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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-24960
COVENANT TRANSPORT, INC.
(Exact name of registrant as specified in its charter)
Nevada 88-0320154
- ---------------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
400 Birmingham Highway
Chattanooga, Tennessee 37419
- ---------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 423/821-1212
------------
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to Section 12(g) of the Act: $0.01 Par Value
Class A Common Stock
--------------------
(Title of class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES [X] NO [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $97.0 million as of June 30, 2003 (based upon the
$17.16 per share closing price on that date as reported by Nasdaq). The
aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $139.1 million as of March 8, 2004 (based upon the
$17.00 per share closing price on that date as reported by Nasdaq). In making
this calculation the registrant has assumed, without admitting for any purpose,
that all executive officers, directors, and holders of more than 10% of a class
of outstanding common stock, and no other persons, are affiliates.
As of March 8, 2004, the registrant had 12,327,693 shares of Class A common
stock and 2,350,000 shares of Class B common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Materials from the registrant's definitive proxy statement for the 2004 annual
meeting of stockholders to be held on May 27, 2004 have been incorporated by
reference into Part III of this Form 10-K.
______________________________________
This report contains "forward-looking statements." These statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those anticipated. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Factors That May
Affect Future Results" for additional information and factors to be considered
concerning forward-looking statements.
2
PART I
ITEM 1. BUSINESS
References in this Annual Report to "we," "us," "our," or the "Company" or
similar terms refer to Covenant Transport, Inc. and its subsidiaries.
General
We are one of the ten largest truckload carriers in the United States measured
by revenue. We focus on longer lengths of haul in targeted markets where we
believe our service standards can provide a competitive advantage. We are a
major carrier for traditional truckload customers such as manufacturers and
retailers, as well as for transportation companies such as freight forwarders,
less-than-truckload carriers, and third-party logistics providers that require a
high level of service to support their businesses.
In our core long-haul business, we use the industry's largest fleet of tractors
operated by two-person driver teams to provide expedited transportation,
generally over distances from 1,500 to 2,500 miles. In this area, we offer
greater speed and reliability than rail or single-driver trucks at a lower cost
than air freight. We also operate a single driver fleet that concentrates on
expedited movements with an average length of haul of approximately 800 miles.
In both our single-driven and team-driven operations we have dedicated fleets,
which operate for the benefit of a single customer or on a defined route. This
part of our business has grown rapidly as we have expanded our participation in
the design, development, and execution of supply chain solutions for our
traditional truckload customers. In each of the past nine years, we have
provided 99% on-time performance to our customers. By targeting premium service
freight, we seek to obtain higher rates, build long-term service-based customer
relationships, and avoid competition from rail, intermodal, and trucking
companies that compete primarily on the basis of price.
Business Strategy
The key elements of our business strategy are:
Offer premium service. We offer just-in-time, transcontinental, express, and
other premium services to shippers with exacting transportation requirements.
Our service standards include transporting loads coast-to-coast in 72 hours,
meeting schedules with delivery windows as narrow as 15 minutes, and delivering
99% of all loads on-time which we have accomplished in each of the last nine
years. We target such premium service freight to obtain higher rates, build
long-term, service-based customer relationships, and avoid competition from
rail, intermodal, and trucking companies that compete primarily on the basis of
price.
Operate in targeted markets. We operate in targeted markets where our service
can provide a competitive advantage. Our primary market historically has been
expedited long-haul freight transportation predominantly using two-person driver
teams. Our industry-leading 1,200 driver teams can provide significantly faster,
more predictable service than rail, intermodal, or single-driver service over
long lengths of haul at a fraction of the cost of air freight. In addition, we
offer dedicated fleets, which operate for the benefit of a single customer or on
a defined route. This part of our business has grown rapidly as we have expanded
our participation in the design, development, and execution of supply chain
solutions for customers. We also offer long-haul refrigerated service that
targets premium temperature-controlled business mainly originating on the West
Coast. We believe that our concentration on longer lengths of haul and our large
capacity of driver teams differentiate us from competitors in our targeted
markets.
