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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 March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-24960
COVENANT TRANSPORT, INC.
(Exact name of registrant as specified in its charter)
Nevada 88-0320154
- -------------------------------- ------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 Birmingham Hwy.
Chattanooga, TN 37419 37419
- -------------------------------- ------------------------------
(Address of principal (Zip Code)
executive 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 (May 5, 2003).
Class A Common Stock, $.01 par value: 12,052,067 shares
Class B Common Stock, $.01 par value: 2,350,000 shares
Page 1
PART I
FINANCIAL INFORMATION
Page Number
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2003 (Unaudited) and December 3
31, 2002
Condensed Consolidated Statements of Operations for the three months ended March 31,
2003 and 2002 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2003 and 2002 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 17
Item 4. Controls and Procedures 18
PART II
OTHER INFORMATION
Page Number
Item 1. Legal Proceedings 19
Items 2, 3, 4, and 5 Not applicable 19
Item 6. Exhibits and reports on Form 8-K 19
Page 2
ITEM 1. FINANCIAL STATEMENTS
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
March 31, 2003 December 31, 2002
ASSETS (unaudited)
------ -------------------- ----------------------
Current assets:
Cash and cash equivalents $ 1,593 $ 42
Accounts receivable, net of allowance of $1,520 in 2003
and $1,800 in 2002 63,352 65,041
Drivers advances and other receivables 5,596 3,480
Inventory and supplies 3,180 3,226
Prepaid expenses 17,462 14,450
Deferred income taxes 11,109 11,105
Income taxes receivable 2,248 2,585
-------------------- ----------------------
Total current assets 104,540 99,929
Property and equipment, at cost 368,624 392,498
Less accumulated depreciation and amortization (146,784) (154,010)
-------------------- ----------------------
Net property and equipment 221,840 238,488
Other assets 23,359 23,124
-------------------- ----------------------
Total assets $349,739 $361,541
==================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt - 43,000
Securitization facility 41,230 39,230
Accounts payable 7,214 6,921
Accrued expenses 19,332 17,220
Insurance and claims accrual 22,111 21,210
-------------------- ----------------------
Total current liabilities 89,887 127,581
Long-term debt, less current maturities 26,300 1,300
Deferred income taxes 57,072 57,072
-------------------- ----------------------
Total liabilities 173,259 185,953
Commitments and contingent liabilities
Stockholders' equity:
Class A common stock, $.01 par value; 20,000,000 shares
authorized; 13,004,164 and 12,999,315 shares issued and 12,032,664
and 12,027,815 outstanding as of March 31, 2003 and December 31,
2002, respectively 130 130
Class B common stock, $.01 par value; 5,000,000 shares authorized;
2,350,000 shares issued and outstanding as of March 31, 2003 and
December 31, 2002 24 24
Additional paid-in-capital 84,545 84,492
Treasury Stock at cost; 971,500 shares as of March 31, 2003 and
December 31, 2002 (7,935) (7,935)
Retained earnings 99,716 98,877
-------------------- ----------------------
Total stockholders' equity 176,480 175,588
-------------------- ----------------------
Total liabilities and stockholders' equity $ 349,739 $361,541
==================== ======================
See accompanying notes to consolidated financial statements.
Page 3
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(In thousands except per share data)
Three months ended March 31,
(unaudited)
2003 2002
---- ----
Freight revenue $ 128,024 $ 129,020
Fuel surcharge and other accessorial revenue 9,851 3,199
---------------------- ---------------------
Total revenue $ 137,875 $ 132,219
Operating expenses:
Salaries, wages, and related expenses 53,810 55,756
Fuel expense 28,788 22,086
Operations and maintenance 9,994 8,863
Revenue equipment rentals and purchased
transportation 14,818 14,803
Operating taxes and licenses 3,431 3,277
Insurance and claims 8,039 7,168
Communications and utilities 1,708 1,846
General supplies and expenses 3,173 3,511
Depreciation, amortization and impairment charge, including gains
(losses) on disposition of equipment (1) 10,600 14,058
---------------------- ---------------------
Total operating expenses 134,361 131,368
---------------------- ---------------------
Operating income 3,514 851
Other (income) expenses:
Interest expense 651 1,063
Interest income (38) (23)
Other (15) (223)
Early extinguishment of debt (2) - 1,434
---------------------- ---------------------
Other (income) expenses, net 598 2,251
---------------------- ---------------------
Income (loss) before income taxes 2,916 (1,400)
Income tax expense 2,077 267
---------------------- ---------------------
Net income (loss) $ 839 $ (1,667)
====================== =====================
Net income (loss) per share:
Total basic and diluted earnings (loss) per share: $ 0.06 $ (0.12)
Weighted average shares outstanding 14,381 14,084
Weighted average shares outstanding adjusted for assumed conversions 14,670 14,084
(1) Includes a $3.3 million pre-tax impairment charge in 2002.
(2) Reflects the reclassification of early extinguishment of debt due to the adoption of SFAS 145.
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 THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(In thousands)
Three months ended March 31,
(unaudited)
--------------------------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income (loss) $ 839 $ (1,667)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Net provision for losses on accounts receivables (162) 209
Loss on early extinguishment of debt - 890
Depreciation, amortization and impairment of assets (1) 10,833 13,552
Provision for losses on guaranteed residuals - 324
Deferred income tax expense (4) 619
(Gain)/loss on disposition of property and equipment (234) 506
Changes in operating assets and liabilities:
Receivables and advances (264) (1,208)
Prepaid expenses (3,012) 1,025
Tire and parts inventory 46 147
Accounts payable and accrued expenses 3,643 (2,102)
------------------ -----------------
Net cash flows provided by operating activities 11,685 12,295
Cash flows from investing activities:
Acquisition of property and equipment (2,103) (16,239)
Proceeds from disposition of property and equipment 8,231 790
------------------ -----------------
Net cash flows provided by (used in) investing activities 6,128 (15,449)
Cash flows from financing activities:
Deferred costs (315) -
Exercise of stock options 53 475
Proceeds from issuance of long-term debt 5,000 38,000
Repayments of long-term debt (21,000) (35,338)
------------------ -----------------
Net cash flows provided by (used in) financing activities (16,262) 3,137
------------------ -----------------
Net change in cash and cash equivalents 1,551 (17)
Cash and cash equivalents at beginning of period 42 383
------------------ -----------------
Cash and cash equivalents at end of period $ 1,593 $ 366
================== =================
(1) Includes a $3.3 million pre-tax impairment charge in 2002.
The accompanying notes are an integral part of these consolidated financial statements.
Page 5
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned
subsidiaries ("Covenant" or the "Company"). All significant intercompany
balances and transactions have been eliminated in consolidation.
