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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 September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number 0-24960
COVENANT TRANSPORT, INC.
(Exact name of registrant as specified in its charter)
Nevada 88-0320154
- -------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
400 Birmingham Hwy.
Chattanooga, TN 37419 37419
- -------------------------------- --------------------------------
(Address of principal executive (Zip Code)
offices)
423-821-1212
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date (October 24, 2003).
Class A Common Stock, $.01 par value: 12,265,525 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 September 30, 2003 (Unaudited) and
December 31, 2002 3
Condensed Consolidated Statements of Operations for the three and nine months ended
September 30, 2003 and 2002 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2003 and 2002 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
PART II
OTHER INFORMATION
Page Number
Item 1. Legal Proceedings 26
Items 2, 3, 4, and 5. Not applicable 26
Item 6. Exhibits and reports on Form 8-K 26
Page 2
ITEM 1. FINANCIAL STATEMENTS
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
September 30, December 31, 2002
2003
ASSETS (unaudited)
-------- --------------------- ----------------------
Current assets:
Cash and cash equivalents $ 1,837 $ 42
Accounts receivable, net of allowance of $1,400 in 2003
and $1,800 in 2002 61,872 65,041
Drivers advances and other receivables 6,204 3,480
Inventory and supplies 3,340 3,226
Prepaid expenses 11,123 14,450
Deferred income taxes 11,108 11,105
Income taxes receivable 2,076 2,585
--------------------- ----------------------
Total current assets 97,560 99,929
Property and equipment, at cost 344,709 392,498
Less accumulated depreciation and amortization (125,872) (154,010)
--------------------- ----------------------
Net property and equipment 218,837 238,488
Other assets 23,193 23,124
--------------------- ----------------------
Total assets $339,590 $361,541
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
--------------------------------------
Current liabilities:
Current maturities of long-term debt 2,000 43,000
Securitization facility 41,353 39,230
Accounts payable 8,661 6,921
Accrued expenses 23,208 17,220
Insurance and claims accrual 25,691 21,210
--------------------- ----------------------
Total current liabilities 100,913 127,581
Long-term debt, less current maturities 1,300 1,300
Deferred income taxes 50,572 57,072
--------------------- ----------------------
Total liabilities 152,785 185,953
Commitments and contingent liabilities
Stockholders' equity:
Class A common stock, $.01 par value; 20,000,000 shares
authorized; 13,215,831 and 12,999,315 shares issued and 12,244,331
and 12,027,815 outstanding as of September 30, 2003 and December 31,
2002, respectively 132 130
Class B common stock, $.01 par value; 5,000,000 shares authorized;
2,350,000 shares issued and outstanding as of September 30, 2003 and
December 31, 2002 24 24
Additional paid-in-capital 87,655 84,492
Treasury stock at cost; 971,500 shares as of September 30, 2003 and
December 31, 2002 (7,935) (7,935)
Retained earnings 106,929 98,877
--------------------- ----------------------
Total stockholders' equity 186,805 175,588
--------------------- ----------------------
Total liabilities and stockholders' equity $ 339,590 $ 361,541
===================== ======================
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 3
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(In thousands except per share data)
Three months ended Nine months ended
September 30, September 30,
(unaudited) (unaudited)
--------------------------------- ------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Freight revenue $ 138,245 $ 135,275 $ 403,708 $ 403,135
Fuel surcharge and other accessorial revenue 8,238 5,948 26,592 14,619
--------------------------------- ------------------------------
Total revenue $ 146,483 $ 141,223 $ 430,300 $ 417,754
Operating expenses:
Salaries, wages, and related expenses 55,863 55,315 165,335 169,647
Fuel expense 26,370 24,077 81,660 70,223
Operations and maintenance 10,161 10,697 30,446 29,824
Revenue equipment rentals and purchased
transportation 18,634 14,711 50,014 44,368
Operating taxes and licenses 3,343 3,165 10,519 10,357
Insurance and claims 8,240 7,840 25,836 22,844
Communications and utilities 1,868 1,567 5,307 5,103
General supplies and expenses 3,527 3,579 10,526 10,727
Depreciation, amortization and impairment
charge, including gains (losses) on disposition
of equipment (1) 9,991 11,492 31,208 37,466
--------------------------------- ------------------------------
Total operating expenses 137,997 132,443 410,851 400,559
--------------------------------- ------------------------------
Operating income 8,486 8,780 19,449 17,195
Other (income) expenses:
Interest expense 538 868 1,786 2,802
Interest income (43) (18) (106) (52)
Other (251) 738 (206) 949
Early extinguishment of debt (2) - - - 1,434
--------------------------------- ------------------------------
Other (income) expenses, net 244 1,588 1,474 5,133
--------------------------------- ------------------------------
Income before income taxes 8,242 7,192 17,975 12,062
Income tax expense 4,192 3,581 9,923 7,138
--------------------------------- ------------------------------
Net income $ 4,050 $ 3,611 $ 8,052 $ 4,924
================================= ==============================
Net income per share:
Basic earnings per share: $ 0.28 $ 0.25 $ 0.56 $ 0.35
Diluted earnings per share: $ 0.28 $ 0.25 $ 0.55 $ 0.34
Weighted average shares outstanding 14,461 14,317 14,413 14,171
Weighted average shares outstanding adjusted for
assumed conversions 14,692 14,704 14,652 14,465
(1) Includes a $3.3 million pre-tax impairment charge in the nine month period ended September 30, 2002.
(2) Reflects the reclassification of early extinguishment of debt due to the adoption of SFAS 145 in the nine
month period ended September 30, 2002.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 4
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(In thousands)
Nine months ended September 30,
(unaudited)
--------------------------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net income $ 8,052 $ 4,924
Adjustments to reconcile net income to net cash
provided by operating activities:
Net provision for losses on accounts receivables 44 672
Loss on early extinguishment of debt, net of tax - 890
Depreciation, amortization and impairment of assets(1) 32,096 35,805
Provision for losses on guaranteed residuals - 324
Deferred income tax (benefit)/expense (6,503) 676
Income tax benefit from exercise of stock options 571 746
(Gain)/loss on disposition of property and equipment (887) 1,661
Changes in operating assets and liabilities:
Receivables and advances 401 (2,999)
Prepaid expenses 3,327 2,583
Inventory and supplies (114) 345
Accounts payable and accrued expenses 12,717 10,090
------------------ -----------------
Net cash flows provided by operating activities 49,704 55,717
Cash flows from investing activities:
Acquisition of property and equipment (58,937) (40,244)
Proceeds from disposition of property and equipment 47,630 6,867
------------------ -----------------
Net cash flows used in investing activities (11,307) (33,377)
Cash flows from financing activities:
Deferred costs (318) -
Exercise of stock options 2,593 3,847
Proceeds from issuance of long-term debt 39,000 54,000
Repayments of long-term debt (77,877) (79,438)
------------------ -----------------
Net cash flows used in financing activities (36,602) (21,591)
------------------ -----------------
Net change in cash and cash equivalents 1,795 749
Cash and cash equivalents at beginning of period 42 383
------------------ -----------------
Cash and cash equivalents at end of period $ 1,837 $ 1,132
================== =================
(1) Includes a $3.3 million pre-tax impairment charge in the nine month period ended September 30, 2002.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Page 5
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned
subsidiaries ("Covenant" or the "Company"). All significant intercompany
balances and transactions have been eliminated in consolidation.
The financial statements have been prepared, without audit, in accordance
with accounting principles generally accepted in the United States of
America, pursuant to the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the accompanying
financial statements include all adjustments which are necessary for a
fair presentation of the results for the interim periods presented, such
adjustments being of a normal recurring nature. Certain information and
footnote disclosures have been condensed or omitted pursuant to such rules
and regulations. The December 31, 2002 consolidated balance sheet was
derived from the audited balance sheet of the Company for the year then
ended. It is suggested that these consolidated financial statements and
notes thereto be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Form 10-K for the
year ended December 31, 2002. Results of operations in interim periods are
not necessarily indicative of results to be expected for a full year.