Focus on equipment utilization. We use a disciplined operating approach to
enhance asset utilization and deliver operating efficiencies. We seek to
continue to improve our asset utilization by adding freight within our existing
traffic lanes faster than adding new equipment capacity. We intend to grow our
fleet only when profit margins justify expansion. A high level of operational
discipline creates more predictable movements, reduces empty miles, and shortens
turn times between loads.
3
Seek partnerships with other transportation companies. A significant portion of
our business focuses on providing services to other transportation companies
that require a high level of service to support their operations. In 2003,
transportation providers, such as logistics companies, freight forwarders,
less-than-truckload companies, and deferred air freight providers, comprised the
largest market sector we served. We seek to grow by continuing to serve as a
partner, rather than a competitor, to other transportation providers.
Use technology to enhance operating efficiency. We have made significant
investments in technologies that reduce costs, afford a competitive advantage
with service-sensitive customers, and promote economies of scale. In particular,
we believe we are beginning to realize the benefits of freight optimization
software that allows us to more accurately analyze the profitability of each
customer, route, and load. We also use satellite-based tracking and
communication systems, document imaging, fuel routing software, and electronic
access to customer load information and electronic transmission of shipping
instructions.
In addition to these longer term business strategies, in 2003 we conducted an
intense evaluation of the freight in what we call "in-between" movements.
In-between movements generally have lengths of haul between 550 and 850 miles.
They are longer than one-day regional moves but not long enough for expedited
team service or two full days with a single driver. In many instances, 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 examined each in-between
movement and negotiated with our customers to raise rates, obtain more favorable
loads, or cease hauling the in-between loads. During the period of our
evaluation in 2003, these in-between movements represented approximately one
quarter of our total loads, and we believe they have been significantly less
profitable than our longer or shorter lengths of haul. Based on the initial
results of these efforts, we believe that we have significant opportunities to
improve our profitability over time as we continue to focus on our in-between
loads.
Customers and Operations
We operate throughout the United States and in parts of Canada and Mexico, with
substantially all of our revenue generated from within the United States. All of
our assets are domiciled in the United States, and for the past three years less
than one percent of our revenue has been generated in Canada and Mexico. The
largest part of our business, which comprised 71% of our 2003 revenue, is
medium-to-long haul dry van service that we provide by using single and
two-person driver teams. Our dedicated fleets, which serve a defined customer or
route, comprised 14% of our 2003 revenue. We also operate a long-haul
temperature-controlled business, which frequently hauls dry freight to the West
Coast and temperature-controlled freight to the East, and this portion of our
business comprised 15% of 2003 revenue. Part of this business is operated by our
subsidiary, Southern Refrigerated Transport, Inc. under its own trade name.
Our primary customers include manufacturers and retailers, as well as other
transportation companies. In 2003, our five largest customers were Con-Way
Transportation, Eagle Global Logistics, Emery Air Freight, Shaw Industries, and
Wal-Mart Stores. In the aggregate, subsidiaries of CNF, Inc. including Con-Way
Transportation and Emery Air Freight, accounted for approximately 11% of our
revenue in 2003 and 2002, and approximately 13% of our revenue in 2001.
We approach our operations as an integrated effort of marketing, customer
service, and fleet management. Our customer service and marketing personnel
emphasize both new account development and expanded service for current
customers. Customer service representatives provide day-to-day contact with
customers, while the sales force targets driver-friendly freight that will
increase lane density.
Fleet managers at each operations center plan load coverage according to
customer requirements and relay pick-up, delivery, routing, and fueling
instructions to our drivers. The fleet managers attempt to route most of our
trucks over selected operating lanes. We believe this assists us in balancing
traffic between eastbound and westbound movements, reducing empty miles, and
improving the reliability of delivery schedules.