The financial statements have been prepared, without audit, in accordance
with accounting principles generally accepted in the United States of
America, pursuant to the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the accompanying
financial statements include all adjustments which are necessary for a fair
presentation of the results for the interim periods presented, such
adjustments being of a normal recurring nature. Certain information and
footnote disclosures have been condensed or omitted pursuant to such rules
and regulations. The December 31, 2002 consolidated balance sheet was
derived from the audited balance sheet of the Company for the year then
ended. It is suggested that these consolidated financial statements and
notes thereto be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Form 10-K for the
year ended December 31, 2002. Results of operations in interim periods are
not necessarily indicative of results to be expected for a full year.
Note 2. Basic and Diluted Earnings (Loss) per Share
The following table sets forth for the periods indicated the calculation of
net earnings (loss) per share included in the Company's consolidated
statements of operations:
(in thousands except per share data) Three months ended March 31,
2003 2002
---- ----
Numerator:
Net earnings (loss) $ 839 ($1,667)
Denominator:
Denominator for basic earnings
per share - weighted-average shares 14,381 14,084
Effect of dilutive securities:
Employee stock options 289 -
--------- ------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and assumed
conversions 14,670 14,084
=========== ============
Net income (loss) per share
Total basic and diluted earnings (loss) per share: $ 0.06 $(0.12)
=========== ============
Dilutive common stock options are included in the diluted EPS calculation
using the treasury stock method. For the three month period ended March 31,
2002, approximately 211,000 shares were excluded in the diluted EPS
computation because the options were anti-dilutive.
At March 31, 2003, the Company had stock-based employee compensation plans.
The Company accounts for the plans under the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees,
and related Interpretations. No stock-based employee compensation cost is
reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on
the date of grant. Under SFAS No. 123, fair value of options granted are
estimated as of the date of grant using the Black-Scholes option pricing
model and the following weighted average assumptions: risk-free interest
rates ranging from 2.8% to 3.5%; expected life of 5 years; dividend rate of
zero percent; and expected volatility of 53.2% for the 2003 period, and
53.3% for the 2002 period. Using these assumptions, the fair value of the
employee stock options granted, net of the related tax effects, in the 2003
and 2002 periods are $0.5 million and $0.4 million respectively, which
would be amortized as compensation expense over the vesting period of the
options. The following
Page 6
table illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Three months ended March 31,
(in thousands except per share data) 2003 2002
-------------------- -------------------
Net income (loss), as reported: $ 839 $(1,667)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (539) (430)
-------------------- -------------------
Pro forma net income (loss) $ 300 $(2,097)
==================== ===================
Basic earnings (loss) per share:
As reported $.06 $(.12)
Pro forma $.02 $(.15)
Diluted earnings (loss) per share:
As reported $.06 $(.12)
Pro forma $.02 $(.15)
Note 3. Income Taxes
Income tax expense varies from the amount computed by applying the federal
corporate income tax rate of 35% to income before income taxes primarily
due to state income taxes, net of federal income tax effect, adjusted for
permanent differences, the most significant of which is the effect of the
per diem pay structure for drivers.
Note 4. Goodwill and Other Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets, which requires the Company to evaluate goodwill
and other intangible assets with indefinite useful lives for impairment on
an annual basis, with any resulting impairment recorded as a cumulative
effect of a change in accounting principle. Goodwill that was acquired in
purchase business combinations completed before July 1, 2001, is no longer
amortized after January 1, 2002. Furthermore, any goodwill that is acquired
in a purchase business combination completed after June 30, 2001, is not
amortized. During the second quarter of 2002, the Company completed its
evaluation of its goodwill for impairment and determined that there was no
impairment. At March 31, 2003, the Company has $11.5 million of goodwill.
Note 5. Derivative Instruments and Other Comprehensive Income
In 1998, the FASB issued SFAS No. 133 ("SFAS 133"), Accounting for
Derivative Instruments and Hedging Activities, as amended by SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS Statement No. 133, an amendment of SFAS
Statement No. 133, and SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities, an amendment of SFAS Statement
No. 133. SFAS No. 133 requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or in other
comprehensive income, depending on whether a derivative is designated as
part of a hedging relationship and, if it is, depending on the type of
hedging relationship.
The Company adopted SFAS No. 133 effective January 1, 2001 but had no
instruments in place on that date. In 2001, the Company entered into two
$10.0 million notional amount cancelable interest rate swap agreements to
manage the risk of variability in cash flows associated with floating-rate
debt. Due to the counter-parties' imbedded options to cancel, these
derivatives did not qualify, and are not designated as hedging instruments
under SFAS No. 133. Consequently, these derivatives are marked to fair
value through earnings, in other expense in the accompanying statement of
operations. At March 31, 2003 and March 31, 2002, the fair value of these
interest rate swap agreements was a liability of $1.6 million and $0.5
million, respectively, which are included in accrued expenses on the
consolidated balance sheet.
During the third quarter of 2001, the Company entered into two heating oil
commodity swap contracts to hedge its cash flow
Page 7
exposure to diesel fuel price fluctuations. These contracts were considered
highly effective in offsetting changes in anticipated future cash flows and
were designated as cash flow hedges under SFAS No. 133. At March 31, 2002
the cumulative fair value of these heating oil contracts was an asset of
$0.2 million, which was recorded in accrued expenses with the offset to
other comprehensive income, net of taxes. The contracts expired December
31, 2002.
The derivative activity as reported in the Company's financial statements
for the quarters ended March 31, is summarized in the following:
Three months ended March 31,
(in thousands) 2003 2002
--------------- ----------------
Net liability for derivatives at January 1, $ (1,645) $ (1,932)
Gain on derivative instruments:
Gain in value of derivative instruments that do not qualify
as hedging instruments 20 223
Gain on fuel hedge contracts that qualify as cash flow hedges - 1,447
--------------- ----------------
Net liability for derivatives at March 31, $ (1,625) $ (262)
=============== ================
The following is a summary of comprehensive income (loss) as of March 31:
Three months ended March 31
(in thousands) 2003 2002
----------------- ------------------
Net Income (loss) $ 839 ($1,667)
Other comprehensive income:
Gain on fuel hedge contracts that qualify as cash flow hedges - 1,447
Tax benefit - (550)
----------------- ------------------
Other comprehensive income-
Unrealized gain on cash flow hedging derivatives,
net of taxes - 897
----------------- ------------------
Comprehensive income (loss) $ 839 $ (770)
================= ==================
Note 6. Impairment of Equipment and Change in Estimated Useful Lives
During 2001, the market value of used tractors was significantly below both
historical levels and the carrying values on the Company's financial
statements. The Company extended the trade cycle of its tractors from three
years to four years during 2001, which delayed any significant disposals
into 2002 and later years. The market for used tractors did not improve by
the time the Company negotiated a tractor purchase and trade package with
Freightliner Corporation for calendar years 2002 and 2003 covering the sale
of model year 1998 through 2000 tractors and the purchase of an equal
number of replacement units. The significant difference between the
carrying values and the sale prices of the used tractors combined with the
Company's less profitable results during 2001 caused the Company to test
for asset impairment under SFAS No. 121, "Accounting for the Impairment of
Long Lived Assets and of Long Lived Assets to be disposed of". In the test,
the Company measured the expected undiscounted future cash flows to be
generated by the tractors over the remaining useful lives and the disposal
value at the end of the useful life against the carrying values. The test
indicated impairment and the Company recognized the pre-tax charges of
approximately $15.4 million and $3.3 million in 2001 and 2002,
respectively, to reflect an impairment in tractor values. The Company
incurred a loss of approximately $324,000 on guaranteed residuals for
leased tractors in the first quarter of 2002, which was recorded in revenue
equipment rentals and purchased transportation in the accompanying
statement of operations. The Company accrued this loss from January 1,
2002, to the date the tractors were purchased off lease in February 2002.