Note 2. Basic and Diluted Earnings per Share
The following table sets forth for the periods indicated the calculation
of net earnings per share included in the Company's consolidated
statements of operations:
(in thousands except per share data) Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Numerator:
Net earnings $ 4,050 $ 3,611 $ 8,052 $ 4,924
Denominator:
Denominator for basic earnings
per share - weighted-average shares 14,461 14,317 14,413 14,171
Effect of dilutive securities:
Employee stock options 231 387 239 294
---------- ---------- ---------- ----------
Denominator for diluted earnings per share -
adjusted weighted-average shares and assumed
conversions 14,692 14,704 14,652 14,465
========== ========== ========== ==========
Net income per share:
Basic earnings per share: $0.28 $0.25 $0.56 $0.35
Diluted earnings per share: $0.28 $0.25 $0.55 $0.34
Dilutive common stock options are included in the diluted EPS calculation
using the treasury stock method. Employee stock options in the table above
exclude 60,000 and 45,000 in the three months ended September 30, 2003 and
2002, respectively, and 60,000 and 47,500 in the nine month periods ended
September 30, 2003 and 2002, respectively, from the computation of diluted
earnings per share because their effect would have been
Page 6
anti-dilutive. At September 30, 2003, the Company had stock-based employee
compensation plans. The Company accounts for the plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting
for Stock Issued to Employees, and related Interpretations. No stock-based
employee compensation cost is reflected in net income, as all options
granted under those plans had an exercise price equal to the market value
of the underlying common stock on the date of grant. Under SFAS No. 123,
Accounting for Stock-Based Compensation, fair value of options granted are
estimated as of the date of grant using the Black-Scholes option pricing
model and the following weighted average assumptions: risk-free interest
rates ranging from 2.3% to 3.5%; expected life of 5 years; dividend rate of
zero percent; and expected volatility of 52.5% for the 2003 periods, and
53.3% for the 2002 periods. Using these assumptions, the fair value of the
employee stock options granted, net of the related tax effects, in the
three months ended September 30, 2003 and 2002 periods are $0.4 million,
and in the nine months ended September 30, 2003 and 2002 periods are $1.4
million and $1.3 million, respectively. The following table illustrates the
effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of SFAS No. 123 to stock-based employee
compensation.
(in thousands except per share data) Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported: $ 4,050 $ 3,611 $ 8,052 $ 4,924
Deduct: Total stock-based employee compensation
expense determined under fair value based method for all
awards, net of related tax effects (384) (444) (1,400) (1,336)
----------- ------------ ------------ ------------
Pro forma net income 3,666 3,167 6,652 3,588
Basic earnings per share:
As reported $0.28 $0.25 $0.56 $0.35
Pro forma $0.25 $0.22 $0.46 $0.25
Diluted earnings per share:
As reported $0.28 $0.25 $0.55 $0.34
Pro forma $0.25 $0.22 $0.45 $0.25
Note 3. Income Taxes
Income tax expense varies from the amount computed by applying the federal
corporate income tax rate of 34% to income before income taxes primarily
due to state income taxes, net of federal income tax effect, adjusted for
permanent differences, the most significant of which is the effect of the
per diem pay structure for drivers.
Note 4. Goodwill and Other Intangible Assets
Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets, which requires the Company to evaluate goodwill
and other intangible assets with indefinite useful lives for impairment on
an annual basis, with any resulting impairment recorded as a cumulative
effect of a change in accounting principle. Goodwill that was acquired in
purchase business combinations completed before July 1, 2001, is no longer
amortized after January 1, 2002. Furthermore, any goodwill that is acquired
in a purchase business combination completed after June 30, 2001, is not
amortized. During the second quarter of 2003, the Company completed its
evaluation of its goodwill for impairment and determined that there was no
impairment. At September 30, 2003 and December 31, 2002, the Company had
$11.5 million of goodwill.
Page 7
Note 5. Derivative Instruments and Other Comprehensive Income
The FASB issued SFAS No. 133 ("SFAS 133"), Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133, as amended, requires that
all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or in other comprehensive income, depending on whether a
derivative is designated as part of a hedging relationship and, if it is,
depending on the type of hedging relationship.
The Company adopted SFAS No. 133 effective January 1, 2001 but had no
instruments in place on that date. In 2001, the Company entered into two
$10.0 million notional amount cancelable interest rate swap agreements to
manage the risk of variability in cash flows associated with floating-rate
debt. Due to the counter-parties' imbedded options to cancel, these
derivatives did not qualify, and are not designated as hedging instruments
under SFAS No. 133. Consequently, these derivatives are marked to fair
value through earnings, in other expense in the accompanying statements of
operations. At September 30, 2003 and September 30, 2002, the fair value of
these interest rate swap agreements was a liability of $1.5 million and
$1.7 million, respectively, which are included in accrued expenses on the
consolidated balance sheets.
During the third quarter of 2001, the Company entered into two heating oil
commodity swap contracts to hedge its cash flow exposure to diesel fuel
price fluctuations. These contracts were considered highly effective in
offsetting changes in anticipated future cash flows and were designated as
cash flow hedges under SFAS No. 133. At September 30, 2002 the cumulative
fair value of these heating oil contracts was an asset of $0.6 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 nine months ended September 30, is summarized in the following:
(in thousands) Nine months ended
September 30,
2003 2002
---- ----
Net liability for derivatives at January 1 $(1,645) $(1,932)
Gain (loss) on derivative instruments:
Loss in value of derivative instruments that do not qualify as
hedging instruments 187 (925)
Gain on fuel hedge contracts that qualify as cash flow hedges - 1,779
----------- -------------
Net liability for derivatives at September 30 $(1,458) $(1,078)
=========== =============
The following is a summary of comprehensive income as of September 30:
(in thousands) Nine months ended
September 30,
2003 2002
---- ----
Net Income: $ 8,052 $ 4,924
Other comprehensive income:
Gain on fuel hedge contracts that qualify as cash flow hedges - 1,779
Tax benefit - (676)
----------- -------------
Unrealized gain on cash flow hedging derivatives, net of tax - 1,103
Comprehensive income $ 8,052 $ 6,027
=========== =============
Page 8
Note 6. Impairment of Equipment and Change in Estimated Useful Lives
During 2001, the market value of used tractors was significantly below both
historical levels and the carrying values on the Company's financial
statements. The Company extended the trade cycle of its tractors from three
years to four years during 2001, which delayed any significant disposals
into 2002 and later years. The market for used tractors did not improve by
the time the Company negotiated a tractor purchase and trade package with
Freightliner Corporation for calendar years 2002 and 2003 covering the sale
of model year 1998 through 2000 tractors and the purchase of an equal
number of replacement units. The significant difference between the
carrying values and the sale prices of the used tractors combined with the
Company's less profitable results during 2001 caused the Company to test
for asset impairment under SFAS No. 121, Accounting for the Impairment of
Long Lived Assets and of Long Lived Assets to be Disposed of. In the test,
the Company measured the expected undiscounted future cash flows to be
generated by the tractors over the remaining useful lives and the disposal
value at the end of the useful life against the carrying values. The test
indicated impairment and the Company recognized the pre-tax charges of
approximately $15.4 million and $3.3 million in 2001 and 2002,
respectively, to reflect an impairment in tractor values. The Company
incurred a loss of approximately $324,000 on guaranteed residuals for
leased tractors in the first quarter of 2002, which was recorded in revenue
equipment rentals and purchased transportation in the accompanying
statement of operations. The Company accrued this loss from January 1,
2002, to the date the tractors were purchased off lease in February 2002.
The Company's approximately 1,400 model year 2001 tractors were not
affected by the charge. The Company adjusted the depreciation rate of these
model year 2001 tractors to approximate its experience with disposition
values and expectation for future disposition values. The Company also
increased the lease expense on its leased units because management
anticipated market values at disposition to have an approximately $1.4
million shortfall versus the guaranteed residual values. The Company is
recording such amount as additional lease expense ratably over the
remaining lease term. In June 2003, the Company entered into a trade-in
agreement with an equipment manufacturer covering the model year 2001
tractors. Based on the trade-in agreement, management believes the
additional depreciation and lease expense will bring the carrying values of
these tractors in line with the disposition values. 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
$0.06 per share annually through the first quarter of 2004.
Note 7. Securitization Facility and Long-term Debt
Outstanding debt consisted of the following at September 30, 2003 and
December 31, 2002:
(in thousands) September 30, 2003 December 31, 2002
---------------------- ----------------------
Securitization Facility $ 41,353 $ 39,230
====================== ======================
Borrowings under credit agreement $ 2,000 $ 43,000
Note payable to former SRT shareholder, bearing
interest at 6.5% with interest payable quarterly 1,300 1,300
---------------------- ----------------------
Total long-term debt 3,300 44,300
Less current maturities 2,000 43,000
---------------------- ----------------------
Long-term debt, less current portion $ 1,300 $ 1,300
====================== ======================
In December 2000, the Company entered into the Credit Agreement with a
group of banks. The facility matures in December 2005. Borrowings under the
Credit Agreement are based on the banks' base rate, which floats daily, or
LIBOR, which accrues 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 (the applicable margin was 0.875% at
September 30, 2003). At September 30, 2003, the Company had only base rate
borrowings outstanding on which the interest rate was 2.4%. The Credit
Agreement is guaranteed by the Company and all of the Company's
subsidiaries except CVTI Receivables Corp. and Volunteer Insurance Limited.
