item 4. Submission of Matters to a Vote of Security Holders 22 Item 5. Other Information 22 Item 6. Exhibits and Reports on Form 8-K 22 Signatures 25 PART I - FINANCIAL INFORMATION Item 1. Financial Statements KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (unaudited) As of June 30, 2004 and December 31, 2003 (In thousands) June 30, 2004 December 31, 2003 ------------------------ ----------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 36,480 $ 40,550 Accounts receivable, net 47,460 38,751 Notes receivable, net 295 515 Inventories and supplies 1,732 1,336 Prepaid expenses 4,060 7,490 Income tax receivable - 1,761 Deferred tax asset 6,077 5,667 ------------------------ ----------------------- Total current assets 96,104 96,070 ------------------------ ----------------------- PROPERTY AND EQUIPMENT: Land and improvements 14,976 13,911 Buildings and improvements 21,191 17,166 Furniture and fixtures 5,267 4,916 Shop and service equipment 2,600 2,409 Revenue equipment 292,416 256,803 Leasehold improvements 783 968 ------------------------ ----------------------- 337,233 296,173 Less: Accumulated depreciation and amortization (89,082) (83,238) ------------------------ ----------------------- PROPERTY AND EQUIPMENT, net 248,151 212,935 ------------------------ ----------------------- NOTES RECEIVABLE - long-term 144 362 GOODWILL 7,504 7,504 OTHER ASSETS 5,307 4,355 $ 357,210 $ 321,226 ======================== ======================= The accompanying notes are an integral part of these condensed consolidated financial statements. 1 KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (unaudited) (continued) As of June 30, 2004 and December 31, 2003 (In thousands, except par values) June 30, 2004 December 31, 2003 ------------------------ --------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 5,251 $ 3,408 Accrued payroll 4,912 3,448 Accrued liabilities 11,600 4,493 Claims accrual 18,065 14,805 ------------------------ --------------------------- Total current liabilities 39,828 26,154 DEFERRED INCOME TAXES 55,540 55,149 ------------------------ --------------------------- Total liabilities 95,368 81,303 ------------------------ --------------------------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY: Preferred stock, $0.01 par value; authorized 50,000 shares; none issued and outstanding - - Common stock, $0.01 par value; authorized 100,000 shares; 56,375 and 56,234 issued and outstanding at June 30, 2004 and December 31, 2003, respectively 564 563 Additional paid-in capital 78,946 77,754 Retained earnings 182,332 161,606 ------------------------ --------------------------- Total shareholders' equity 261,842 239,923 ------------------------ --------------------------- $ 357,210 $ 321,226 ======================== =========================== The accompanying notes are an integral part of these condensed consolidated financial statements. 2 KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Income (unaudited) (In thousands, except per share data) Three Months Ended Six Months Ended June 30, June 30, 2004 2003 2004 2003 ---- ---- ---- ---- REVENUE Revenue, before fuel surcharge $100,168 $81,790 $190,411 $155,341 Fuel surcharge 6,980 3,319 11,049 6,977 ------------ ------------ ------------ ------------ Total revenue 107,148 85,109 201,460 162,318 ------------ ------------ ------------ ------------ OPERATING EXPENSES: Salaries, wages and benefits 32,333 26,398 62,463 50,189 Fuel 20,418 13,638 37,132 27,866 Operations and maintenance 6,128 5,033 11,789 9,721 Insurance and claims 5,714 4,274 10,603 8,101 Operating taxes and licenses 2,366 2,289 4,590 4,415 Communications 872 747 1,741 1,467 Depreciation and amortization 9,573 7,266 18,471 14,052 Lease expense - revenue equipment 1,035 1,948 2,268 3,923 Purchased transportation 7,549 6,542 14,137 12,054 Miscellaneous operating expenses 2,228 2,016 3,947 3,719 ------------ ------------ ------------ ------------ 88,216 70,151 167,141 135,507 ------------ ------------ ------------ ------------ Income from operations 18,932 14,958 34,319 26,811 ------------ ------------ ------------ ------------ OTHER INCOME (EXPENSE): Interest income 83 173 207 309 Interest expense - (181) - (383) ------------ ------------ ------------ ------------ 83 (8) 207 (74) ------------ ------------ ------------ ------------ Income before taxes 19,015 14,950 34,526 26,737 INCOME TAXES (7,600) (6,000) (13,800) (10,710) ------------ ------------ ------------ ------------ Net income $11,415 $8,950 $20,726 $16,027 ============ ============ ============ ============ Net income per common share and common share equivalent: Basic $0.20 $0.16 $0.37 $0.29 ============ ============ ============ ============ Diluted $0.20 $0.16 $0.36 $0.28 ============ ============ ============ ============ Weighted average number of common shares and common share equivalents outstanding: Basic 56,340 56,001 56,298 55,895 ============ ============ ============ ============ Diluted 57,479 57,342 57,435 57,248 ============ ============ ============ ============ The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3 KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (unaudited) (In thousands) Six Months Ended June 30, 2004 2003 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 20,726 $ 16,027 Adjustments to reconcile net income to net cash Provided by operating activities: Depreciation and amortization 18,471 14,052 Non-cash compensation expense for issuance of stock to certain members of board of directors 13 18 Allowance for doubtful accounts 224 314 Interest rate swap agreement - fair value change - 167 Tax benefit from exercise of stock options 550 1,400 Deferred income taxes (20) 1,806 Changes in assets and liabilities: Increase in trade receivables (8,932) (1,636) Increase in inventories and supplies (396) (15) Decrease (increase) in prepaid expenses 3,430 (352) Decrease in income tax receivable 1,761 - Increase in other assets (952) (925) (Decrease) increase in accounts payable (604) 1,970 Increase in accrued liabilities and claims accrual 11,831 4,326 ------------------ ------------------ Net cash provided by operating activities 46,102 37,152 ------------------ ------------------ CASH FLOW FROM INVESTING ACTIVITIES: Purchase of property and equipment (51,240) (37,925) Investment in/advances to other companies - (213) Cash received from advance to other company - 1,600 Decrease in notes receivable, net 438 885 ------------------ ------------------ Net cash used in investing activities (50,802) (35,653) ------------------ ------------------ The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 4 KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (unaudited) (continued) (In thousands) Six Months Ended June 30, 2004 2003 ---- ---- CASH FLOW FROM FINANCING ACTIVITIES: Payments on long-term debt - (1,954) Proceeds from exercise of stock options 630 1,447 ---------------------- --------------------- Net cash used in financing activities 630 (507) ---------------------- --------------------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (4,070) 992 CASH AND CASH EQUIVALENTS, Beginning of period 40,550 36,198 ---------------------- --------------------- CASH AND CASH EQUIVALENTS, end of period $ 36,480 $ 37,190 ====================== ===================== SUPPLEMENTAL DISCLOSURES: Noncash investing and financing transactions: Equipment acquired in accounts payable $ 2,522 $ 1,133 Net book value of equipment traded 16,974 15,810 Cash Flow Information: Income taxes paid $ 5,746 $ 6,593 Interest paid - 214 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5 KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. Financial Information The accompanying condensed consolidated financial statements include the accounts of Knight Transportation, Inc., and its wholly owned subsidiaries (the Company). All material inter-company balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures have been omitted or condensed pursuant to such rules and regulations. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Results of operations in interim periods are not necessarily indicative of results for a full year. For additional information, please refer to other filings with the SEC, including our Form 10Q for the quarter ended March 31, 2004, and our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003. Note 2. Stock-Based Compensation Stock-Based Compensation - At June 30, 2004, the Company had one stock-based employee compensation plan. The Company applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations including Financial Accounting Standards Board (FASB) Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25," issued in March 2000, to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of the grant. Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123. The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards for the three-month and six-month periods ended June 30, 2004 and 2003, respectively (in thousands, except per share data): 6 Three Months Ended Six Months Ended June 30, June 30, 2004 2003 2004 2003 ---- ---- ---- ---- Net income, as reported $ 11,415 $ 8,950 $ 20,726 $ 16,027 Deduct total stock-based compensation expense determined under fair-value based method for all awards, net of tax (326) (151) (586) (302) ---------------- ---------------- --------------- ---------------- Pro forma net income $ 11,089 $ 8,799 $ 20,140 $ 15,725 ================ ================ =============== ================ Diluted earnings per share: As reported $0.20 $0.16 $0.36 $0.28 ================ ================ =============== ================ Pro forma $0.19 $0.15 $0.35 $0.27 ================ ================ =============== ================ The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2004: risk free interest rate of 4.0%; expected life of 6.5 years; expected volatility of 49%; expected dividend yield rate of zero; and expected forfeitures of 3.68%. The following weighted average assumptions were used for grants in 2003: risk free interest rate 3.36%; expected life of 6.0 years; expected volatility of 52%; expected dividend yield rate of zero; and expected forfeitures of 3.04%. Note 3. Net Income Per Share A reconciliation of the basic and diluted net income per share computations for the three months and six months ended June 30, 2004 and 2003, respectively, is as follows: Three Months Ended Six Months Ended June 30, June 30, 2004 2003 2004 2003 ---- ---- ---- ---- Weighted average common shares outstanding - Basic 56,340 56,001 56,298 55,895 Effect of stock options 1,139 1,341 1,137 1,353 ---------------- ---------------- --------------- ---------------- Weighted average common share and common share equivalents outstanding - Diluted 57,479 57,342 57,435 57,248 ================ ================ =============== ================ Net income $ 11,415 $ 8,950 $ 20,726 $ 16,027 ================ ================ =============== ================ Net income per common share and common share equivalent Basic $0.20 $0.16 $0.37 $0.29 ================ ================ =============== ================ Diluted $0.20 $0.16 $0.36 $0.28 ================ ================ =============== ================ 7 Note 4. Comprehensive Income Comprehensive income for the three and six-month periods ended June 30, 2004 and 2003 was as follows (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2004 2003 2004 2003 ---- ---- ---- ---- Net Income $11,415 $8,950 $20,726 $16,027 Other comprehensive income: Interest rate swap agreement - fair market value adjustment - 83 - 167 ---------------- ---------------- --------------- ---------------- Comprehensive income $11,415 $9,033 $20,726 $16,194 ================ ================ =============== ================ Note 5. Segment Information Although we have seventeen operating divisions, we have determined that we have one reportable segment. Sixteen of the divisions are managed based on regions in the United States in which we operate. Each of these divisions has similar economic characteristics as they all provide short to medium-haul truckload carrier services of general commodities to a similar class of customers. In addition, each division exhibits similar financial performance, including average revenue per mile and operating ratio. The remaining division is not reported because it does not meet the materiality thresholds in SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". As a result, we have determined that it is appropriate to aggregate our operating divisions into one reportable segment consistent with the guidance in SFAS No. 131. Accordingly, we have not presented separate financial information for each of our operating divisions as our consolidated financial statements present our one reportable segment. Note 6. Derivative Instruments All derivatives are recognized on the balance sheet at their fair value. In August and September 2000, and in July 2001, we entered into three agreements, respectively, which are derivative instruments. These three contracts relate to the price of heating oil on the New York Merchantile Exchange ("NYMX") and were entered into in connection with volume diesel fuel purchases between October 2000 and February 2002. The three agreements described above are stated at their fair market value in the accompanying condensed consolidated financial statements. During 2001, we entered into an interest rate swap agreement on the $12.2 million outstanding on our line of credit for purposes of better managing cash flow. On November 7, 2001, we paid $762,500 to settle this swap agreement. The amount was included in other comprehensive income and had been fully amortized to interest expense at December 31, 2003. Note 7. Recently Adopted and to be Adopted Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51", which was revised in December 2003. This interpretation addresses the consolidation by business enterprises of variable interest entities as defined in this interpretation. This interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. For public enterprises with a variable interest in a variable interest entity created before February l, 2003, 8 this interpretation applies to that enterprise no later than the beginning of the first interim or annual reporting period beginning after December 15, 2003. The application of this interpretation did not have a material effect on our consolidated financial statements. In December 2003, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 104 ("SAB No. 104"), "Revenue Recognition", which codifies, revises and rescinds certain sections of SAB No. 101, "Revenue Recognition", in order to make this interpretive guidance consistent with current authoritative accounting guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our consolidated financial statements. Note 8. 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 condensed consolidated financial statements. Note 9. Stock Split On July 20, 2004, we effected a 3-for-2 stock split. The stock split increased the weighted average number of diluted shares outstanding for the quarter ended June 30, 2004 to 57.5 million. Earnings per share for all periods presented have been adjusted to reflect the stock split. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Cautionary Note Regarding Forward-Looking Statements Except for certain historical information contained herein, the following discussion contains forward-looking statements that involve risks, assumptions and uncertainties which are difficult to predict. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including without limitation: any projections of earnings, revenues, or other financial items; any statement of plans, strategies, and objectives of management for future operations; any statements concerning proposed new services or developments; any statements regarding future economic conditions or performance; and any statements of belief and any statement of assumptions underlying any of the foregoing. Words such as "believe," "may," "could," "expects," "hopes," "anticipates," and "likely," and variations of these words, or similar expressions, are intended to identify such forward-looking statements. Actual events or results could differ materially from those discussed in forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled "Factors That May Affect Future Results," set forth below. We do not assume, and specifically disclaim, any obligation to update any forward-looking statement contained in this Report. Introduction Business Overview We are primarily a dry van truckload carrier based in Phoenix, Arizona. We transport general commodities for shippers throughout the United States, generally focusing our operations on short-to-medium lengths of haul. We provide regional truckload carrier services from our 16 operations centers located throughout the United States. Over the past five years we have achieved substantial revenue and income growth as a result of our continuing expansion into new regional markets, emphasis on maintaining and improving efficiencies and cost control discipline, and success at obtaining rate increases as a result of providing a high level of customer service. During this period, our revenue, before fuel surcharge, grew at a 21% compounded annual rate from $125.0 million in 1998 to $326.9 million in 2003, and our net income grew at a 22% compounded annual rate from $13.3 million in 1998 to $35.5 million in 2003. Operating and Growth Strategy Our operating strategy is focused on the following core elements: o Focusing on Regional Operations. We seek to operate primarily in high-density, predictable traffic lanes in selected geographic regions. We believe our regional operations allow us to obtain greater freight volumes and higher revenue per mile, and also enhance safety and driver recruitment and retention. o Maintaining Operating Efficiencies and Controlling Costs. We focus almost exclusively on operating dry-vans in distinct geographic and shipping markets in order to achieve increased penetration of targeted service areas and higher equipment utilization in dense traffic lanes. We actively seek to control costs by, among other things, operating a modern equipment fleet, maintaining a high tractor to non-driver employee ratio, and regulating vehicle speed. o Providing a High Level of Customer Service. We seek to compete on the basis of service in addition to price, and offer our customers a broad range of services to meet their specific needs, including multiple pick ups and deliveries, on-time pick ups and deliveries within narrow time frames, dedicated fleet and personnel, and specialized driver training. 10 o Using Technology to Enhance Our Business. Our tractors are equipped with a satellite-based tracking and communications systems to permit us to stay in contact with our drivers, obtain load position updates, and provide our customers with freight visibility. A significant number of our trailers are equipped with tracking technology to allow us to manage our trailers more effectively, maintain a low trailer to tractor ratio, efficiently assess detention fees, and minimize cargo loss. The primary source of our revenue growth has been our ability to open new regional facilities in certain geographic areas and operate these facilities at a profit. We opened our most recent regional facilities in Carlisle, Pennsylvania in June 2004 and Lakeland, Florida in August 2004. Based on our current expectations concerning the economy, we anticipate increasing our total tractors by 350 to 400 system-wide for the entire year of 2004. We have increased our total tractors by 171 through June 30, 2004. As part of our growth strategy, we also periodically evaluate acquisition opportunities and we will continue to consider acquisitions that meet our financial and operating criteria. In addition, in July 2004, we began operating a refrigerated division based out of a separate facility located in Phoenix. This new refrigerated division began with approximately 20 tractors. Revenue and Expenses We primarily generate revenue by transporting freight for our customers. Generally we are paid a rate per mile for our services. We enhance our revenue by charging for tractor and trailer detention, loading and unloading activities, and other specialized services, as well as through the collection of fuel surcharges to mitigate the impact of increases in the cost of fuel. The main factors that affect our revenue are the revenue per mile we receive from our customers, the percentage of miles for which we are compensated, and the number of miles we generate with our equipment. These factors relate, among other things, to the general level of economic activity in the United States, inventory levels, specific customer demand, the level of capacity in the trucking industry, and driver availability. For much of 2001, 2002, and 2003, economic activity in the United States was somewhat sluggish, which limited to some extent our ability to obtain rate increases. During the first half of 2004, however, the United States economy experienced strong growth. Business inventory levels also improved during this period. As a result of these positive developments, we have experienced stronger and more stable freight demand among current and prospective customers thus far in 2004 than we experienced in the preceding three years. Historically, the excess capacity in the transportation industry has limited our ability to improve rates. Over the past two years, however, the transportation industry has seen some reduction in capacity. We hope that, over the remainder of 2004, lower capacity coupled with stronger freight demand will continue to provide us with better pricing power. The main factors that impact our profitability on the expense side are the variable costs of transporting freight for our customers. These costs include fuel expense, driver-related expenses, such as wages, benefits, training, and recruitment, and owner-operator costs, which are recorded under purchased transportation. Expenses that have both fixed and variable components include maintenance and tire expense and our total cost of insurance and claims. These expenses generally vary with the miles we travel, but also have a controllable component based on safety, fleet age, efficiency, and other factors. Our main fixed costs are the acquisition and financing of long-term assets, such as revenue equipment and operating terminals, and the compensation of non-driver personnel. Effectively controlling our expenses is an important element of assuring our profitability. The primary measure we use to evaluate our profitability is operating ratio, excluding the impact of fuel surcharge revenue (operating expenses, net of fuel surcharge, as a percentage of revenue, before fuel surcharge). We view any operating ratio, whether for the Company or any operations center, in excess of 85% as unacceptable performance. 