The Company's approximately 1,400 model year 2001 tractors were not
affected by the charge. The Company adjusted the depreciation rate of these
model year 2001 tractors to approximate its recent experience with
disposition values and expectation
Page 8
for future disposition values. The Company also increased the lease expense
on its leased units since it expects to have a shortfall in its guaranteed
residual values of approximately $1.4 million. The Company is recording its
additional lease expense ratably over the remaining lease term. Although
management believes the additional depreciation and lease expense will
bring the carrying values of the model year 2001 tractors in line with
future disposition values, the Company does not have trade-in agreements
covering those tractors. These assumptions represent management's best
estimate and actual values could differ by the time those tractors are
scheduled for trade. Management estimates the impact of the change in the
estimated useful lives and depreciation on the 2001 model year tractors to
be approximately $1.5 million pre-tax or $.06 per share annually.
Note 7. Long-term Debt and Securitization Facility
Outstanding debt consisted of the following at March 31, 2003 and December
31, 2002:
(in thousands) March 31, 2003 December 31, 2002
---------------------- ----------------------
Borrowings under credit agreement $ 25,000 $ 43,000
Securitization Facility 41,230 39,230
Note payable to former SRT shareholder, bearing
interest at 6.5% with interest payable quarterly 1,300 1,300
---------------------- ----------------------
Total Long-Term Debt 67,530 83,530
Less current maturities 41,230 82,230
---------------------- ----------------------
Long-term debt, less current portion $ 26,300 $ 1,300
====================== ======================
In December 2000, the Company entered into the Credit Agreement with a
group of banks. The facility matures in December 2005. Borrowings under the
Credit Agreement are based on the banks' base rate or LIBOR and accrue
interest based on one, two, or three month LIBOR rates plus an applicable
margin that is adjusted quarterly between 0.75% and 1.25% based on cash
flow coverage. At March 31, 2003, the margin was 1.0%. The Credit Agreement
is guaranteed by the Company and all of the Company's subsidiaries except
CVTI Receivables Corp. and Volunteer Insurance Limited.
The Credit Agreement has a maximum borrowing limit of $100.0 million with
an accordion feature which permits an increase up to a maximum borrowing
limit of $160.0 million. Borrowings related to revenue equipment are
limited to the lesser of 90% of net book value of revenue equipment or the
maximum borrowing limit. Letters of credit are limited to an aggregate
commitment of $50.0 million. The Credit Agreement includes a "security
agreement" such that the Credit Agreement may be collateralized by
virtually all assets of the Company if a covenant violation occurs. A
commitment fee, that is adjusted quarterly between 0.15% and 0.25% per
annum based on cash flow coverage, is due on the daily unused portion of
the Credit Agreement. As of March 31, 2003, the Company had borrowings
under the Credit Agreement in the amount of $25.0 million with a weighted
average interest rate of 2.2%.
In October 1995, the Company issued $25 million in ten-year senior notes to
an insurance company. On March 15, 2002, the Company retired the remaining
$20 million in senior notes with borrowings from the Credit Agreement and
incurred a $0.9 million after-tax extraordinary item ($1.4 million pre-tax)
to reflect the early extinguishment of this debt. Upon adoption of SFAS 145
in 2003, the Company reclassified the charge and it is no longer classified
as an extraordinary item.
At March 31, 2003 and December 31, 2002, the Company had unused letters of
credit of approximately $32.1 and $19.2 million, respectively.
In December 2000, the Company entered into a $62 million revolving accounts
receivable securitization facility (the "Securitization Facility"). On a
revolving basis, the Company sells its interests in its accounts receivable
to CVTI Receivables Corp. ("CRC"), a wholly-owned bankruptcy-remote special
purpose subsidiary incorporated in Nevada. CRC sells a percentage ownership
in such receivables to an unrelated financial entity. The transaction does
not meet the criteria for sale treatment under SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities and is reflected as a secured borrowing in the financial
statements.
The Company can receive up to $62 million of proceeds, subject to eligible
receivables and will pay a service fee recorded as interest expense, as
defined in the agreement. The Company will pay commercial paper interest
rates plus an applicable margin of 0.41% per annum and a commitment fee of
0.10% per annum on the daily unused portion of the Facility. The
Securitization Facility includes certain significant events that could
cause amounts to be immediately due and payable in the event of certain
ratios. The proceeds received are reflected as a current liability on the
consolidated financial statements because the committed term, subject to
annual renewals, is 364 days. As of March 31, 2003 and December 31, 2002,
the Company had received $41.2 million and $39.2 million, respectively, in
proceeds, with a weighted average interest rate of 1.4% and 1.5%,
respectively.
Page 9
The Credit Agreement and Securitization Facility contain certain
restrictions and covenants relating to, among other things, dividends,
tangible net worth, cash flow, acquisitions and dispositions, and total
indebtedness and are cross-defaulted. As of March 31, 2003, the Company was
in compliance with the Credit Agreement and Securitization Facility.
Note 8. Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS 143 provides new guidance on the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. The Company
adopted SFAS 143 effective January 1, 2003. The adoption did not have a
material impact on the Company's consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 amends existing guidance on reporting gains and
losses on extinguishment of debt to prohibit the classification of the gain
or loss as extraordinary, as the use of such extinguishments have become
part of the risk management strategy of many companies. SFAS 145 also
amends SFAS 13 to require sale-leaseback accounting for certain lease
modifications that have economic effects similar to sale-leaseback
transactions. The provisions of the Statement related to the rescission of
Statement No. 4 is applied in fiscal years beginning after May 15, 2002.
The provisions of the Statement related to Statement No. 13 were effective
for transactions occurring after May 15, 2002. The Company adopted SFAS 145
effective January 1, 2003, which resulted in the reclassification of the
fiscal year 2002 loss on extinguishment of debt.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements
No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This
Interpretation elaborates on the disclosures to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees issued. Interpretation No. 45 also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the
fair value of the obligation undertaken. The initial recognition and
measurement provisions of the Interpretation are applicable to guarantees
issued or modified after December 31, 2002, and are not expected to have a
material effect on the Company's financial statements. The disclosure
requirements are effective for financial statements of interim or annual
periods ending after December 15, 2002. The Company has guarantees which
are disclosed in the notes to these consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation/Transition and Disclosure, an amendment of FASB Statement No.
123. SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial
statements. Certain of the disclosure modifications are required for fiscal
years and interim periods ending after December 15, 2002 and are included
in the notes to these consolidated financial statements.
Page 10
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The consolidated financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned subsidiaries.
References in this report to "we," "us," "our," the "Company," and similar
expressions refer to Covenant Transport, Inc. and its consolidated subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation.
Except for the historical information contained herein, the discussion in this
quarterly report contains forward-looking statements that involve risk,
assumptions, and uncertainties that are difficult to predict. Statements that
constitute forward-looking statements are usually identified by words such as
"anticipates," "believes," "estimates," "projects," "expects," or similar
expressions. These statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Such statements are based
upon the current beliefs and expectations of our management and are subject to
significant risks and uncertainties. Actual results may differ from those set
forth in the forward-looking statements. The following factors, among others,
could cause actual results to differ materially from those in forward-looking
statements: excess capacity in the trucking industry; decreased demand for our
services or loss of one or more or our major customers; surplus inventories;
recessionary economic cycles and downturns in customers' business cycles;
strikes or work stoppages; increases or rapid fluctuations in fuel prices,
interest rates, fuel taxes, tolls, and license and registration fees; increases
in the prices paid for new revenue equipment; the resale value of our used
equipment and the price of new equipment; increases in compensation for and
difficulty in attracting and retaining qualified drivers and owner-operators;
increases in insurance premiums and deductible amounts or claims relating to
accident, cargo, workers' compensation, health, and other matters; seasonal
factors such as harsh weather conditions that increase operating costs;
competition from trucking, rail, and intermodal competitors; regulatory
requirements that increase costs or decrease efficiency; and the ability to
identify acceptable acquisition candidates, consummate acquisitions, and
integrate acquired operations. Readers should review and consider these factors
along with the various disclosures we make in press releases, stockholder
reports, and public filings, as well as the factors explained in greater detail
in the Company's annual report on Form 10-K.
We generate substantially all of our revenue by transporting freight for our
customers. We also derive revenue from fuel surcharges, loading and unloading
activities, equipment detention, and other accessorial services. Generally, we
are paid by the mile or by the load for our services. The main factors that
affect our revenue are the revenue per mile we receive from our customers, the
percentage of miles for which we are compensated, and the numbers of miles we
generate with our equipment. These factors relate, among other things, to the
U.S. economy, inventory levels, the level of truck capacity in our markets,
specific customer demand, the percentage of team-driven tractors in our fleet,
and our average length of haul. Since 2000 we have held our fleet size
relatively constant. An overcapacity of trucks in our fleet and the industry
generally as the economy slowed has contributed to lower equipment utilization
and pricing pressure since 2000.
In addition to constraining fleet size, we reduced our number of two-person
driver teams to better match the demand for expedited long-haul service. Our
single driver fleets generally operate in shorter lengths of haul, generate
fewer miles per tractor, and experience more non-revenue miles, but the
additional expenses and lower productive miles are expected to be offset by
generally higher revenue per loaded mile and the reduced employee expense of
compensating only one driver. We expect operating statistics and expenses to
shift with the mix of single and team operations.
The trucking industry has experienced a significant increase in operating costs.
The main factors for the industry as well as for us have been an increased
annual cost of tractors due to higher initial prices and lower used truck
values, a higher overall cost of insurance and claims, and elevated fuel prices.
Other than those categories, our expenses have remained relatively constant or
have declined as a percentage of revenue.
Looking forward, our profitability goal is to return to an operating ratio of
approximately 90%. We expect this to require additional improvements in revenue
per tractor per week to overcome expected additional cost increases of new
revenue equipment (discussed below), and other general increases in operating
costs, as well as to expand our margins. Because a large percentage of our costs
is variable, changes in revenue per mile affect our profitability to a greater
extent than changes in miles per tractor.
We operate approximately 3,717 tractors and 7,516 trailers. Of our tractors at
March 31, 2003, approximately 2,438 were owned, 916 were financed under
operating leases, and 363 were provided by owner-operators, who own and drive
the tractors. Of our trailers at March 31, 2003, approximately 4,697 were owned
and approximately 2,819 were financed under operating leases. Between 1999 and
2001, the market value of used equipment deteriorated. In recognition of this
fact, we recognized pre-tax impairment charges of $15.4 million in the fourth
quarter of 2001 and $3.3 million in the first quarter of 2002 in relation to the
reduced value of our model year 1998 through 2000 tractors. In addition, we
increased the depreciation rate/lease expense on our remaining tractors to
reflect our expectations concerning market value at disposition. We estimate the
impact of the change in the estimated useful lives and depreciation on the 2001
model year tractors to be approximately $1.5 million pre-tax or $.06 per share
annually. Although we believe
Page 11
the additional depreciation will bring the carrying values of the model year
2001 tractors in line with future disposition values, we do not have trade-in
agreements covering those tractors. Our assumptions represent our best estimate,
and actual values could differ by the time those tractors are scheduled for
trade.
Because of the adverse change from historical purchase prices and residual
values, the annual expense per tractor on model year 2003 and 2004 tractors is
expected to be higher than the annual expense on the model year 1999 and 2000
units being replaced. We believe the increase in depreciation expense was
approximately one-half cent per mile pre-tax during 2002 and will grow to
approximately one cent per mile pre-tax in 2003 as all of these new units are
delivered. By the time the model year 2001 tractors are traded and the entire
fleet is converted in 2004, we expect the total increase in expense to be
approximately one and one-half cent pre-tax per mile. The timing of these
expenses could be affected if we change our tractor trade cycle to three years,
which we are considering. If the tractors are leased instead of purchased, the
references to increased depreciation would be reflected as additional lease
expense.
We finance a portion of our tractor and trailer fleet with off-balance sheet
operating leases. These leases generally run for a period of three years for
tractors and seven years for trailers. With our tractor trade cycle currently at
approximately four years, we have been purchasing the leased tractors at the
expiration of the lease term, although there is no commitment to purchase the
tractors. The first trailer leases expire in 2005, and we have not determined
whether to purchase trailers at the end of these leases.
Owner-operators provide a tractor and a driver and are responsible for all
operating expenses in exchange for a fixed payment per mile. We do not have the
capital outlay of purchasing the tractor. The payments to owner-operators and
the financing of equipment under operating leases are recorded in revenue
equipment rentals and purchased transportation. Expenses associated with owned
equipment, such as interest and depreciation, are not incurred, and for
owner-operator tractors, driver compensation, fuel, and other expenses are not
incurred. Because obtaining equipment from owner-operators and under operating
leases effectively shifts financing expenses from interest to "above the line"
operating expenses, we evaluate our efficiency using net margin rather than
operating ratio.