Page 9
The Credit Agreement has a maximum borrowing limit of $100.0 million with
an accordion feature which permits an increase up to a maximum borrowing
limit of $140.0 million. Borrowings related to revenue equipment are
limited to the lesser of 90% of net book value of revenue equipment or the
maximum borrowing limit. Letters of credit are limited to an aggregate
commitment of $50.0 million. The Credit Agreement includes a "security
agreement" such that the Credit Agreement may be collateralized by
virtually all assets of the Company if a covenant violation occurs. A
commitment fee, that is adjusted quarterly between 0.15% and 0.25% per
annum based on cash flow coverage, is due on the daily unused portion of
the Credit Agreement. As of September 30, 2003, the Company had $2.0
million of borrowings outstanding under the Credit Agreement. At September
30, 2003 and December 31, 2002, the Company had undrawn letters of credit
outstanding of approximately $41.6 million and $19.2 million, respectively.
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 No.
145 in 2003, the Company reclassified the charge and it is no longer
classified as an extraordinary item.
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 September 30, 2003 and December 31,
2002, the Company had received $41.4 million and $39.2 million,
respectively, in proceeds, with a weighted average interest rate of 1.1%
and 1.5%, respectively.
The Credit Agreement and Securitization Facility contain certain
restrictions and covenants relating to, among other things, dividends,
tangible net worth, cash flow, acquisitions and dispositions, and total
indebtedness and are cross-defaulted. As of September 30, 2003, the Company
was in compliance with the Credit Agreement and Securitization Facility.
Note 8. Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS 143 provided new guidance on the recognition and
measurement of an asset retirement obligation and its associated asset
retirement cost. It also provides accounting guidance for legal obligations
associated with the retirement of tangible long-lived assets. This
pronouncement was effective January 1, 2003. The pronouncement did not have
a material impact on the Company's consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 amends existing guidance on reporting gains and
losses on extinguishment of debt to prohibit the classification of the gain
or loss as extraordinary, as the use of such extinguishments have become
part of the risk management strategy of many companies. SFAS 145 also
amends SFAS 13 to require sale-leaseback accounting for certain lease
modifications that have economic effects similar to sale-leaseback
transactions. The provisions of SFAS 145 related to the rescission of SFAS
No. 4 are applied in fiscal years beginning after May 15, 2002. The
provisions of SFAS 145 related to SFAS No. 13 were effective for
transactions occurring after May 15, 2002. The Company
Page 10
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 did not 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.
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, SFAS 148 amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial
statements. Certain of the disclosure modifications are required for fiscal
years and interim periods ending after December 15, 2002 and are included
in the notes to these consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51. Interpretation
46 addresses the consolidation by business enterprises of variable interest
entities, as defined. Interpretation 46 applied immediately to variable
interests in variable interest entities created after January 31, 2003. For
a variable interest in a variable interest entity created before February
1, 2003, the recognition provisions of Interpretation 46 apply to that
entity as of the first interim period ending after December 15, 2003. The
Company is evaluating the impact of this interpretation on the Company's
financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS 149 amended and
clarified accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities under SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities. SFAS 149 amended SFAS 133 regarding implementation
issues raised in relation to the application of the definition of a
derivative, particularly regarding the meaning of an "underlying" and the
characteristics of a derivative that contains financing components. The
amendments set forth in SFAS 149 improve financial reporting by requiring
that contracts with comparable characteristics be accounted for similarly.
In particular, SFAS 149 clarifies under what circumstances a contract with
an initial net investment meets the characteristic of a derivative as
discussed in SFAS 133. In addition, it clarifies when a derivative contains
a financing component that warrants special reporting in the statement of
cash flows. SFAS 149 was effective for contracts entered into or modified
after June 30, 2003. The Company's adoption of this statement will not have
any significant impact on the Company's financial condition or results of
operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. SFAS 150 was developed in
response to concerns expressed about issuers' classification in the
statement of financial position of certain financial instruments that have
characteristics of both liabilities and equity, but that have been
presented either entirely as equity or between the liabilities section and
the equity section of the balance sheet. SFAS 150 was effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise was effective at the beginning of the first interim period
beginning after June 15, 2003. SFAS 150 did not affect the Company's
balance sheet presentation of its debt and equity financial instruments.
Page 11
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The consolidated financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned subsidiaries.
References in this report to "we," "us," "our," the "Company," and similar
expressions refer to Covenant Transport, Inc. and its consolidated subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation.
Except for the historical information contained herein, the discussion in this
quarterly report contains forward-looking statements that involve risk,
assumptions, and uncertainties that are difficult to predict. Statements that
constitute forward-looking statements are usually identified by words such as
"anticipates," "believes," "estimates," "projects," "expects," "plans,"
"intends," or similar expressions. These statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Such statements are based upon the current beliefs and expectations of our
management and are subject to significant risks and uncertainties. Actual
results may differ from those set forth in the forward-looking statements. The
following factors, among others, could cause actual results to differ materially
from those in forward-looking statements: excess tractor or trailer 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, work slow downs, or work
stoppages at our facilities, or at customer, port, or other shipping related
facilities; increases or rapid fluctuations in fuel prices as well as
fluctuations in hedging activities and surcharge collection, the volume and
terms of diesel purchase commitments, interest rates, fuel taxes, tolls, and
license and registration fees; increases in the prices paid for new revenue
equipment; the resale value of our used equipment and the price of new
equipment; increases in compensation for and difficulty in attracting and
retaining qualified drivers and independent contractors; elevated experience in
the frequency and severity of claims relating to accident, cargo, workers'
compensation, health, and other matters; high insurance premiums and deductible
amounts; seasonal factors such as harsh weather conditions that increase
operating costs; competition from trucking, rail, and intermodal competitors;
regulatory requirements that increase costs or decrease efficiency, including
revised hours-of-service requirements for drivers; our ability to successfully
execute our initiative of improving the profitability of medium length of haul,
or "in-between," movements; and the ability to identify acceptable acquisition
candidates, consummate acquisitions, and integrate acquired operations. Readers
should review and consider these factors along with the various disclosures we
make in press releases, stockholder reports, and filings with the Securities and
Exchange Commission.
For the quarter ended September 30, 2003, our total revenue increased 3.7%, our
net income increased 12.1%, and our net income per diluted share increased
12.0%, all as compared to the same quarter of 2002. The primary factors that led
to this improvement were strong freight demand, particularly during September,
which helped us raise our revenue per tractor by approximately 3.8%. This
improvement was partially offset by an increase of just less than one cent per
mile in our after-tax costs.
We generate substantially all of our revenue by transporting freight for our
customers. We also derive revenue from fuel surcharges, loading and unloading
activities, equipment detention, and other accessorial services. Generally, we
are paid by the mile or by the load for our services. The main factors that
affect our revenue are the revenue per mile we receive from our customers, the
percentage of miles for which we are compensated, and the numbers of miles we
generate with our equipment. These factors relate, among other things, to the
U.S. economy, inventory levels, the level of truck capacity in our markets,
specific customer demand, the percentage of team-driven tractors in our fleet,
and our average length of haul. Since 2000 we have held our fleet size
relatively constant. An overcapacity of trucks in our fleet and the industry
generally as the economy slowed has contributed to lower equipment utilization
and pricing pressure since 2000.
In addition to constraining fleet size, we reduced our number of two-person
driver teams during 2002 and have since held the percentage relatively constant
to better match the demand for expedited long-haul service. Our single driver
fleets generally operate in shorter lengths of haul, generate fewer miles per
tractor, and experience more non-revenue miles, but the additional expenses and
lower productive miles are expected to be offset by generally higher revenue per
loaded mile and the reduced employee expense of compensating only one driver. We
expect operating statistics and expenses to shift with the mix of single and
team operations.
Page 12
We are currently undertaking an intense evaluation of the freight in what we
call "in-between" movements. In-between movements generally have lengths of haul
between 510 and 800 miles. They are longer than one-day regional moves but not
long enough for expedited team service or two full days with a single driver. In
many instances, the revenue we have generated from in-between movements has been
insufficient to generate the profitability we desire based on the amount of time
the tractor and driver are committed to the load. Accordingly, we are examining
each in-between movement and are negotiating with customers to raise rates,
obtain more favorable loads, or cease hauling the in-between loads. During our
most recent quarter, these in-between movements represented approximately one
quarter of our total loads, and we believe they have been significantly less
profitable than our longer lengths of haul. Based on the initial results of
these efforts, we believe that we have significant opportunities to improve our
profitability as we continue to focus on our in-between loads.
The trucking industry has experienced significant increases in operating costs
over the past three years. The main factors for the industry as well as for us
have been an increased annual cost of tractors due to higher initial prices and
lower used truck values, higher maintenance expense due to operating an older
fleet, a higher overall cost of insurance and claims, and elevated fuel prices.