11 Recent Results of Operations and Quarter-End Financial Condition For the quarter ended June 30, 2004, our results of operations improved as follows versus the same period in 2003: o Revenue, before fuel surcharge, increased 22.5%, to $100.2 million from $81.8 million; o Net income increased 27.5%, to $11.4 million from $9.0 million; and o Net income per diluted share increased 25.0% to $0.20 from $0.16. We believe the improvements in our profitability are attributable primarily to higher average revenue per tractor per week (excluding fuel surcharge), our main measure of asset productivity, which increased 7.8% to $3,052 in the second quarter of 2004 from $2,831 in the second quarter of 2003. This improvement was driven by a 5.9% increase in average revenue per loaded mile (excluding fuel surcharge) to $1.516 from $1.431 and a 1.3% increase in average miles per tractor to 29,125 from 28,763. We believe these increases were attributable to stronger freight demand and a better rate environment in the 2004 quarter primarily due to the improving U.S. economy and a favorable relationship between demand and trucking capacity. Rate and mile improvements were partially offset by a 0.9% increase in our percentage of non-revenue miles to 10.9% for the second quarter of 2004 from 10.8% for the same period in the prior year, which was principally due to positioning of our revenue equipment in areas which allowed us to capitalize on the most favorable freight in terms of the highest rates. At June 30, 2004, our balance sheet reflected $36.5 million in cash and cash equivalents, no long-term debt, and shareholders' equity of $261.8 million. For the quarter, we generated $25.9 million in cash flow from operations and used $30.8 million for net capital expenditures (net of net book value of equipment traded of $17.0 million). 12 Results of Operations The following table sets forth the percentage relationships of our expense items to total revenue and revenue, before fuel surcharge, for the three-month and six-month periods ended June 30, 2004, and 2003, respectively. Fuel expense as a percentage of revenue, before fuel surcharge, is calculated using fuel expense, net of surcharge. Management believes that eliminating the impact of this sometimes volatile source of revenue affords a more consistent basis for comparing our results of operations from period to period. (Revenue, before) (Revenue, before) (Total revenue) (fuel surcharge) (Total revenue) (fuel surcharge) Three-Month Three-Month Six-Month Six-Month Period Ended Period Ended Period Ended Period Ended ------------------ ------------------ ------------------ ------------------ June 30, June 30, June 30, June 30, 2004 2003 2004 2003 2004 2003 2004 2003 ---- ---- ---- ---- ---- ---- ---- ---- Revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Operating expenses: Salaries, wages and benefits 30.2 31.0 32.3 32.3 31.0 30.9 32.8 32.3 Fuel 19.1 16.0 13.4(1) 12.6(1) 18.4 17.2 13.7(1) 13.4(1) Operations and maintenance 5.7 5.9 6.1 6.2 5.9 6.0 6.2 6.3 Insurance and claims 5.3 5.0 5.7 5.2 5.3 5.0 5.6 5.2 Operating taxes and licenses 2.2 2.7 2.4 2.8 2.3 2.7 2.4 2.8 Communications 0.8 0.9 0.9 0.9 0.9 0.9 0.9 0.9 Depreciation and amortization 8.9 8.5 9.6 8.9 9.2 8.7 9.7 9.0 Lease expense - revenue equipment 1.0 2.3 1.0 2.4 1.1 2.4 1.2 2.5 Purchased transportation 7.0 7.7 7.5 8.0 7.0 7.4 7.4 7.8 Miscellaneous operating expenses 2.1 2.4 2.2 2.5 2.0 2.3 2.1 2.4 ------ ------ ------ ------ ------ ------ ------ ------ Total Operating Expenses 82.3 82.4 81.1 81.7 83.0 83.5 82.0 82.7 ------ ------ ------ ------ ------ ------ ------ ------ Income from operations 17.7 17.6 18.9 18.3 17.0 16.5 18.0 17.3 Net interest expense 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 ------ ------ ------ ------ ------ ------ ------ ------ Income before income taxes 17.7 17.6 18.9 18.3 17.7 16.5 18.0 17.3 Income taxes 7.1 7.0 7.5 7.4 6.8 6.6 7.1 7.0 ------ ------ ------ ------ ------ ------ ------ ------ Net income 10.7 10.6 11.4 10.9 10.3 9.9 10.9 10.3 ====== ====== ====== ====== ====== ====== ====== ====== _______________________________________ (1) Net of fuel surcharge. There are minor rounding differences in the above table. A discussion of our results of operations for the six and three month periods ended June 30, 2004 and 2003 is set forth below. Comparison of Six Months and Three Months Ended June 30, 2004 to Six Months and Three Months Ended June 30, 2003 Our total revenue for the six months ended June 30, 2004 increased 24.2% to $201.5 million from $162.3 million for the same period in 2003. Total revenue included $11.0 million of fuel surcharge revenue in the 2004 period compared to $7.0 million in the 2003 period. Our total revenue for the quarter ended June 30, 2004 increased 25.9% to $107.1 million from $85.1 million for the same quarter in 2003. Total revenue included $7.0 million of fuel surcharge revenue in the 2004 quarter compared to $3.3 million in the 2003 quarter. In discussing our results of operations we use revenue, before fuel surcharge, and fuel expense, net of surcharge, because management believes that eliminating the impact of this sometimes volatile source of revenue affords a more consistent basis for comparing our results of operations from period to period. We also discuss the changes in our expenses as a percentage of revenue, before fuel surcharge, rather than absolute dollar changes. We do this because we believe the 13 high variable cost nature of our business makes a comparison of changes in expenses as a percentage of revenue more meaningful than absolute dollar changes. Revenue, before fuel surcharge, increased by 22.6% to $190.4 million in the six months ended June 30, 2004 from $155.3 million for the same period in 2003. Revenue, before fuel surcharge, increased by 22.5% to $100.2 million in the quarter ended June 30, 2004 from $81.8 million in the same quarter in 2003. These increases primarily resulted from the expansion of our customer base as we continue to open additional regional facilities, as well as improved rates and utilization in the 2004 period. As a result of our expansion into new regions and improving freight demand, our tractor fleet grew to 2,589 tractors (including 251 owned by independent contractors) as of June 30, 2004, from 2,267 tractors (including 234 owned by independent contractors) as of June 30, 2003, a 14.6% increase. This growth in our fleet, coupled with higher average revenue per tractor per week in the 2004 periods, resulted in the significant period-over-period improvement in revenue. Salaries, wages and benefits expense increased as a percentage of revenue, before fuel surcharge, to 32.8% for the six months ended June 30, 2004 from 32.3% for the same period in 2003. This increase was primarily due to the increases in driver pay rates implemented during the previous nine months. Salaries, wages and benefits expense remained constant as a percentage of revenue, before fuel surcharge, at 32.3% for the quarter ended June 30, 2004 and 2003. This expense remained constant for the quarter as the increases in driver pay rates that we implemented were offset by increases in average revenue per tractor per week. As of June 30, 2004, 90.3% of our fleet was operated by Company drivers, compared to 89.7% as of June 30, 2003. For our employees, we record accruals for workers' compensation benefits as a component of our claims accrual, and the related expense is reflected in salaries, wages and benefits in our consolidated statements of income. Fuel expense, net of fuel surcharge, increased, as a percentage of revenue before fuel surcharge, to 13.7% for the six months ended June 30, 2004 from 13.4% for the same period in 2003. For the quarter ended June 30, 2004, fuel expense, net of fuel surcharge, increased, as a percentage of revenue before fuel surcharge, to 13.4% from 12.6% for the same quarter in 2003. The Company maintains a fuel surcharge program to assist us in recovering a portion of increased fuel costs. The increases noted above were due mainly to higher than average fuel prices in the 2004 periods, partially offset by increased fuel surcharge collections and improved revenue per mile. As a percentage of total revenue, including fuel surcharge, fuel expense increased to 18.4% for the six months ended June 30, 2004 from 17.2% for the same period