Freight revenue excludes $9.9 million of fuel and accessorial surcharge revenue
in the 2003 period and $3.2 million in the 2002 period. For comparison purposes
in the table below, we use freight revenue when discussing changes as a
percentage of revenue. We believe removing this sometimes volatile source of
revenue affords a more consistent basis for comparing the results of operations
from period to period. The following table sets forth the percentage
relationship of certain items to freight revenue:
Three Months Ended March 31,
2003 2002
--------------- --------------
Freight revenue (1) 100.0% 100.0%
Operating expenses:
Salaries, wages, and related expenses (1) 40.6 42.1
Fuel expense (1) 16.6 16.1
Operations and maintenance (1) 7.4 6.5
Revenue equipment rentals and purchased
transportation 11.5 11.5
Operating taxes and licenses 2.7 2.6
Insurance and claims 6.3 5.6
Communications and utilities 1.3 1.4
General supplies and expenses 2.5 2.7
Depreciation and amortization (2) 8.3 10.9
--------------- --------------
Total operating expenses 97.2 99.4
--------------- --------------
Operating income 2.8 0.6
Other (income) expense, net 0.5 1.7
--------------- --------------
Income (loss) before income taxes 2.3 (1.1)
Income tax expense 1.6 0.2
--------------- --------------
Net income (loss) 0.7% (1.3%)
=============== ==============
(1) Freight revenue is total revenue less fuel surcharge and accessorial
revenue. In this table, fuel surcharge and other accessorial revenue are
shown netted against the appropriate expense category (Salaries, wages, and
related expenses, $1.8 million in the 2003 period and $1.4 million in the
2002 period; Fuel expense, $7.5 million in the 2003 period and $1.3 million
in the 2002 period; Operations and maintenance, $0.5 million in the 2003
period and $0.4 million in the 2002 period.)
(2) Includes a $3.3 million pre-tax impairment charge or 2.6% of revenue in
2002.
Page 12
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2003 TO THREE MONTHS ENDED MARCH 31,
2002
For the quarter ending March 31, 2003, revenue increased $5.7 million (4.3%), to
$137.9 million, from $132.2 million in the 2002 period. Freight revenue excludes
$9.9 million of fuel and accessorial surcharge revenue in the 2003 period and
$3.2 million in the 2002 period. For comparison purposes in the discussion
below, we use freight revenue when discussing changes as a percentage of
revenue. We believe removing this sometimes volatile source of revenue affords a
more consistent basis for comparing the results of operations from period to
period.
Freight revenue (total revenue less fuel surcharge and accessorial revenue)
decreased $1.0 million (0.8%), to $128.0 million in the three months ended March
31, 2003, from $129.0 million in the same period of 2002. Our revenue was
affected by a 2.2% decrease in miles per tractor and an increase in non revenue
miles, which were partially offset by 2.5% increase in rate per loaded mile.
Revenue per tractor per week decreased to $2,667 in the 2003 period from $2,680
in the 2002 period. Weighted average tractors increased to 3,726 in the 2003
period from 3,713 in the 2002 period. Due to a weak freight environment, we have
elected to constrain the size of our tractor fleet until fleet production and
profitability improve.
Salaries, wages, and related expenses, net of accessorial revenue of $1.8
million in the 2003 period and $1.4 million in the 2002 period, decreased $2.3
million (4.2%), to $52.0 million in the 2003 period, from $54.3 million in the
2002 period. As a percentage of freight revenue, salaries, wages, and related
expenses decreased to 40.6% in the 2003 period, from 42.1% in the 2002 period.
The decrease was largely attributable to our utilizing a larger percentage of
single-driver tractors, with only one driver per tractor to be compensated and
implementing changes in our pay structure. Our payroll expense for employees
other than over the road drivers increased to 7.6% of freight revenue in the
2003 period from 7.0% of freight revenue in the 2002 period due to growth in
headcount and a larger number of local drivers in the dedicated fleet. Health
insurance, employer paid taxes, workers' compensation, and other employee
benefits remained essentially constant at 6.9% of freight revenue in the 2003
and 2002 periods.
Fuel expense, net of fuel surcharge revenue of $7.5 million in the 2003 period
and $1.3 million in the 2002 period, increased $0.5 million (2.3%), to $21.3
million in the 2003 period, from $20.8 million in the 2002 period. As a
percentage of freight revenue, net fuel expense increased to 16.6% in the 2003
period from 16.1% in the 2002 period. Fuel surcharges amounted to $.072 per
loaded mile in the 2003 period compared to $.012 per loaded mile in the 2002
period. Fuel prices have increased sharply during the first quarter of 2003
because of reasons such as unrest in Venezuela and the Middle East and low
inventories. 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, and lower fuel mileage due to government mandated emissions
standards that were effective October 1, 2002, and will result in less fuel
efficient engines. We did not have any fuel hedging contracts at March 31, 2003.
Operations and maintenance, net of accessorial revenue of $0.5 million in the
2003 period and $0.4 million in the 2002 period, consisting primarily of vehicle
maintenance, repairs and driver recruitment expenses, increased $1.1 million
(13.2%), to $9.5 million in the 2003 period, from $8.4 million in the 2002
period. As a percentage of freight revenue, operations and maintenance increased
to 7.4% in the 2003 period, from 6.5% in the 2002 period. We extended the trade
cycle on our tractor fleet from three years to four years, which resulted in an
increase in the number of required repairs.
Revenue equipment rentals and purchased transportation remained essentially
constant at $14.8 million and 11.5% as a percentage of freight revenue in the
2003 and 2002 periods. The owner-operators fleet increased slightly to an
average of 367 units in the 2003 period compared to an average of 348 units in
the 2002 period. Over the past couple of years, it has become more difficult to
retain owner-operators due to the challenging operating conditions.
Owner-operators are independent contractors, who provide a tractor and driver
and cover all of their operating expenses in exchange for a fixed payment per
mile. Accordingly, expenses such as driver salaries, fuel, repairs,
depreciation, and interest normally associated with Company-owned equipment are
consolidated in revenue equipment rentals and purchased transportation when
owner-operators are utilized. The revenue equipment rental expense remained
essentially constant in the two periods at approximately $5.1 million, as lease
rates fell while we added equipment under leases. As of March 31, 2003, we had
financed approximately 916 tractors and 2,819 trailers under operating leases as
compared to 636 tractors and 2,564 trailers under operating leases as of March
31, 2002. On April 14, 2003, we engaged in a sale-leaseback transaction
involving approximately 1,266 dry van trailers. We sold the trailers to a
finance company for approximately $15.5 million in cash and leased the trailers
back under three year walkaway leases. Our revenue equipment rental expense is
expected to increase in the future to reflect this transaction. We will no
longer recognize depreciation and interest expense with respect to these
trailers.