Other than those categories, our total expenses have remained relatively
constant or have declined as a percentage of revenue.
Looking forward, our profitability goal is to return to an operating ratio of
approximately 90%. We expect this to require additional improvements in revenue
per tractor per week to overcome expected additional cost increases of insurance
and claims, new revenue equipment (discussed below), and other general increases
in operating costs, as well as to expand our margins. Because a large percentage
of our costs are variable, changes in revenue per mile affect our profitability
to a greater extent than changes in miles per tractor.
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 and in June 2003 we entered
into a trade-in agreement with an equipment manufacturer with trade-in values
which approximate the expected disposition value.
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 units being replaced. By
the time the entire fleet is converted, anticipated in 2004, we expect the total
increase in expense to be approximately one and one-half cent pre-tax per mile,
excluding cost of financing. The timing of these expenses could be affected in
future periods, because we are in the process of changing our tractor trade
cycle from a period of approximately four years to three years. 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
transitioning from approximately four years back to three years, we have been
purchasing the leased tractors at the expiration of the lease term, although
there is no commitment to purchase the tractors. The first trailer leases expire
in 2005, and we have not determined whether to purchase trailers at the end of
these leases. In April 2003, we entered into a sale-leaseback arrangement
covering approximately 1,266 of our trailers. This arrangement is more fully
described below.
Independent contractors (owner operators) provide a tractor and a driver and are
responsible for all operating expenses in exchange for a fixed payment per mile.
We do not have the capital outlay of purchasing the tractor. The payments to
independent contractors and the financing of equipment under operating leases
are recorded in revenue equipment rentals and purchased transportation. Expenses
associated with owned equipment, such as interest and depreciation, are not
incurred, and for independent contractor tractors, driver compensation, fuel,
and other expenses are not incurred. Because obtaining equipment from
independent contractors and under operating leases effectively shifts financing
expenses from interest to "above the line" operating expenses, we evaluate our
efficiency using net margin rather than operating ratio.
Page 13
Freight revenue (total revenue less fuel surcharge and accessorial revenue)
excludes $8.2 million and $5.9 million of fuel and accessorial surcharge revenue
in the three months ended September 30, 2003 and 2002, respectively. In the nine
months ended September 30, 2003 and 2002, freight revenue excludes $26.6 million
and $14.6 million of fuel and accessorial surcharge revenue, respectively. For
comparison purposes in the table below, we use freight revenue when discussing
changes as a percentage of revenue. We believe excluding these sometimes
volatile sources 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 Nine Months Ended
September 30, September 30,
----------------------------------- ------------------------------
2003 2002 2003 2002
------------------- -------------- -------------- ---------------
Freight revenue (1) 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Salaries, wages, and related expenses (1) 39.3 39.5 39.8 40.8
Fuel expense (1) 14.6 15.2 15.2 15.4
Operations and maintenance (1) 6.9 7.5 7.2 7.0
Revenue equipment rentals and purchased
transportation 13.5 10.9 12.4 11.0
Operating taxes and licenses 2.4 2.3 2.6 2.6
Insurance and claims 6.0 5.8 6.4 5.7
Communications and utilities 1.4 1.2 1.3 1.3
General supplies and expenses 2.6 2.6 2.6 2.7
Depreciation and amortization (2) 7.2 8.5 7.7 9.3
------------------- -------------- -------------- ---------------
Total operating expenses 93.9 93.5 95.2 95.8
------------------- -------------- -------------- ---------------
Operating income 6.1 6.5 4.8 4.2
Other (income) expense, net 0.2 1.2 0.4 1.2
------------------- -------------- -------------- ---------------
Income before income taxes 5.9 5.3 4.4 3.0
Income tax expense 3.0 2.6 2.4 1.8
------------------- -------------- -------------- ---------------
Net income 2.9% 2.7% 2.0% 1.2%
=================== ============== ============== ===============
(1) Freight revenue is total revenue less fuel surcharge and accessorial
revenue. In this table, fuel surcharge and other accessorial revenue are
shown netted against the appropriate expense category (Salaries, wages, and
related expenses, $1.5 million and $1.9 million in the three months ended
September 30, 2003, and 2002, respectively; Fuel expense, $6.2 million and
$3.5 million in the three months ended September 30, 2003, and 2002,
respectively; Operations and maintenance, $0.5 million and $0.6 million in
the three months ended September 30, 2003, and 2002, respectively.
Salaries, wages, and related expenses, $4.8 million and $5.1 million in the
nine months ended September 30, 2003, and 2002, respectively; Fuel expense,
$20.2 million and $8.0 million in the nine months ended September 30, 2003,
and 2002, respectively; Operations and maintenance, $1.5 million in the
nine months ended September 30, 2003, and 2002.)
(2) Includes a $3.3 million pre-tax impairment charge or 0.8% of revenue in the
nine months ended September 30, 2002.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2003 TO THREE MONTHS ENDED
SEPTEMBER 30, 2002
For the quarter ended September 30, 2003, total revenue increased $5.3 million,
or 3.7%, to $146.5 million, from $141.2 million in the 2002 period. Freight
revenue excludes $8.2 million of fuel and accessorial surcharge revenue in the
2003 period and $5.9 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.
Page 14
Freight revenue (total revenue less fuel surcharge and accessorial revenue)
increased $3.0 million, or 2.2%, to $138.2 million in the three months ended
September 30, 2003, from $135.3 million in the same period of 2002. Revenue per
tractor per week increased to $2,927 in the 2003 period from $2,819 in the 2002
period, primarily attributable to a 2.8% increase in miles per tractor and a
1.9% increase in rate per loaded mile, which were partially offset by an
increase in non revenue miles. Weighted average tractors decreased to 3,584 in
the 2003 period from 3,639 in the 2002 period. 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 $1.5
million in the 2003 period and $1.9 million in the 2002 period, increased $0.9
million, or 1.7%, to $54.4 million in the 2003 period, from $53.5 million in the
2002 period. As a percentage of freight revenue, salaries, wages, and related
expenses decreased to 39.3% in the 2003 period, from 39.5% in the 2002 period.
Driver pay decreased to 27.2% of freight revenue in the 2003 period from 27.8%
of freight revenue in the 2002 period principally because of a decline in the
percentage of revenue generated by company trucks as a percentage of the total
revenue generated by all trucks, including independent contractors. Our payroll
expense for employees other than over the road drivers increased to 7.5% of
freight revenue in the 2003 period from 7.3% 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 approximately 5.8%
of freight revenue in the 2003 and 2002 periods. As a percentage of freight
revenue, salaries, wages, and related expenses was impacted in the current
quarter in part by an approximately $723,000 claim relating to a natural gas
explosion in our Indianapolis terminal that injured four employees, which was
partially offset by favorable workers' compensation experience otherwise.
Fuel expense, net of fuel surcharge revenue of $6.2 million in the 2003 period
and $3.5 million in the 2002 period, decreased $0.4 million, or 1.7%, to $20.2
million in the 2003 period, from $20.6 million in the 2002 period. As a
percentage of freight revenue, net fuel expense decreased to 14.6% in the 2003
period from 15.2% in the 2002 period. Fuel prices averaged approximately $0.08
per gallon higher in the 2003 period compared to the 2002 period which resulted
in approximately $2.2 million additional fuel expense. However, fuel surcharges
amounted to $0.056 per revenue mile in the 2003 period compared to $0.033 per
loaded mile in the 2002 period, which more than offset the increased fuel
expense. 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 September 30, 2003.
Operations and maintenance, net of accessorial revenue of $0.5 million in the
2003 period and $0.6 million in the 2002 period, consisting primarily of vehicle
maintenance, repairs and driver recruitment expenses, decreased $0.5 million to
$9.6 million in the 2003 period from $10.1 in the 2002 period. As a percentage
of freight revenue, operations and maintenance decreased to 6.9% in the 2003
period from 7.5% in the 2002 period. We believe this decrease is due to a
reduction in the average age of our tractor fleet to 24.5 months at September
2003 from 30.1 months as of September 2002.
Revenue equipment rentals and purchased transportation increased $3.9 million,
or 26.7%, to $18.6 million in the 2003 period, from $14.7 million in the 2002
period. As a percentage of freight revenue, revenue equipment rentals and
purchased transportation expense increased to 13.5% in the 2003 period from
10.9% in the 2002 period. The increase is due principally to two factors. First,
payments to independent contractors increased $1.2 million to $11.7 million in
the 2003 period from $10.5 million in the 2002 period, mainly due to an increase
in the independent contractor fleet to an average of 396 during the third
quarter of 2003 versus an average of 362 in the third quarter of 2002. Second,
the revenue equipment rental expense increased $2.7 million, or 64.7%, to $6.9
million in the 2003 period, from $4.2 million in the 2002 period. As of
September 30, 2003, we had financed approximately 910 tractors and 4,560
trailers under operating leases as compared to 636 tractors and 2,631 trailers
under operating leases as of September 30, 2002. On April 14, 2003, we entered
into a sale-leaseback transaction involving approximately 1,266 dry van
trailers. We sold the trailers to a finance company for approximately $15.6
million in cash and leased the trailers back under three year walk away leases.