in 2003. For the quarter ended June 30, 2004, fuel expense, as a percentage of total revenue, including fuel surcharge, increased to 19.1% from 16.0% for the corresponding quarter in the prior year. These increases were due primarily to higher fuel prices. See "Quantitative and Qualitative Disclosure About Market Risk - Commodity Price Risk," below. Operations and maintenance expense remained relatively constant as a percentage of revenue, before fuel surcharge, at 6.2% for the six months ended June 30, 2004, compared to 6.3% for the same period in 2003. For the quarter ended June 30, 2004, operations and maintenance expense also remained relatively constant as a percentage of revenue, before fuel surcharge, at 6.1% compared to 6.2% for the same quarter in 2003. Insurance and claims expense increased as a percentage of revenue, before fuel surcharge, to 5.6% for the six months ended June 30, 2004, compared to 5.2% for the same period in 2003. Insurance and claims expense increased as a percentage of revenue, before fuel surcharge, to 5.7% for the quarter ended June 30, 2004, compared to 5.2% for the same quarter in 2003. These increases were primarily a result of higher insurance premiums and an increase in claims incurred by the Company. Operating taxes and licenses expense as a percentage of revenue, before fuel surcharge, decreased to 2.4% for both the quarter and six months ended June 30, 2004 from 2.8% for the same periods in 2003. These decreases resulted primarily from the improvements in average revenue per tractor per week in the 2004 periods described above, which more efficiently covered this largely fixed cost. 14 Communications expenses as a percentage of revenue, before fuel surcharge, remained constant at 0.9% for each of the 2004 and 2003 periods. Depreciation and amortization expense, as a percentage of revenue before fuel surcharge, increased to 9.7% for the six months ended June 30, 2004 from 9.0% for the same period in 2003. Depreciation and amortization expense, as a percentage of revenue before fuel surcharge, increased to 9.6% for the quarter ended June 30, 2004 from 8.9% for the same quarter in 2003. These increases were primarily related to an increase in the percentage of our Company fleet comprised of purchased vehicles. At June 30, 2004, 91% of our Company fleet was comprised of purchased vehicles, compared to 76% at June 30, 2003. Our Company fleet includes purchased vehicles and vehicles held under operating leases, while our total fleet includes vehicles in our Company fleet as well as vehicles provided by independent contractors. Lease expense for revenue equipment as a percentage of revenue, before fuel surcharge, decreased to 1.2% for the six months ended June 30, 2004, compared to 2.5% for the same period in 2003. Lease expense for revenue equipment as a percentage of revenue, before fuel surcharge, decreased to 1.0% for the quarter ended June 30, 2004, compared to 2.4% for the same quarter in 2003. These decreases primarily resulted from the reduction in the percentage of the Company fleet comprised of vehicles held under operating leases discussed above. Purchased transportation expense as a percentage of revenue, before fuel surcharge, decreased to 7.4% for the six months ended June 30, 2004 compared to 7.8% for the same period in 2003. Purchased transportation expense as a percentage of revenue, before fuel surcharge, decreased to 7.5% for the quarter ended June 30, 2004 compared to 8.0% for the same quarter in 2003. These decreases were primarily the result of the improvements in revenue per mile during the 2004 periods described above, along with the slight decrease in the percentage of our total fleet comprised of independent contractors. As of June 30, 2004, 9.7% of our fleet was operated by independent contractors, compared to 10.3% at June 30, 2003. Miscellaneous operating expenses as a percentage of revenue, before fuel surcharge, decreased to 2.1% for the six months ended June 30, 2004 from 2.4% for the same period in 2003. Miscellaneous operating expenses as a percentage of revenue, before fuel surcharge, decreased to 2.2% for the quarter ended June 30, 2004 from 2.5% for the same quarter in 2003. These decreases were primarily due to the improvements in average revenue per tractor per week in the 2004 periods described above. As a result of the above factors, our operating ratio (operating expenses, net of fuel surcharge, expressed as a percentage of revenue, before fuel surcharge) was 82.0% for the six months ended June 30, 2004, compared to 82.7% for same period in 2003. For the quarter ended June 30, 2004, our operating ratio was 81.1% compared to 81.7% for same quarter in 2003. Income taxes have been provided at the statutory federal and state rates, adjusted for certain permanent differences between financial statement income and income for tax reporting. Our effective tax rate was 40.0% for 2004 and 2003. As a percentage of revenue, before fuel surcharge, income tax expense increased to 7.1% for the six months ended June 30, 2004, from 7.0% for the same period in 2003. For the quarter ended June 30, 2004, income tax expense, as a percentage of revenue, before fuel surcharge, increased to 7.5% from 7.4% for the same quarter in 2003. These increases were primarily due to the increases in our income before income taxes. As a result of the preceding changes, our net income, as a percentage of revenue before fuel surcharge, was 10.9% for the six months ended June 30, 2004, compared to 10.3% for the same period in 2003. For the quarter ended June 30, 2004, our net income, as a percentage of revenue before fuel surcharge, was 11.4% compared to 10.9% in the same quarter in 2003. 15 Liquidity and Capital Resources The growth of our business has required, and will continue to require, a significant investment in new revenue equipment. Our primary sources of liquidity have been funds provided by operations, and to a lesser extent lease financing arrangements, issuances of equity securities, and borrowings under our line of credit. Net cash provided by operating activities was approximately $46.1 million for the six months ended June 30, 2004, compared to $37.2 million for the same period in 2003. The increase for the 2004 period was primarily the result of an increase in revenue and the improvement in our operating ratio. Capital expenditures for the purchase of revenue equipment (net of trade-ins), office equipment, land and leasehold improvements, totaled $51.2 million for the six months ended June 30, 2004 compared to $37.9 million for the same period in 2003. During the 2004 period, we acquired a significant number of tractors and trailers for cash, including some that previously had been held under operating leases. Net cash provided by financing activities was approximately $0.6 million for the six months ended June 30, 2004, compared to net cash used for financing activities of approximately $0.5 million for same period in 2003. Net cash provided by financing during the 2004 period was the result of stock option exercises. The net cash used for financing during the 2003 period was primarily for the payments on our line of credit and long-term debt, which was retired in full during the fourth quarter of 2003. At June 30, 2004, we did not have any borrowings outstanding. We currently maintain a line of credit, which permits revolving borrowings and letters of credit totaling $11.0 million. At June 30, 2004, the line of credit consisted solely of issued but unused letters of credit totaling $9.6 million. Historically this line of credit had been maintained at $50.0 million. However, due to our continued strong positive cash position, and in an effort to minimize bank fees, we do not believe a revolving credit facility or term loans are necessary to meet our current