Operating taxes and licenses increased $0.2 million (4.7%), to $3.4 million in
the 2003 period, from $3.3 million in the 2002 period. As a percentage of
freight revenue, operating taxes and licenses remained essentially constant at
2.7% in the 2003 period and 2.6% in the 2002 period.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, increased
$0.9 million (12.2%), to $8.0 million in the 2003 period from $7.2 million in
the 2002 period. As a percentage of freight revenue, insurance increased to 6.3%
in the 2003 period from 5.6% in the 2002 period. The increase is a result
Page 13
of an industry-wide increase in insurance rates, which we addressed by adopting
an insurance program with significantly higher deductible exposure that is
partially offset by lower premium rates. The retention level for our primary
insurance layer increased from $250,000 in 2001 to $500,000 in March of 2002, to
$1.0 million in November of 2002, and to $2.0 million on March 1, 2003. We also
have a $2.0 million self-insured layer between $5.0 million and $7.0 million per
occurence. Our insurance program for liability, physical damage, and cargo
damage involves self-insurance with varying risk retention levels. Claims in
excess of these risk retention levels are covered by insurance in amounts which
management considers adequate. We accrue the estimated cost of the uninsured
portion of pending claims. These accruals are based on management's evaluation
of the nature and severity of the claim and estimates of future claims
development based on historical trends. Insurance and claims expense will vary
based on the frequency and severity of claims, the premium expense, and the
level of self-insured retention. Because of higher self-insured retentions, our
future expenses of insurance and claims may be higher or more volatile than in
historical periods.
Communications and utilities expense decreased $0.1 million (7.5%), to $1.7
million in the 2003 period, from $1.8 million in the 2002 period. As a
percentage of freight revenue, communications and utilities remained essentially
constant at 1.3% in the 2003 period as compared to 1.4% in the 2002 period.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses, decreased $0.3 million (9.6%), to $3.2 million in
the 2003 period, from $3.5 million in the 2002 period. As a percentage of
freight revenue, general supplies and expenses decreased to 2.5% in the 2003
period from 2.7% in the 2002 period.
Depreciation, amortization and impairment charge, consisting primarily of
depreciation of revenue equipment, decreased $3.5 million (24.6%), to $10.6
million in the 2003 period from $14.1 million in the 2002 period. As a
percentage of freight revenue, depreciation and amortization decreased to 8.3%
in the 2003 period from 10.9% in the 2002 period. The decrease is the result of
an impairment charge, partially offset by increased depreciation expense. In the
2002 period, we recognized a pre-tax charge of approximately $3.3 million to
reflect an impairment in tractor values. See "Impairment of Equipment and Change
in Estimated Useful Lives," in Note 6 to the Consolidated Financial Statements
for additional information. We expect our annual cost of tractor and trailer
ownership and/or leasing to increase in future periods. The increase is expected
to result from a combination of higher initial prices of new equipment, lower
resale values for used equipment, and increased depreciation/lease payments on
some of our existing equipment over their remaining lives in order to better
match expected book values or lease residual values with market values at the
equipment disposal date. To the extent equipment is leased under operating
leases, the amounts will be reflected in revenue equipment rentals and purchased
transportation. To the extent equipment is owned or obtained under capitalized
leases, the amounts will be reflected as depreciation expense and interest
expense. Those expense items will fluctuate with changes in the percentage of
our equipment obtained under operating leases versus owned and under capitalized
leases. Depreciation and amortization expense is net of any gain or loss on the
disposal of tractors and trailers. Gain on the disposal of tractors and trailers
was approximately $0.2 million in the 2003 period compared to a loss of $0.5
million in the 2002 period. Amortization expense relates to deferred debt costs
incurred and covenants not to compete from five acquisitions. Goodwill
amortization ceased beginning January 1, 2002, in accordance with SFAS No. 142,
and we evaluate goodwill and certain intangibles for impairment, annually.
During the second quarter of 2002, we tested our goodwill for impairment and
found no impairment.
Other expense, net, decreased $1.7 million (73.4%), to $0.6 million in the 2003
period, from $2.3 million in the 2002 period. As a percentage of freight
revenue, other expense decreased to 0.5% in the 2003 period from 1.7% in the
2002 period. Included in the other expense category are interest expense,
interest income, pre-tax non-cash gains related to the accounting for interest
rate derivatives under SFAS No. 133 which amounted to approximately $20,000 in
the 2003 period and approximately $0.2 million in the 2002 period and an early
extinguishment of debt charge.
During the first quarter of 2002, we prepaid the remaining $20 million in
previously outstanding 7.39% ten year, private placement notes with borrowings
from the Credit Agreement. In conjunction with the prepayment of the borrowings,
the Company recognized an approximate $1.4 million pre-tax charge to reflect the
early extinguishment of debt. The losses related to the write off of debt
issuance and other deferred financing costs and a premium paid on the retirement
of the notes.
Our income tax expense was $2.1 million and $0.3 million in the 2003 and 2002
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem, our
tax rate will fluctuate in future periods as income fluctuates.
Primarily as a result of the factors described above, net earnings increased
$2.5 million (150.3%), to $0.8 million income in the 2003 period (0.7% of
revenue), from $1.7 million loss in the 2002 period (1.3% of revenue).
As a result of the foregoing, our net margin increased to 0.7% in the 2003
period from (1.3%) in the 2002 period.
Page 14
LIQUIDITY AND CAPITAL RESOURCES
Historically our growth has required significant capital investments. We
historically have financed our expansion requirements with borrowings under a
line of credit, cash flows from operations and long-term operating leases. Our
primary sources of liquidity at March 31, 2003, were funds provided by
operations, proceeds under the Securitization Facility (as defined below),
borrowings under our primary credit agreement, which had maximum available
borrowing of $100.0 million at March 31, 2003 (the "Credit Agreement") and
operating leases of revenue equipment. We believe our sources of liquidity are
adequate to meet our current and projected needs for at least the next twelve
months.
Net cash provided by operating activities was $11.7 million in the first quarter
of 2003 and $12.3 million in the first quarter of 2002. Our primary sources of
cash flow from operations in the 2003 period were net income and depreciation
and amortization. Depreciation and amortization in the 2002 period included a
$3.3 million pre-tax impairment charge.
Net cash provided by investing activities was $6.1 million in the first quarter
of 2003 and was derived from the sale of revenue equipment during the quarter.
The cash used in the 2002 period related to the financing of tractors, which
were previously financed through operating leases, using proceeds from the
Credit Agreement. Anticipated capital expenditures are expected to increase in
2003 as the Company has agreed to purchase and trade a significant number of
tractors and trailers. We expect capital expenditures, primarily for revenue
equipment (net of trade-ins), to be approximately $80.0 million in 2003,
exclusive of acquisitions, if we remain on a four-year trade cycle for tractors.
If we change our trade cycle back to three years, our capital expenditures could
increase significantly. We also are considering alternatives for accelerating
our trailer disposition schedule, which could affect our capital expenditures or
lease commitments.