The approximately $0.3 million gain on the sale-leaseback transaction will be
amortized over the life of the lease. Also in April 2003, we entered into an
agreement with a finance company to sell approximately 2,585 dry van trailers
for approximately $20.5 million in cash and to lease 3,600 model year 2004 dry
van trailers over the next twelve months. The leases on the new trailers are
seven year walk away leases. The approximately $2.0 million loss on the dry van
transaction will be recognized with additional
Page 15
depreciation expense from the date of the transaction until the units are sold.
Our revenue equipment rental expense is expected to increase in the future to
reflect these transactions. We will no longer recognize depreciation and
interest expense with respect to these trailers or tractors. In addition, in
September 2003, we entered into an agreement with Volvo for the lease with an
option to purchase of up to 500 new tractors, with these units being leased
under 39 month walk away leases.
Operating taxes and licenses increased $0.2 million, or 5.6%, to $3.3 million in
the 2003 period, from $3.2 million in the 2002 period. As a percentage of
freight revenue, operating taxes and licenses remained essentially constant at
2.4% in the 2003 period and 2.3% 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
$0.4 million, or 5.1%, to $8.2 million in the 2003 period from $7.8 million in
the 2002 period. As a percentage of freight revenue, insurance and claims
remained relatively constant at 6.0% in the 2003 period and 5.8% in the 2002
period. Although the percentage of freight revenue remained relatively constant
for the 2002 and 2003 quarters, this expense has increased greatly since 2001.
The increase is a result of an industry-wide increase in insurance rates, which
we addressed by adopting an insurance program with significantly higher
deductible exposure, and unfavorable accident experience. Under our current
casualty program, we generally are self-insured for personal injury and property
damage claims for amounts up to $2.0 million per occurrence for the first $5.0
million of exposure. However, our insurance policy also provides for an
additional $2.0 million self-insured aggregate amount, with a limit of $1.0
million per occurrence until the $2.0 million aggregate threshold is reached.
For example, if we were to experience during the policy year three separate
personal injury and property damage claims each resulting in exposure of $4.0
million, we would be self-insured for $3.0 million with respect to each of the
first two claims, and for $2.0 million with respect to the third claim and any
subsequent claims during the policy year. In addition to amounts for which we
are self-insured in the primary $5.0 million layer, we self-insure for the first
$2.0 million in the layer from $5.0 million to $20.0 million, which is our
excess coverage limit. We are also self-insured for cargo loss and damage claims
for amounts up to $1.0 million per occurrence. We maintain a workers'
compensation plan and group medical plan for our employees with a deductible
amount of $1.0 million for each workers' compensation claim and a deductible
amount of $250,000 for each group medical claim. Claims in excess of these
retention levels are covered by insurance 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 increased $0.3 million, or 19.2%, to $1.9
million in the 2003 period, from $1.6 million in the 2002 period, principally
due to increased expense associated with replacement parts for the satellite
units used in our revenue equipment. As a percentage of freight revenue,
communications and utilities increased to 1.4% in the 2003 period from 1.2% in
the 2002 period.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses remained essentially constant at $3.5 million in
the 2003 period and $3.6 million in the 2002 period. As a percentage of freight
revenue, general supplies and expenses remained essentially constant at 2.6%.
Depreciation and amortization, consisting primarily of depreciation of revenue
equipment, decreased $1.5 million, or 13.1%, to $10.0 million in the 2003 period
from $11.5 million in the 2002 period. As a percentage of freight revenue,
depreciation and amortization decreased to 7.2% in the 2003 period from 8.5% in
the 2002 period. The decrease is the result of several transactions mentioned in
the revenue equipment rentals and purchased transportation section above. On
April 14, 2003, we entered into a sale-leaseback transaction involving
approximately 1,266 dry van trailers. We sold the trailers to a finance company
for approximately $15.6 million in cash and leased the trailers back under three
year walk away leases. The approximately $0.3 million gain on the sale-leaseback
transaction will be amortized over the life of the lease. Also in April 2003, we
entered into an agreement with a finance company to sell approximately 2,585 dry
van trailers for approximately $20.5 million in cash and to lease 3,600 model
year 2004 dry van trailers over the next twelve months. The leases on the new
trailers are seven year walk away leases. The approximately $2.0 million loss on
the dry van transaction will be recognized with additional depreciation expense
from the date of the transaction until the units are sold. Our revenue equipment
Page 16
rental expense is expected to increase in the future to reflect these
transactions. We will no longer recognize depreciation and interest expense with
respect to these trailers or tractors. The monthly cost of the lease payments
for both of these transactions will be higher than the cost of the depreciation
and interest expense; however there will be no residual risk of loss at
disposition. We expect our annual cost of tractor and trailer ownership and/or
leasing to increase in future periods. The increase is expected to result from a
combination of higher initial prices of new equipment, lower resale values for
used equipment, and increased depreciation/lease payments on some of our
existing equipment over their remaining lives in order to better match expected
book values or lease residual values with market values at the equipment
disposal date. To the extent equipment is leased under operating leases, the
amounts will be reflected in revenue equipment rentals and purchased
transportation. To the extent equipment is owned or obtained under capitalized
leases, the amounts will be reflected as depreciation expense and interest
expense. Those expense items will fluctuate with changes in the percentage of
our equipment obtained under operating leases versus owned and under capitalized
leases.
Depreciation and amortization expense is net of any gain or loss on the disposal
of tractors and trailers. Gain on the disposal of revenue equipment was
approximately $0.7 million in the 2003 period compared to a loss of $0.3 million
in the 2002 period. Amortization expense relates to deferred debt costs incurred
and covenants not to compete from five acquisitions. Goodwill amortization
ceased beginning January 1, 2002, in accordance with SFAS No. 142, and we
evaluate goodwill and certain intangibles for impairment, annually. During the
second quarter of 2003 and 2002, we tested our goodwill for impairment and found
no impairment.
Other expense, net, decreased $1.3 million, or 84.6%, to $0.2 million in the
2003 period, from $1.6 million in the 2002 period. As a percentage of freight
revenue, other expense decreased to 0.2% in the 2003 period from 1.2% in the
2002 period. Included in the other expense category are interest expense,
interest income, and pre-tax non-cash gains and losses related to the accounting
for interest rate derivatives under SFAS No. 133. Interest expense was down $0.3
million, or 38.0% to $0.5 million in the 2003 period from $0.9 million in the
2002 period due to a 38.9% reduction in balance sheet indebtedness.
Additionally, the 2003 period included a $0.2 million gain related to the SFAS
No. 133 adjustment versus a loss of $0.7 million in the 2002 period.
Our income tax expense was $4.2 million and $3.6 million in the 2003 and 2002
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem, our
tax rate will fluctuate in future periods as income fluctuates.
Primarily as a result of the factors described above, net income increased $0.4
million, or 12.1%, to $4.1 million in the 2003 period from $3.6 million in the
2002 period. As a result of the foregoing, our net margin improved to 2.9% in
the 2003 period from 2.7% in the 2002 period.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2003 TO NINE MONTHS ENDED
SEPTEMBER 30, 2002
For the nine months ended September 30, 2003, total revenue increased $12.5
million, or 3.0%, to $430.3 million, from $417.8 million in the 2002 period.
Freight revenue excludes $26.6 million of fuel and accessorial surcharge revenue
in the 2003 period and $14.6 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)
increased $0.6 million, or 0.1%, to $403.7 million in the nine months ended
September 30, 2003, from $403.1 million in the same period of 2002. Revenue per
tractor per week increased to $2,818 in the 2003 period from $2,796 in the 2002
period, primarily attributable to a 2.3% increase in rate per loaded mile, which
was partially offset by a 0.7% decrease in miles per tractor and an increase in
non revenue miles. Weighted average tractors decreased to 3,665 in the 2003
period from 3,679 in the 2002 period. Due to a weak freight environment, we have
elected to constrain the size of our tractor fleet until fleet production and
profitability improve.