and anticipated near-term cash needs. We believe any necessary increase in our line of credit to provide for a revolving line or credit or term loans could be accomplished quickly as needed. We are obligated to comply with certain financial covenants under our line of credit and were in compliance with these covenants at June 30, 2004. As of June 30, 2004, we held $36.5 million in cash and cash equivalents. Management believes we will be able to finance our near term needs for working capital over the next twelve months, as well as capital expenditures during such period, with cash balances, cash flows from operations, and borrowings and operating lease financing believed to be available from financing sources. We will continue to have significant capital requirements over the long-term, which may require us to incur debt or seek additional equity capital. The availability of additional capital will depend upon prevailing market conditions, the market price of our common stock and other factors over which we have limited control, as well as our financial condition and results of operations. Nevertheless, based on our recent operating results, current cash position, anticipated future cash flows, and sources of financing that we expect will be available to us, we do not expect that we will experience any significant liquidity constraints in the foreseeable future. Off-Balance Sheet Transactions Our liquidity is not materially affected by off-balance sheet transactions. Like many other trucking companies, from time-to-time we have utilized non-cancelable operating leases to finance a portion of our revenue equipment acquisitions. At June 30, 2004, we leased 217 tractors under operating leases with varying termination dates ranging from August 2004 to April 2006. 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 "lease expense - revenue equipment." Our rental expense related to operating leases was $2.3 million for the six months ended June 30, 2004, compared to $3.9 million for the same period of 2003. The total amount outstanding under operating leases as of 16 June 30, 2004, was $3.8 million, with $1.7 million due in the next 12 months. The effective annual interest rates under these operating leases range from 5.2% to 5.9%. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that management make a number of assumptions and estimates that affect the reported amounts of assets, liabilities, revenue and expenses in our consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management's best knowledge of current events and actions that may impact the Company in the future, actual results may differ from these estimates and assumptions. Our critical accounting policies are those that affect our financial statements materially and involve a significant level of judgment by management. Revenue Recognition. We recognize revenue, including fuel surcharges, upon delivery of a shipment. Revenue Equipment. Property and equipment are stated at cost. Depreciation on property and equipment is calculated by the straight-line method over the estimated useful life down to an estimated salvage value of the property and equipment. We periodically evaluate the useful lives and salvage values of our property and equipment based upon, among other things, our experience with similar assets, including gains or losses upon dispositions of such assets. Our determinations with respect to salvage values are based upon the expected market values of equipment at the end of the expected life. We presently do not expect any decrease in the salvage values of our revenue equipment as a result of conditions in the used equipment market or otherwise. We do not conduct "fair value" assessments of our capital assets in the ordinary course of business and, unless a triggering event under SFAS 144 occurs, we do not expect to do so in the future. Tires on revenue equipment purchased are capitalized as a part of the equipment cost and depreciated over the life of the vehicle. Replacement tires and recapping costs are expensed when placed in service. Claims Reserves and Estimates. Reserves and estimates for claims is another of our critical accounting policies. The primary claims arising for us consist of cargo liability, personal injury, property damage, collision and comprehensive, workers' compensation, and employee medical expenses. We maintain self-insurance levels for these various areas of risk and have established reserves to cover these self-insured liabilities. We also maintain insurance to cover liabilities in excess of the self-insurance amounts. The claims reserves represent accruals for the estimated uninsured portion of pending claims, including adverse development of known claims, as well as incurred but not reported claims. These estimates are based on historical information, primarily our own claims experience and the experience of our third party administrator, along with certain assumptions about future events. Changes in assumptions as well as changes in actual experience could cause these estimates to change in the near term. The significant recent increases in our self-insured retention for personal injury and property damage claims amplify the importance and potential impact of these estimates. Estimates also are involved in other aspects of our business. For instance, we make similar types of estimates concerning the collectibility of our accounts receivable and the concentration of our credit exposure based on our historical experience and certain assumptions about future events. Accounting for Income Taxes. Significant management judgment is required in determining our provision for income taxes and in determining whether deferred tax assets will be realized in full or in part. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. When it is more likely than not that all or some portion of specific deferred tax assets will not be realized, a 17 valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. A valuation allowance for deferred tax assets has not been deemed necessary due to the Company's profitable operations. We continually evaluate strategies that would allow for the future utilization of our deferred tax assets and currently believe we have the ability to enact strategies to fully realize our deferred tax assets should our earnings in future periods not support the full realization of the deferred tax assets. Factors That May Affect Future Results The following issues and uncertainties, among others, should be considered in evaluating our business outlook: Business Uncertainties. Our future results may be affected by a number of factors over which we have little or no control. Fuel prices, insurance and claims costs, interest rates, the availability of qualified drivers, fluctuations in the resale value of revenue equipment, economic and customer business cycles and shipping demands are factors over which we have little or no control. Significant increases or rapid fluctuations in fuel prices, interest rates or insurance costs or claims, to the extent not offset by fuel surcharges and increases in freight rates, and the resale value of revenue equipment, could reduce our profitability. Weakness in the general economy, including a weakness in consumer demand for goods and services, could adversely affect our customers and our growth and revenues, if customers reduce their demand for transportation services. Weakness in customer demand for our services or in the general rate environment may also restrain our ability to increase rates or obtain fuel surcharges. It is also not possible to predict the effects of terrorist attacks and subsequent events on the economy or on customer confidence in the United States, or the impact, if any, on our future results of operations. Managing Growth We have experienced significant