4
We use proven technology, including freight optimization software that permits
us to perform sophisticated analyses of profitability and other factors on each
customer, route, and load. We installed the software in late 2000 and in 2001
began inputting and tracking data and customizing our analyses. We have begun to
realize the benefits of superior freight selection based on several months of
history.
We equip our tractors with a satellite-based tracking and communications system
that permits direct communication between drivers and fleet managers. We believe
that this system enhances our operating efficiency and improves customer service
and fleet management. This system also updates the tractor's position every 30
minutes, which allows us and our customers to locate freight and accurately
estimate pick-up and delivery times. We also use the system to monitor engine
idling time, speed, performance, and other factors that affect operating
efficiency.
As an additional service to customers, we offer electronic data interchange and
Internet-based communication for customer usage in tendering loads and accessing
information such as cargo position, delivery times, and billing information.
These services allow us to communicate electronically with our customers,
permitting real-time information flow, reductions or eliminations in paperwork,
and the employment of fewer clerical personnel. Since 1997, we have used a
document imaging system to reduce paperwork and enhance access to important
information.
Our operations generally follow the seasonal norm for the trucking industry.
Equipment utilization is usually at its highest from May to August, maintains
high levels through October, and generally decreases during the winter holiday
season and as inclement weather impedes operations.
Drivers and Other Personnel
Driver recruitment, retention, and satisfaction are essential to our success,
and we have made each of these factors a primary element of our strategy. We
recruit both experienced and student drivers as well as independent contractor
drivers who own and drive their own tractor and provide their services to us
under lease. We conduct recruiting and/or driver orientation efforts from four
of our locations and we offer ongoing training throughout our terminal network.
We emphasize driver-friendly operations throughout the Company. We have
implemented automated programs to signal when a driver is scheduled to be routed
toward home, and we assign fleet managers specific tractor units, regardless of
geographic region, to foster positive relationships between the drivers and
their principal contact with us.
We use driver teams in a substantial portion of our tractors. Driver teams
permit us to provide expedited service over our long average length of haul,
because driver teams are able to handle longer routes and drive more miles while
remaining within Department of Transportation ("DOT") safety rules. We believe
that these teams contribute to greater equipment utilization of the tractors
they drive than most carriers with predominately single drivers. The use of
teams, however, increases personnel costs as a percentage of revenue and the
number of drivers we must recruit. At December 31, 2003, teams operated
approximately 32% of our tractors. The single driver fleets operate fewer miles
per tractor and experience more empty miles but these factors are expected to be
offset by higher revenue per loaded mile and the reduced employee expense of
only one driver.
We are not a party to a collective bargaining agreement. At December 31, 2003,
we employed approximately 5,138 drivers and approximately 952 nondriver
personnel. At December 31, 2003, we also contracted with approximately 413
independent contractor drivers. We believe that we have a good relationship with
our personnel.
Revenue Equipment
We believe that operating high quality, late-model equipment contributes to
operating efficiency, helps us recruit and retain drivers, and is an important
part of providing excellent service to customers. Our historical policy has been
to operate our tractors while under warranty to minimize repair and maintenance
cost and reduce service interruptions caused by breakdowns. We also order most
of our equipment with uniform specifications to reduce our parts inventory and
facilitate maintenance. At December 31, 2003, our tractors had an average age of
approximately 19 months and our trailers had an average age of approximately 34
months. Approximately 82% of our trailers were dry vans and the remainder were
temperature-controlled vans.
5
We have taken delivery of our model year 2004 tractors from Freightliner and
expect to begin taking delivery of model year 2005 tractors shortly. The new
tractors are covered by trade back agreements that guarantee us a defined
trade-in value if we purchase a replacement tractor from Freightliner. The
combination of an increased price for the new tractors and a decreased trade-in
value for used tractors is increasing our cost of equipment for future periods.
We are in the process of changing our tractor trade cycle from a period of
approximately four years to three years. We evaluated the decision based on
maintenance costs, capital requirements, prices of new and used tractors, and
other factors. We decided to return to a shorter trade cycle, therefore we
expect our capital expenditures and financing costs to increase, and we expect
our maintenance costs to decrease.