Page 17
Salaries, wages, and related expenses, net of accessorial revenue of $4.8
million in the 2003 period and $5.1 million in the 2002 period, decreased $4.1
million, or 2.5%, to $160.5 million in the 2003 period, from $164.6 million in
the 2002 period. As a percentage of freight revenue, salaries, wages, and
related expenses decreased to 39.8% in the 2003 period, from 40.8% 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 7.4% of freight
revenue in the 2003 period from 7.1% of freight revenue in the 2002 period due
to growth in headcount and a larger number of local drivers in the dedicated
fleet. Health insurance, employer paid taxes, workers' compensation, and other
employee benefits decreased to 6.1% of freight revenue in the 2003 period from
6.5% of freight revenue in the 2002 period, mainly due to improving claims
experience in the Company's workers' compensation plan. As a percentage of
freight revenue, salaries, wages, and related expenses was impacted in the
current quarter in part by an approximately $723,000 claim relating to a natural
gas explosion in our Indianapolis terminal that injured four employees, which
was partially offset by favorable workers' compensation experience otherwise.
Fuel expense, net of fuel surcharge revenue of $20.2 million in the 2003 period
and $8.0 million in the 2002 period, decreased $0.7 million, or 1.1%, to $61.5
million in the 2003 period, from $62.2 million in the 2002 period. As a
percentage of freight revenue, net fuel expense decreased slightly to 15.2% in
the 2003 period from 15.4% in the 2002 period. Fuel prices have on average been
$0.21 per gallon higher in the 2003 period as compared to the 2002 period which
resulted in approximately $10.9 million of additional fuel expense. However,
fuel surcharges amounted to $0.062 per loaded mile in the 2003 period compared
to $0.024 per loaded mile in the 2002 period, which more than offset the
increased fuel expense. 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 September 30, 2003.
Operations and maintenance, net of accessorial revenue of $1.5 million in the
2003 and 2002 periods, consisting primarily of vehicle maintenance, repairs and
driver recruitment expenses, increased $0.6 million, or 2.2%, to $28.9 million
in the 2003 period, from $28.3 million in the 2002 period. As a percentage of
freight revenue, operations and maintenance increased slightly to 7.2% in the
2003 period from 7.0 % in the 2002 period. We extended the trade cycle on our
tractor fleet from three years to four years in 2001, which resulted in an
increase in the number of required repairs, during the first half of 2003. We
are in the process of changing our tractor trade cycle back to a period of
approximately three years.
Revenue equipment rentals and purchased transportation increased $5.6 million,
or 12.7%, to $50.0 million in the 2003 period, from $44.4 million in the 2002
period. As a percentage of freight revenue, revenue equipment rentals and
purchased transportation expense increased to 12.4% in the 2003 period from
11.0% in the 2002 period. The independent contractor fleet increased slightly to
an average of 374 units in the 2003 period compared to an average of 350 units
in the 2002 period, which resulted in purchased transportation expense
increasing $1.3 million to $32.0 million in the 2003 period versus $30.7 million
in the 2002 period. Revenue equipment rental expense increased $4.3 million, or
31.8%, to $18.0 million in the 2003 period, from $13.7 million in the 2002
period. As of September 30, 2003, we had financed approximately 910 tractors and
4,560 trailers under operating leases as compared to 636 tractors and 2,631
trailers under operating leases as of September 30, 2002. On April 14, 2003, we
entered into a sale-leaseback transaction involving approximately 1,266 dry van
trailers. We sold the trailers to a finance company for approximately $15.6
million in cash and leased the trailers back under three year walk away leases.
The approximately $0.3 million gain on the sale-leaseback transaction will be
amortized over the life of the lease. Also in April 2003, we entered into an
agreement with a finance company to sell approximately 2,585 dry van trailers
for approximately $20.5 million in cash and to lease 3,600 model year 2004 dry
van trailers over the next twelve months. The leases on the new trailers are
seven year walk away leases. The approximately $2.0 million loss on the dry van
transaction will be recognized with additional depreciation expense from the
date of the transaction until the units are sold. Our revenue equipment rental
expense is expected to increase in the future to reflect these transactions. We
will no longer recognize depreciation and interest expense with respect to these
trailers or tractors. In addition, in September 2003, we entered into an
agreement with Volvo for the lease with an option to purchase of up to 500 new
tractors, with these units being leased under 39 month walk away leases.
Page 18
Operating taxes and licenses increased slightly to $10.5 million in the 2003
period from $10.4 in the 2002 period. As a percentage of freight revenue,
operating taxes and licenses remained essentially constant at 2.6% in the 2003
and 2002 periods.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, increased
$3.0 million, or 13.1%, to $25.8 million in the 2003 period from $22.8 million
in the 2002 period. As a percentage of freight revenue, insurance and claims
increased to 6.4% in the 2003 period from 5.7% in the 2002 period. The increase
is a result of an industry-wide increase in insurance rates, which we addressed
by adopting an insurance program with significantly higher deductible exposure,
and unfavorable accident experience. Under our current casualty program, we
generally are self-insured for personal injury and property damage claims for
amounts up to $2.0 million per occurrence for the first $5.0 million of
exposure. However, our insurance policy also provides for an additional $2.0
million self-insured aggregate amount, with a limit of $1.0 million per
occurrence until the $2.0 million aggregate threshold is reached. For example,
if we were to experience during the policy year three separate personal injury
and property damage claims each resulting in exposure of $4.0 million, we would
be self-insured for $3.0 million with respect to each of the first two claims,
and for $2.0 million with respect to the third claim and any subsequent claims
during the policy year. In addition to amounts for which we are self-insured in
the primary $5.0 million layer, we self-insure for the first $2.0 million in the
layer from $5.0 million to $20.0 million, which is our excess coverage limit. We
are also self-insured for cargo loss and damage claims for amounts up to $1.0
million per occurrence. We maintain a workers' compensation plan and group
medical plan for our employees with a deductible amount of $1.0 million for each
workers' compensation claim and a deductible amount of $250,000 for each group
medical claim. Claims in excess of these retention levels are covered by
insurance which management considers as 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 increased $0.2 million, or 4.0%, to $5.3
million in the 2003 period from $5.1 million in the 2002 period. As a percentage
of freight revenue, communications and utilities remained essentially constant
at 1.3% in the 2003 and 2002 periods.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses, decreased $0.2 million, or 1.9%, to $10.5 million
in the 2003 period, from $10.7 million in the 2002 period. As a percentage of
freight revenue, general supplies and expenses remained essentially constant at
2.6% in the 2003 period and 2.7% in the 2002 period.
Depreciation, amortization and impairment charge, consisting primarily of
depreciation of revenue equipment, decreased $6.3 million, or 16.7%, to $31.2
million in the 2003 period from $37.5 million in the 2002 period. As a
percentage of freight revenue, depreciation and amortization decreased to 7.7%
in the 2003 period from 9.3% in the 2002 period. The decrease in part resulted
because we did not have an impairment charge in the 2003 period, as we did in
the 2002 period. In addition, we executed the April 2003 sale-leaseback
transaction, and improved the results of our sale of equipment. These factors
were partially offset by increased depreciation expense on our 2001 tractors and
on our new tractors. In the 2002 period, we recognized a pre-tax charge of
approximately $3.3 million to reflect an impairment in tractor values. See
"Impairment of Equipment and Change in Estimated Useful Lives," in Note 6 to the
Consolidated Financial Statements, for additional information. On April 14,
2003, we entered into a sale-leaseback transaction involving approximately 1,266
dry van trailers. We sold the trailers to a finance company for approximately
$15.6 million in cash and leased the trailers back under three year walk away
leases. The approximately $0.3 million gain on the sale-leaseback transaction
will be amortized over the life of the lease. Also in April 2003, we entered
into an agreement with a finance company to sell approximately 2,585 dry van
trailers for approximately $20.5 million in cash and to lease 3,600 model year
2004 dry van trailers over the next twelve months. The leases on the new
trailers are seven year walk away leases. The approximately $2.0 million loss on
the dry van transaction will be recognized with additional depreciation expense
from the date of the transaction until the units are sold. Our revenue equipment
rental expense is expected to increase in the future to reflect these
transactions. We will no longer recognize depreciation and interest expense with
respect to these trailers or tractors. We expect our annual cost of tractor and
trailer ownership and/or leasing to increase in future periods. The increase
Page 19
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. Gains on the disposal of tractors and trailers were
approximately $0.9 million in the 2003 period compared to a loss of $1.7 million
in the 2002 period. Amortization expense relates to deferred debt costs incurred
and covenants not to compete from five acquisitions. Goodwill amortization
ceased beginning January 1, 2002, in accordance with SFAS No. 142, and we
evaluate goodwill and certain intangibles for impairment, annually. During the
second quarter of 2003 and 2002, we tested our goodwill for impairment and found
no impairment.
Other expense, net, decreased $3.7 million, or 71.3%, to $1.5 million in the
2003 period, from $5.1 million in the 2002 period. As a percentage of freight
revenue, other expense decreased to 0.4% in the 2003 period from 1.2% in the
2002 period. Included in the other expense category are interest expense,
interest income and pre-tax non-cash gains or losses related to the accounting
for interest rate derivatives under SFAS No. 133. Interest expense was down $1.0
million, or 36.3% to $1.8 million in the 2003 period from $2.8 million in the
2002 period due to a 38.9% reduction in balance sheet indebtedness.