and rapid growth in revenue and profits since the inception of our business in 1990. There can be no assurance that our business will continue to grow in a similar fashion in the future or that we can effectively adapt our management, administrative, and operational systems to respond to any future growth. Further, there can be no assurance that our operating margins will not be adversely affected by future changes in and expansion of our business or by changes in economic conditions. In addition, we have recently commenced operation of a refrigerated division as part of our growth strategy and are subject to the risks inherent in entering a new market, including but not limited to: unfamiliarity with pricing, service, and operational issues; the risk that customer relationships may be difficult to obtain or that we may have to reduce rates to gain customer relationships; the risk that the specialized refrigerated equipment may not be adequately utilized; and the risk that cargo claims may exceed our past experience. Insurance. Our future insurance and claims expenses might exceed historical levels, which could reduce our earnings. Insurance premiums have increased significantly over the past several years, which we have managed, in part, by increasing the levels of our self-insured retention. We are self-insured for personal injury and property damage liability, cargo liability, collision and comprehensive up to a maximum limit of $2.0 million per occurrence. Our maximum self-retention for workers' compensation where a traffic accident is not involved is $500,000 per occurrence. We maintain insurance with licensed insurance companies above the amounts for which we self-insure. Our insurance policies provide for excess personal injury and property damage liability up to a total of $40.0 million per occurrence and cargo liability, collision, comprehensive and workers' compensation coverage up to a total of $10.0 million per occurrence. Our personal injury and property damage policies also include coverage for punitive damages where such coverage is allowed. If these costs were to increase further, or if the severity or number of claims were to increase our earnings could be materially and adversely affected. Revenue Equipment. Our growth has been made possible through the addition of new revenue equipment. Difficulty in financing or obtaining new revenue equipment (for example, delivery delays 18 from manufacturers, a significant decline in used revenue equipment values, or the unavailability of independent contractors) could restrict future growth. EPA emissions control regulations require that diesel engines manufactured in October 2002 and thereafter must satisfy considerably more restrictive emissions standards. Furthermore, even more restrictive engine design requirements will take effect in 2007. In part to offset the costs of compliance with the EPA engine design requirements, some manufacturers have significantly increased new equipment prices and further increases may result in connection with the implementation of the 2007 standards. If new equipment prices increase more than anticipated, we may be required to increase our depreciation and financing costs and/or retain some of our equipment longer, with a resulting increase in maintenance expenses. To the extent we are unable to offset any such increases in expenses with rate increases or cost savings, our results of operations would be adversely affected. In addition to increases in equipment costs, the EPA-compliant engines are generally less fuel efficient than those in later model tractors manufactured before October 2002, and compliance with the 2007 EPA standards is expected to result in further declines in fuel economy. To the extent we are unable to offset resulting increases in fuel expenses with higher rates or surcharge revenue, our results of operations would be adversely affected. Inflation. Many of our operating expenses, including fuel costs and fuel taxes, are sensitive to the effects of inflation, which could result in higher operating costs. During the first six months of 2004, we experienced fluctuations in fuel costs, as a result of conditions in the petroleum industry. We maintain an aggressive program to obtain rate and fuel surcharge increases. Competitive conditions in the transportation industry, including lower demand for transportation services, could limit our ability to continue to obtain rate increases or fuel surcharges. Due to our significant operations in the West Coast region, we are particularly affected by the substantially higher fuel prices currently prevailing in that portion of the country. Generally, West Coast fuel prices are on average approximately $0.10 per gallon higher than the national average. For much of the first six months of 2004, however, this regional difference has been considerably more pronounced. As fuel surcharges generally are based on national fuel price averages, this fuel price disparity disproportionately affects carriers, like us, with substantial operations on the West Coast. We continue to address this situation by implementing a higher West Coast surcharge on our tariff customers and negotiating with our contract customers to obtain higher fuel surcharge rates. To the extent we are not successful in these negotiations, our results of operations may be adversely affected. See "Quantitative and Qualitative Disclosure About Market Risk - Commodity Price Risk," below. We also have periodically experienced some wage increases for drivers. Increases in driver compensation could continue during 2004 and may affect our operating income, unless we are able to pass those increased costs to customers through rate increases. Driver Retention. Difficulty in attracting or retaining qualified drivers, including independent contractors, or a downturn in customer business cycles or shipping demands also could have a materially adverse effect on our growth and profitability. If a shortage of drivers should occur in the future, or if we were unable to continue to attract and contract with independent contractors, we could be required to make further adjustments to our driver compensation package, which could adversely affect our profitability if not offset by a corresponding increase in rates. For other risks and uncertainties that might affect our future operations, please review Part II of our Annual Report on Form 10-K - "Management's Discussion and Analysis of Financial Conditions and Results of Operations - Factors That May Affect Future Results." 19 Item 3. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risk changes in interest rate on debt and from changes in commodity prices. Under Financial Accounting Reporting Release Number 48 and Securities and Exchange Commission rules and regulations, we are required to disclose information concerning market risk with respect to foreign exchange rates, interest rates, and commodity prices. We have elected to make such disclosures, to the extent applicable, using a sensitivity analysis approach, based on hypothetical changes in interest rates and commodity prices. We generally have not had occasion to use derivative financial instruments for risk management purposes and do not use them for either speculation or trading. Because our operations are confined to the United States, we are not subject to foreign currency risk. Interest Rate Risk We are subject to interest rate risk to the extent the Company borrows against its line of credit or incurs debt in the acquisition of revenue equipment. We attempt to manage our interest rate risk by managing the amount of debt we carry. At June 30, 2004, we did not have any outstanding borrowings. In the opinion of management, an increase in short-term interest rates could have a materially adverse effect on our