Net cash used in financing activities was $16.3 million in the first quarter of
2003, and $3.1 million was provided by financing activities in the first quarter
of 2002. During the first quarter of 2003, we reduced outstanding balance sheet
debt by $16.0 million. At March 31, 2003, we had outstanding debt of $67.5
million, primarily consisting of $41.2 million in the Securitization Facility,
$25.0 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 1.4% to 6.5%.
During the first quarter of 2002, we prepaid the remaining $20.0 million in
previously outstanding 7.39% ten year private placement notes with borrowings
from the Credit Agreement. In conjunction with the prepayment of the borrowings,
we recognized an approximate $0.9 million after-tax extraordinary item to
reflect the early extinguishment of debt. Upon adoption of SFAS 145 in 2003, we
reclassified the charge and it is no longer classified as an extraordinary item.
In December 2000, we entered into the Credit Agreement with a group of banks,
which expires in December, 2005. Borrowings under the Credit Agreement are based
on the banks' base rate or LIBOR and accrue interest based on one, two, or three
month LIBOR rates plus an applicable margin that is adjusted quarterly between
0.75% and 1.25% based on cash flow coverage. At March 31, 2003, the margin was
1.00%. The Credit Agreement is guaranteed by the Company and all of the
Company's subsidiaries except CVTI Receivables Corp. and Volunteer Insurance
Limited.
At December 31, 2002, the Credit Agreement had a maximum borrowing limit of
$120.0 million. When the facility was extended in February 2003, the borrowing
limit was reduced to $100.0 million with an accordion feature which permits an
increase up to a borrowing limit of $160.0 million. Borrowings related to
revenue equipment are limited to the lesser of 90% of net book value of revenue
equipment or the maximum borrowing limit. Letters of credit were limited to an
aggregate commitment of $20.0 million at December 31, 2002, and were increased
to a limit of $50.0 million in February 2003. The Credit Agreement includes a
"security agreement" such that the Credit Agreement may be collateralized by
virtually all of our assets if a covenant violation occurs. A commitment fee,
that is adjusted quarterly between 0.15% and 0.25% per annum based on cash flow
coverage, is due on the daily unused portion of the Credit Agreement. As of
March 31, 2003, we had borrowings under the Credit Agreement in the amount of
$25.0 million with a weighted average interest rate of 2.2%.
In December 2000, we entered into a $62 million revolving accounts receivable
securitization facility (the "Securitization Facility"). On a revolving basis,
we sell our interests in our accounts receivable to CRC, a wholly-owned
bankruptcy-remote special purpose subsidiary incorporated in Nevada. CRC sells a
percentage ownership in such receivables to an unrelated financial entity. We
can receive up to $62 million of proceeds, subject to eligible receivables and
will pay a service fee recorded as interest expense, based on commercial paper
interest rates plus an applicable margin of 0.41% per annum and a commitment fee
of 0.10% per annum on the daily unused portion of the Facility. The net proceeds
under the Securitization Facility are required to be shown as a current
liability because the term, subject to annual renewals, is 364 days. As of March
31, 2003, there were $41.2 million in proceeds received. The transaction did not
meet the criteria for sale treatment under Financial Accounting Standard No. 140
and is reflected as a secured borrowing in the financial statements.
Page 15
The Credit Agreement and Securitization Facility contain certain restrictions
and covenants relating to, among other things, dividends, tangible net worth,
cash flow, acquisitions and dispositions, and total indebtedness. All of these
agreements are cross-defaulted. The Company is in compliance with these
agreements as of March 31, 2003.
Contractual Obligations and Commitments - We had commitments outstanding related
to equipment, debt obligations, and diesel fuel purchases as of January 1, 2003.
These purchases are expected to be financed by debt, proceeds from sales of
existing equipment, and cash flows from operations. We have the option to cancel
commitments relating to equipment with 60 days notice.
The following table sets forth our contractual cash obligations and commitments
as of January 1, 2003.
Payments Due By Period There-
(in thousands) Total 2003 2004 2005 2006 2007 after
-------------------------------------------------------------------------------------
Long Term Debt $ 1,300 $ - $ 1,300 $ - $ - $ - $ -
Short Term Debt 82,230 82,230 - - - - -
Operating Leases 62,308 21,017 12,502 10,852 6,823 4,665 6,449
Lease residual value guarantees 56,802 25,699 - 9,910 3,553 5,590 12,050
Purchase Obligations:
Diesel fuel 52,477 48,020 4,457 - - - -
Equipment 85,986 85,986 - - - - -
-------------------------------------------------------------------------------------
Total Contractual Cash
Obligations $341,103 $262,952 $18,259 $20,762 $10,376 $10,255 $18,499
=====================================================================================
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. Other footnotes describe
various elements of the financial statements and the assumptions on which
specific amounts were determined.
Our critical accounting policies include the following:
Property and Equipment - Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. Historically, we
depreciated revenue equipment over five to seven years with salvage values
ranging from 25% to 33 1/3%. During 2000, we extended our estimate for the
useful life of our dry van trailers acquired between July 2000 and March 2001
from seven to eight years and increased the salvage value to approximately 48%
of cost. We based this decision on market experience at that time. We are
re-evaluating the salvage value, useful life, and annual depreciation of these
trailers based on the current market environment. Any change could result in
greater annual expense in the future. In September 2001, we changed our
estimated useful life and salvage value to seven years and 43% of cost for new
trailers. Gains or losses on disposal of revenue equipment are included in
depreciation in the statements of income.
Impairment of Long-Lived Assets - We evaluate the carrying value of long-lived
assets by analyzing the operating performance and future cash flows for those
assets, whenever events or changes in circumstances indicate that the carrying
amounts of such assets may not be recoverable. We adjust the carrying value of
the underlying assets if the sum of the expected cash flows is less than the
carrying value. Impairment can be impacted by our projection of future cash
flows, the level of cash flows and salvage values, the methods of estimation
used for determining fair values and the impact of guaranteed residuals.
Insurance and Other Claims - Our insurance program for liability, property
damage, and cargo loss and damage, involves self- insurance with high risk
retention levels. We have increased the self-insured retention portion of our
insurance coverage from $12,500 for each claim in 2000 to $1.0 million plus an
additional layer from $4.0 million to $7.0 million for each claim at November
2002.
Page 16
Effective March 2003, we increased our primary coverage to $5.0 million with a
$2.0 million retention level, plus an additional layer from $5.0 million to $7.0
million for each claim. We accrue the estimated cost of the uninsured portion of
pending claims. These accruals are based on our evaluation of the nature and
severity of the claim and estimates of future claims development based on
historical trends. The rapid and substantial increase in our self-insured
retention makes these estimates an important accounting judgment. Insurance and
claims expense will vary based on the frequency and severity of claims, the
premium expense and the lack of self-insured retention.