Additionally, the 2003 period included a $0.2 million gain related to the SFAS
No. 133 adjustment versus a loss of $0.9 million in the 2002 period.
During the first quarter of 2002, we prepaid the remaining $20 million in
previously outstanding 7.39% ten year, private placement notes with borrowings
from the Credit Agreement. In conjunction with the prepayment of the borrowings,
we recognized an approximate $1.4 million pre-tax charge to reflect the early
extinguishment of debt. The losses related to the write off of debt issuance and
other deferred financing costs and a premium paid on the retirement of the
notes. Upon adoption of SFAS 145 in 2003, we reclassified the charge and it is
no longer classified as an extraordinary item.
Our income tax expense was $9.9 million and $7.1 million in the 2003 and 2002
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem, our
tax rate will fluctuate in future periods as income fluctuates.
Primarily as a result of the factors described above, net income increased $3.1
million, or 63.5%, to $8.1 million in the 2003 period, from $4.9 million in the
2002 period. As a result of the foregoing, our net margin increased to 2.0% in
the 2003 period from 1.2% in the 2002 period.
LIQUIDITY AND CAPITAL RESOURCES
Our business requires significant capital investments. We historically have
financed our capital requirements with borrowings under a line of credit, cash
flows from operations and long-term operating leases. Our primary sources of
liquidity at September 30, 2003, were funds provided by operations, proceeds
under the Securitization Facility (as defined below), borrowings under our
primary credit agreement, which had maximum available borrowing of $100.0
million at September 30, 2003 (the "Credit Agreement"), the April 2003 trailer
transactions, 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 $49.7 million in the 2003 period
and $55.7 million in the 2002 period. Our primary sources of cash flow from
operations in the 2003 period were net income and depreciation and amortization.
Depreciation and amortization in the 2002 period included a $3.3 million pre-tax
impairment charge.
Net cash used in investing activities was $11.3 million in the 2003 period and
was for the purchase of revenue equipment. The cash used in the 2002 period,
$33.4 million, related to the financing of tractors, which were
Pagea 20
previously financed through operating leases, using proceeds from the Credit
Agreement. We expect capital expenditures, primarily for revenue equipment (net
of trade-ins), to be $40.0 to $45.0 million in 2003, exclusive of acquisitions,
as we begin a transition back to a three-year trade cycle for tractors and a
seven year trade cycle on dry van trailers. The reduction from the first quarter
estimate of $80.0 million is primarily due to entering into operating leases.
Net cash used in financing activities was $36.6 million in the 2003 period, and
$21.6 million in the 2002 period. During the nine month period ended September
30, 2003, we reduced outstanding balance sheet debt by $38.9 million.
Approximately $15.6 million of this reduction was from proceeds of the April
2003 sale-leaseback transaction. At September 30, 2003, we had outstanding debt
of $44.7 million, primarily consisting of $41.4 million in the Securitization
Facility, $2.0 million 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 1.1% 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 incurred a $0.9 million after-tax extraordinary item ($1.4 million pre-tax)
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 (the applicable margin was 0.875% at
September 30, 2003). At September 30, 2003, the Company had only base rate
borrowings outstanding on which the interest rate was 2.4%. The Credit Agreement
is guaranteed by the Company and all of the Company's subsidiaries except CVTI
Receivables Corp. and Volunteer Insurance Limited.
At December 31, 2002, the Credit Agreement had a maximum borrowing limit of
$120.0 million. When the facility was extended in February 2003, the borrowing
limit was reduced to $100.0 million with an accordion feature which permits an
increase up to a borrowing limit of $140.0 million. Borrowings related to
revenue equipment are limited to the lesser of 90% of net book value of revenue
equipment or the maximum borrowing limit. Letters of credit were limited to an
aggregate commitment of $20.0 million at December 31, 2002, and were increased
to a limit of $50.0 million in February 2003. The Credit Agreement includes a
"security agreement" such that the Credit Agreement may be collateralized by
virtually all of our assets if a covenant violation occurs. A commitment fee,
that is adjusted quarterly between 0.15% and 0.25% per annum based on cash flow
coverage, is due on the daily unused portion of the Credit Agreement. As of
September 30, 2003, we had borrowings under the Credit Agreement in the amount
of $2.0 million, on which the interest rate was 2.4%.
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
September 30, 2003, there were $41.4 million in proceeds received. The
transaction did not meet the criteria for sale treatment under Financial
Accounting Standard No. 140 and is reflected as a secured borrowing in the
financial statements.
The Credit Agreement and Securitization Facility contain certain restrictions
and covenants relating to, among other things, dividends, tangible net worth,
cash flow, acquisitions and dispositions, and total indebtedness. All of these
agreements are cross-defaulted. The Company is in compliance with these
agreements as of September 30, 2003.
Contractual Obligations and Commitments - In April 2003, we engaged in a
sale-leaseback transaction involving approximately 1,266 dry van trailers. We
sold the trailers to a finance company for approximately $15.6 million in cash
and leased the trailers back under three year walk away leases. The resulting
gain was approximately $0.3
Page 21
million and will be amortized over the life of the lease. The monthly cost of
the lease payments will be higher than the cost of the depreciation and interest
expense; however, there will be no residual risk of loss at disposition.
In April 2003, we also entered into an agreement with a finance company to sell
approximately 2,585 dry van trailers and to lease an additional 3,600 model year
2004 dry van trailers over the next 12 months. We sold the trailers, which
consist of model year 1991 to model year 1997 dry van trailers, to the finance
company for approximately $20.5 million in cash and leased the 3,600 dry van
trailers back under seven year walk away leases. Depending on the delivery
schedule of the trade equipment, we will recognize either additional
depreciation expense or losses on the disposal of equipment up to approximately
$2.0 million. The monthly cost of the lease payments will be higher than the
cost of the depreciation and interest expense; however there will be no residual
risk of loss at disposition.
We had commitments outstanding related to equipment, debt obligations, and
diesel fuel purchases as of January 1, 2003. These purchases are expected to be
financed by debt, proceeds from sales of existing equipment, and cash flows from
operations. We generally have the option to cancel our new tractor and some
trailer deliveries with a specified amount of notice.
The following table sets forth our contractual cash obligations and commitments
as of January 1, 2003.
Payments Due By Period There-
(in thousands) Total 2003 2004 2005 2006 2007 after
------------ ----------- ----------- ------------ ----------- ----------- ------------
Long Term Debt $ 1,300 $ - $ 1,300 $ - $ - $ - $ -
Short Term Debt (1) 82,230 82,230 - - - - -
Operating Leases 62,308 21,017 12,502 10,852 6,823 4,665 6,449
Lease residual value 56,802 25,699 - 9,910 3,553 5,590 12,050
guarantees
Purchase Obligations:
Diesel fuel (2) 52,477 48,020 4,457 - - - -
Equipment (3) 85,986 85,986 - - - - -
------------ ----------- ----------- ------------ ----------- ----------- ------------
Total Contractual Cash
Obligations $341,103 $262,952 $18,259 $20,762 $10,376 $10,255 $18,499
============ =========== =========== ============ =========== =========== ============
(1) In the 2003 period, approximately $39 million of this amount represents
proceeds drawn under our Securitization Facility. The net proceeds under
the Securitization Facility are required to be shown as a current
liability because the term, subject to annual renewals, is 364 days. We
expect the Securitization Facility to be renewed in December 2003.
(2) This amount represents volume purchase commitments for the 2003 period
through our truck stop network. We estimate that this amount represents
approximately one-half of our fuel needs for the 2003 period.
(3) Amount reflects gross purchase price of obligations if all leased
equipment is purchased.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make decisions
based upon estimates, assumptions, and factors we consider as relevant to the
circumstances. Such decisions include the selection of applicable accounting
principles and the use of judgment in their application, the results of which
impact reported amounts and disclosures. Changes in future economic conditions
or other business circumstances may affect the outcomes of our estimates and
assumptions. Accordingly, actual results could differ from those anticipated. A
summary of the significant accounting policies
Page 22
followed in preparation of the financial statements is contained in Note 1 of
the financial statements contained in the Company's annual report on Form 10-K
for the fiscal year ended December 31, 2002. Other footnotes describe various
elements of the financial statements and the assumptions on which specific
amounts were determined.
Our critical accounting policies include the following:
Property and Equipment - Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. We depreciate revenue
equipment over three to ten years with salvage values ranging from 3% to 51%. We
continually evaluate the salvage value, useful life, and annual depreciation of
tractors and trailers annually based on the current market environment and on
our recent experience with disposition values. Any change could result in
greater or lesser annual expense in the future. Gains or losses on disposal of
revenue equipment are included in depreciation in the statements of income.