financial condition if our debt levels increase. Management does not foresee or expect in the near future any significant changes in our exposure to interest rate fluctuations or in how that exposure is managed by us. Commodity Price Risk We are also subject to commodity price risk with respect to purchases of fuel. Prices and availability of 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 if we are unable to pass increased costs on to customers through rate increases or fuel surcharges. Historically, we have sought to recover a portion of our short-term fuel price increases from customers through fuel surcharges. Fuel surcharges that can be collected do not always fully offset an increase in the cost of diesel fuel. Based on our recent historical experience, we believe that we generally pass through to our customers approximately 80% to 90% of increases in fuel prices. For the six months ended June 30, 2004, fuel expense, net of fuel surcharge, represented 16.7% of our total operating expenses, net of fuel surcharge, compared to 16.3% for the same period in 2003. We are party to three fuel contracts relating to the price of heating oil on the New York Mercantile Exchange ("NYMX") that we entered into between October 2000 and February 2002 in connection with volume diesel fuel purchases. If the price of heating oil on the NYMX falls below $0.58 per gallon we may be required to pay the difference between $0.58 and the index price (1) for 1.0 million gallons per month for any selected twelve months through March 31, 2005, and (2) for 750,000 gallons per month for the twelve months of 2005. At July 9, 2004, the price of heating oil on the NYMX was $1.09 for October 2004 contracts. For each $0.05 per gallon the price of heating oil would fall below $0.58 per gallon during the relevant periods, our potential loss on the contracts would be approximately $900,000. However, our net savings on fuel costs resulting from lower fuel prices under our volume diesel fuel purchase contracts would be approximately $1.4 million, after taking the loss on the contracts into consideration. We have valued these items at fair value in the accompanying June 30, 2004 consolidated financial statements. 20 Item 4. Controls and Procedures As required by Rule 13a-15 under the Exchange Act, the Company has carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report. This evaluation was carried out under the supervision and with the participation of the Company's management, including our Chief Executive Officer and our Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report. During the Company's second fiscal quarter, there were no changes in the Company's internal control over financial reporting 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 and Chief Financial 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 controls and procedures 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. 21 PART II - OTHER INFORMATION Item 1. Legal Proceedings We are a party to ordinary, routine litigation and administrative proceedings incidental to our business. These proceedings primarily involve claims for personal injury or property damage incurred in the transportation of freight and for personnel matters. Item 2. Changes in Securities and use of Proceeds Not Applicable Item 3. Defaults Upon Senior Securities Not Applicable Item 4. Submission of Matters to a Vote of Security Holders The Company's Annual Meeting of Shareholders was held on May 21, 2004. At the Annual Meeting, the shareholders elected Kevin Knight, Randy Knight, and Michael Garnreiter to serve as Class III directors for three-year terms. Gary Knight, G.D. Madden, Matt Salmon, Timothy Kohl, Donald Bliss, and Mark Scudder also continued as directors of the Company after the Annual Meeting. Shareholders representing 34,715,597 shares, or approximately 92.5%, of the Company's outstanding Common Stock as of the record date were present in person or by proxy at the Annual Meeting. A tabulation of the vote with respect to each nominee follows: Votes Votes Cast Votes For Withheld ----------- ------------- ------------ Kevin Knight 34,715,597 28,729,658 5,985,939 Randy Knight 34,715,597 28,870,205 5,845,392 Michael Garnreiter 34,715,597 33,756,145 959,452 Item 5. Other Information Not Applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits required by Item 601 of Regulation S-K Exhibit No. Description ----------- ----------- Exhibit 3 Articles of Incorporation and Bylaws (3.1) Restated Articles of Incorporation of the Company (Incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1. No 33-83534.) 22 (3.1.1) First Amendment to Restated Articles of Incorporation of the Company (Incorporated by reference to Exhibit 3.1.1 to the Company's report on Form 10-K for the period ended December 31, 2000.) (3.1.2) Second Amendment to Restated Articles of Incorporation of the Company (Incorporated by reference to Exhibit 3.1.2 to the Company's Registration Statement on Form S-3 No.333-72130.) (3.1.3) Third Amendment to Restated Articles of Incorporation of the Company. (Incorporated by reference to Exhibit 3.1.3 to the Company's Report on Form 10-K for the period ended December 31, 2002.) (3.2) Restated Bylaws of the Company Incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-3 No. 333-72130.) (3.2.1) First Amendment to Restated Bylaws of the Company (Incorporated by reference to Exhibit 3.2.1 to the Company's Report on Form 10-K for the period ended December 31, 2002.) Exhibit 4 Instruments defining the rights of security holders, including indentures (4.1) Articles 4, 10 and 11 of the Restated Articles of Incorporation of the Company. (Incorporated by reference to Exhibit 3.1 to this Report on Form 10-Q.) (4.2) Sections 2 and 5 of the Restated Bylaws of the Company. (Incorporated by reference to Exhibit 3.2 to this Report on Form 10-Q.) Exhibit 11 Schedule of Computation of Net Income Per Share (Incorporated by reference from Note 3, Net Income Per Share, in the Notes To Consolidated Financial Statements contained in this Report on Form 10-Q.) Exhibit 31 Section 302 Certifications (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 Kevin P. Knight, 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 David A. Jackson, the Company's Chief Financial Officer Exhibit 32 Section 906 Certifications (32.1) Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Kevin P. Knight, the Company's Chief Executive Officer 23 (32.2) Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by David A. Jackson, the Company's Chief Financial Officer (b) Reports on Form 8-K During the quarter ended June 30, 2004, the Company filed with, or furnished to, the Securities and Exchange Commission (the "Commission") the following Current Reports on Form 8-K: Current Report on Form 8-K dated April 12, 2004 (filed with the Commission on the same date) reporting the appointment of Deloitte & Touche LLP as the Company's principal independent accountants for fiscal 2004; and Current Report on Form 8-K dated April 21, 2004 (furnished to the Commission on April 22, 2004) reporting the issuance of a press releasing announcing the Company's financial results for the quarter ended March 31, 2004. 24 SIGNATURES 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. KNIGHT TRANSPORTATION, INC. Date: August 6, 2004 By: /s/ Kevin P. Knight --------------------------------- Kevin P. Knight Chief Executive Officer, in his capacity as such and on behalf of the registrant Date: August 6, 2004 By: /s/ David A. Jackson --------------------------------- David A. Jackson Chief Financial Officer, in his capacity as such and on behalf of the registrant Date: August 6, 2004 By: /s/ Robert Johnson --------------------------------- Robert Johnson Chief Accounting Officer, in his capacity as such and on behalf of the registrant 25