From 1999 to present, we carried excess coverage in amounts that have ranged
from $15.0 million to $49.0 million in addition to our primary insurance
coverage. On July 15, 2002, we received a binder for $48.0 million of excess
insurance coverage over our $2.0 million primary layer. Subsequently, we were
forced to seek replacement coverage after the insurance agent retained the
premium and failed to produce proof of insurance coverage. If one or more claims
from the period July to November 2002 exceeded $2.0 million in amount, we would
be required to accrue for the potential or actual loss and our financial
condition and results of operations could be materially and adversely affected.
We are not aware of any such claims at this time.
At December 31, 2002, we maintained a workers' compensation plan and a group
medical plan for our employees with a deductible amount of $500,000 for each
workers' compensation claim and a deductible amount of $225,000 for each group
medical claim. In the first quarter of 2003, we adopted a workers' compensation
plan with a self-insured retention level of $1.0 million per occurrence and
renewed our group medical plan with a deductible amount of $250,000.
Lease Accounting - We lease a significant portion of our tractor and trailer
fleet using operating leases. Substantially all of the leases have residual
value guarantees under which we must insure that the lessor receives a
negotiated amount for the equipment at the expiration of the lease. In
accordance with SFAS No. 13, Accounting for Leases, the rental expense under
these leases is reflected as an operating expense under "revenue equipment
rentals and purchased transportation." To the extent the expected value at the
lease termination date is lower than the residual value guarantee, we accrue for
the difference over the remaining lease term. The estimated values at lease
termination involve management judgments. Operating leases are carried off
balance sheet in accordance with SFAS No. 13.
INFLATION AND FUEL COSTS
Most of our operating expenses are inflation-sensitive, with inflation generally
producing increased costs of operations. During the past three years, the most
significant effects of inflation have been on revenue equipment prices and the
compensation paid to the drivers. Innovations in equipment technology and
comfort have resulted in higher tractor prices, and there has been an
industry-wide increase in wages paid to attract and retain qualified drivers. We
historically have limited the effects of inflation through increases in freight
rates and certain cost control efforts.
In addition to inflation, fluctuations in fuel prices can affect profitability.
Fuel expense comprises a larger percentage of revenue for us than many other
carriers because of our long average length of haul. Most of our contracts with
customers contain fuel surcharge provisions. Although we historically have been
able to pass through most long-term increases in fuel prices and taxes to
customers in the form of surcharges and higher rates, increases usually are not
fully recovered. Fuel prices have remained high throughout most of 2000, 2001,
and 2002, which has increased our cost of operating. The elevated level of fuel
prices has continued into 2003.
SEASONALITY
In the trucking industry, revenue generally decreases as customers reduce
shipments during the winter holiday season and as inclement weather impedes
operations. At the same time, operating expenses generally increase, with fuel
efficiency declining because of engine idling and weather creating more
equipment repairs. For the reasons stated, first quarter net income historically
has been lower than net income in each of the other three quarters of the year.
Our equipment utilization typically improves substantially between May and
October of each year because of the trucking industry's seasonal shortage of
equipment on traffic originating in California and our ability to satisfy some
of that requirement. The seasonal shortage typically occurs between May and
August because California produce carriers' equipment is fully utilized for
produce during those months and does not compete for shipments hauled by our dry
van operation. During September and October, business increases as a result of
increased retail merchandise shipped in anticipation of the holidays.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks from changes in (i) certain commodity
prices and (ii) certain interest rates on its debt.
COMMODITY PRICE RISK
Prices and availability of all petroleum products are subject to political,
economic, and market factors that are generally outside our
Page 17
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 first quarter of 2003, diesel fuel expenses
net of fuel surcharge represented 15.8% of our total operating expenses and
16.6% of freight revenue. At March 31, 2003, we had no derivative financial
instruments to reduce our exposure to fuel price fluctuations.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
INTEREST RATE RISK
The Credit Agreement, provided there has been no default, carries a maximum
variable interest rate of LIBOR for the corresponding period plus 1.25%. During
the first quarter of 2001, we entered into two $10 million notional amount
interest rate swap agreements to manage the risk of variability in cash flows
associated with floating-rate debt. At March 31, 2003, we had drawn $25.0
million under the Credit Agreement. Approximately $5.0 million was subject to
variable rates and the remaining $20 million was subject to interest rate swaps
that fixed the interest rates at 5.16% and 4.75% plus the applicable margin per
annum. The swaps expire January 2006 and March 2006. These derivatives are not
designated as hedging instruments under SFAS No. 133 and consequently are marked
to fair value through earnings, in other expense in the accompanying statement
of operations. At March 31, 2003, the fair value of these interest rate swap
agreements was a liability of $1.6 million. Assuming the March 31, 2003 variable
rate borrowings, each one-percentage point increase or decrease in LIBOR would
affect our pre-tax interest expense by $50,000 on an annualized basis, excluding
the portion of variable rate debt covered by cancelable interest rate swaps, and
the effect of changes in fair values resulting from those swaps.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
ITEM 4. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this report, an evaluation was performed
under the supervision and with the Company's management, including its Chief
Executive Officer and its Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, the Company's management, including its Chief Executive
Officer and Chief Financial Officer, concluded that the Company's disclosure
controls and procedures were effective as of March 31, 2003. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to March 31, 2003,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
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 18
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
None
Items 2, 3, 4 and 5. Not applicable
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Reference Description
3.1 (1) Restated Articles of Incorporation.
3.2 (1) Amended Bylaws dated September 27, 1994.
4.1 (1) Restated Articles of Incorporation.
4.2 (1) Amended Bylaws dated September 27, 1994.
10.1 # Amendment No. 2 to Credit Agreement dated August 28, 2001, among Covenant
Asset Management, Inc., Covenant Transport, Inc., Bank of America, N.A., and
each other financial institution which is a party to the Credit Agreement.
- -------------------------------------------------------------------------------------------------------------------
References:
(1) Incorporated by reference from Form S-1, Registration No. 33-82978,
effective October 28, 1994.
# Filed herewith.
(b) There were no reports on Form 8-K filed during the first quarter ended
March 31, 2003.
Page 19
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: May 14, 2003 /s/ Joey B. Hogan
-----------------
Joey B. Hogan
Senior Vice President and Chief Financial
Officer, in his capacity as such and on
behalf of the issuer.
Page 20
CERTIFICATIONS
I, David R. Parker, certify that:
1. I have reviewed this quarterly report on Form 10-Q for the quarterly
period ended March 31, 2003, of Covenant Transport, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures for the
registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board or directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize, and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ David R. Parker
------------------------
David R. Parker
Chief Executive Officer
Page 21
I, Joey B. Hogan, certify that:
1. I have reviewed this quarterly report on Form 10-Q for the quarterly
period ended March 31, 2003, of Covenant Transport, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures for the
registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board or directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize, and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ Joey B. Hogan
------------------------
Joey B. Hogan
Chief Financial Officer
Page 22