Impairment of Long-Lived Assets - We evaluate the carrying value of long-lived
assets by analyzing the operating performance and future cash flows for those
assets, whenever events or changes in circumstances indicate that the carrying
amounts of such assets may not be recoverable. We adjust the carrying value of
the underlying assets if the sum of the expected cash flows is less than the
carrying value. Impairment can be impacted by our projection of future cash
flows, the level of cash flows and salvage values, the methods of estimation
used for determining fair values and the impact of guaranteed residuals.
Insurance and Other Claims - Our insurance program for liability, property
damage, and cargo loss and damage, involves self-insurance with high risk
retention levels. Under our current casualty program, we generally are
self-insured for personal injury and property damage claims for amounts up to
$2.0 million per occurrence for the first $5.0 million of exposure. However, our
insurance policy also provides for an additional $2.0 million self-insured
aggregate amount, with a limit of $1.0 million per occurrence until the $2.0
million aggregate threshold is reached. For example, if we were to experience
during the policy year three separate personal injury and property damage claims
each resulting in exposure of $4.0 million, we would be self-insured for $3.0
million with respect to each of the first two claims, and for $2.0 million with
respect to the third claim and any subsequent claims during the policy year. In
addition to amounts for which we are self-insured in the primary $5.0 million
layer, we self-insure for the first $2.0 million in the layer from $5.0 million
to $20.0 million, which is our excess coverage limit. We are also self-insured
for cargo loss and damage claims for amounts up to $1.0 million per occurrence.
We maintain a workers' compensation plan and group medical plan for our
employees with a deductible amount of $1.0 million for each workers'
compensation claim and a deductible amount of $250,000 for each group medical
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, or from November
2002 to March 2003 exceeded $4.0 million, 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.
Lease Accounting - We lease a significant portion of our tractor and trailer
fleet using operating leases. Substantially all of the leases have residual
value guarantees under which we must insure that the lessor receives a
negotiated amount for the equipment at the expiration of the lease. In
accordance with SFAS No. 13, Accounting for Leases, the rental expense under
these leases is reflected as an operating expense under "revenue equipment
rentals and purchased transportation." To the extent the expected value at the
lease termination date is lower than the residual value guarantee, we accrue for
the difference over the remaining lease term. The estimated values at lease
termination involve management judgments. Operating leases are carried off
balance sheet in accordance with SFAS No. 13.
Page 23
INFLATION AND FUEL COSTS
Most of our operating expenses are inflation-sensitive, with inflation generally
producing increased costs of operations. During the past three years, the most
significant effects of inflation have been on revenue equipment prices and the
compensation paid to the drivers. Innovations in equipment technology and
comfort have resulted in higher tractor prices, and there has been an
industry-wide increase in wages paid to attract and retain qualified drivers. We
historically have limited the effects of inflation through increases in freight
rates and certain cost control efforts.
In addition to inflation, fluctuations in fuel prices can affect profitability.
Fuel expense comprises a larger percentage of revenue for us than many other
carriers because of our long average length of haul. Most of our contracts with
customers contain fuel surcharge provisions. Although we historically have been
able to pass through most long-term increases in fuel prices and taxes to
customers in the form of surcharges and higher rates, increases usually are not
fully recovered. Fuel prices have remained high throughout most of 2000, 2001,
and 2002, which has increased our cost of operating. The elevated level of fuel
prices has continued into 2003.
SEASONALITY
In the trucking industry, revenue generally decreases as customers reduce
shipments during the winter holiday season and as inclement weather impedes
operations. At the same time, operating expenses generally increase, with fuel
efficiency declining because of engine idling and weather creating more
equipment repairs. For the reasons stated, first quarter net income historically
has been lower than net income in each of the other three quarters of the year.
Our equipment utilization typically improves substantially between May and
October of each year because of the trucking industry's seasonal shortage of
equipment on traffic originating in California and our ability to satisfy some
of that requirement. The seasonal shortage typically occurs between May and
August because California produce carriers' equipment is fully utilized for
produce during those months and does not compete for shipments hauled by our dry
van operation. During September and October, business increases as a result of
increased retail merchandise shipped in anticipation of the holidays.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks from changes in (i) certain commodity
prices and (ii) certain interest rates on its debt.
COMMODITY PRICE RISK
Prices and availability of all petroleum products are subject to political,
economic, and market factors that are generally outside our control. Because our
operations are dependent upon diesel fuel, significant increases in diesel fuel
costs could materially and adversely affect our results of operations and
financial condition. Historically, we have been able to recover a portion of
long-term fuel price increases from customers in the form of fuel surcharges.
The price and availability of diesel fuel can be unpredictable as well as the
extent to which fuel surcharges could be collected to offset such increases. For
the nine months ended September 30, 2003, diesel fuel expenses net of fuel
surcharge represented 15.0% of our total operating expenses and 15.2% of freight
revenue. At September 30, 2003, we had no derivative financial instruments to
reduce our exposure to fuel price fluctuations.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
INTEREST RATE RISK
Our market risk is also affected by changes in interest rates. Historically, we
have used a combination of fixed rate and variable rate obligations to manage
our interest rate exposure. Fixed rate obligations expose us to the risk that
interest rates might fall. Variable rate obligations expose us to the risk that
interest rates might rise.
Our variable rate obligations consist of our Credit Agreement and our accounts
receivable Securitization Facility. Borrowings under the Credit Agreement,
provided there has been no default, are based on the banks' base rate, which
Page 24
floats daily, or LIBOR, which accrues 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 (the applicable margin was 0.875% at
September 30, 2003). During the first quarter of 2001, we entered into two $10
million notional amount interest rate swap agreements to manage the risk of
variability in cash flows associated with floating-rate debt. The swaps expire
January 2006 and March 2006. These derivatives are not designated as hedging
instruments under SFAS No. 133 and consequently are marked to fair value through
earnings, in other expense in the accompanying statement of operations. At
September 30, 2003, the fair value of these interest rate swap agreements was a
liability of $1.5 million. At September 30, 2003, we had variable, base rate
borrowings of $2.0 million outstanding under the Credit Agreement. Our
Securitization Facility carries a variable interest rate based on the commercial
paper rate plus an applicable margin of 0.41%. At September 30, 2003, borrowings
of $41.4 million had been drawn on the Securitization Facility. Assuming
variable rate borrowings under the Credit Agreement and Securitization Facility
at September 30, 2003 levels, a one percentage point increase in interest rates
would increase our annual interest expense by $434,000.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Exchange Act, the Company has carried out
an evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of the end of the period covered by this
report. This evaluation was carried out under the supervision and with the
participation of the Company's management, including its Chief Executive Officer
and its Chief Financial Officer. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our controls and procedures
were effective as of the end of the period covered by this report. There were no
changes in our internal control over financial reporting that occurred during
the period covered by this report that have materially affected or that are
reasonably likely to materially affect the Company's internal control over
financial reporting.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in the Company's
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include controls and procedures designed to ensure that information required to
be disclosed in Company reports filed under the Exchange Act is accumulated and
communicated to management, including the Company's Chief Executive Officer as
appropriate, to allow timely decisions regarding disclosures.
The Company has confidence in its internal controls and procedures.
Nevertheless, the Company's management, including the Chief Executive Officer
and Chief Financial Officer, does not expect that our disclosure procedures and
controls or our internal controls will prevent all errors or intentional fraud.
An internal control system, no matter how well-conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of such
internal controls are met. Further, the design of an internal control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all internal control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected.
Page 25
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
None
Items 2, 3, 4, Not applicable
and 5.
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.
31.1 # Certification of David R. Parker pursuant to Securities Exchange Act Rules 13a-14(a)
or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 # Certification of Joey B. Hogan pursuant to Securities Exchange Act Rules 13a-14(a) or
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 # Certification of David R. Parker and Joey B. Hogan pursuant to Securities Exchange
Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the
United States Code.
- ------------------------------------------------------------------------------------------------------------------------
References:
(1) Incorporated by reference from Form S-1, Registration No. 33-82978,
effective October 28, 1994.
# Filed herewith.
(b) A Form 8-K was filed on July 29, 2003 to report information regarding the
Company's press release announcing its second quarter financial and
operating results, and providing the transcript of the conference call
relating to same. A Form 8-K was filed on September 19, 2003 to report the
removal of an investment option under the Covenant Transport, Inc. Profit
Sharing & 401(k) Plan (the "Plan") and information regarding notification
of directors, officers, and Plan participants of the resulting blackout
period.
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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: October 27, 2003 /s/ Joey B. Hogan
--------------------------------
Joey B. Hogan
Executive Vice President and Chief Financial Officer,
in his capacity as such and on behalf of the issuer.