Industry and Competition
According to the American Trucking Associations (ATA), the U.S. market for
truck-based transportation services generated total revenues of approximately
$585 billion in 2002 and is projected to follow in line with the overall U.S.
economy. We operate in the highly fragmented for-hire truckload segment of this
market, which the ATA estimates generated revenues of approximately $250 billion
in 2002. Our dedicated business also competes for the private fleet portion of
the overall trucking market (estimated by the ATA at approximately $277 billion
in revenues in 2002), by seeking to convince private fleet operators to
outsource or supplement their private fleets.
The United States trucking industry is highly competitive and includes thousands
of for-hire motor carriers, none of which dominates the market. Service and
price are the principal means of competition in the trucking industry. Measured
by annual revenue, the ten largest dry van truckload carriers accounted for
approximately $12 billion or approximately five percent of annual for-hire
truckload revenue in 2002. We compete to some extent with railroads and
rail-truck intermodal service but differentiate ourself from rail and rail-truck
intermodal carriers on the basis of service because rail and rail-truck
intermodal movements are subject to delays and disruptions arising from rail
yard congestion, which reduces the effectiveness of such service to customers
with time-definite pick-up and delivery schedules.
We believe that the cost and complexity of operating trucking fleets are
increasing and that economic and competitive pressures are likely to force many
smaller competitors and private fleets to consolidate or exit the industry. As a
result, we believe that larger, better capitalized companies, like us, will have
greater opportunities to increase profit margins and gain market share. In the
market for dedicated services, we believe that truckload carriers, like us, have
a competitive advantage over truck lessors, who are the other major participants
in the market, because we can offer lower prices by utilizing back-haul freight
within our network that traditional lessors do not have.
Insurance and Claims
We have increased the self-insured retention portion of our insurance coverage
for most claims significantly over the past several years. During the first
quarter of 2004, we renewed our casualty and workers' compensation programs
through February 2005. Under our casualty program, we are self-insured for
personal injury and property damage claims for amounts up to $2.0 million per
occurrence for the first $5.0 million of exposure. However, our insurance policy
also provides for an additional $4.0 million self-insured aggregate amount, with
a limit of $2.0 million per occurrence until the $4.0 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 $5.0 million, we would be self-insured for $4.0 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
stop loss amount of $275,000 for each group medical claim. The following chart
reflects the major changes in our casualty program since March 1, 2001:
6
Primary Coverage Excess Coverage
Coverage Period Primary Coverage SIR/deductible Excess Coverage SIR/deductible
- -------------------------------------------------------------------------------------------------------------------
March 2001 - Feb. 2002 $1.0 million $250,000 $49.0 million $3.0 million
March 2002 - July 2002 $2.0 million $500,000 $48.0 million $3.0 million
July 2002 - November 2002 $2.0 million $500,000 $0 * $0 *
November 2002- Feb. 2003 $4.0 million $1.0 million $16.0 million $3.0 million
March 2003 - Feb. 2004 $5.0 million $2.0 million** $15.0 million $2.0 million
March 2004 - Feb. 2005 $5.0 million $2.0 million*** $15.0 million $2.0 million
* Represents period for which no proof of insurance was available from
agent and coverage was determined to be invalid. We expensed the
premiums paid in 2002 and are pursuing legal remedies against the
insurance agency and its errors and omissions policy, but we can make
no assurance of recovery.
** Does not include $1.0 million self insured retention for cargo.
Subject to an additional $2.0 million self-insured aggregate amount,
limited to $1.0 million per occurrence, which results in the total
self-insured retention of up to $3.0 million per occurrence in the
$5.0 million layer until the $2.0 million aggregate threshold is
reached.
*** Does not include $1.0 million self insured retention for cargo.
Subject to an additional $4.0 million self-insured aggregate amount,
limited to $2.0 million per occurrence, which results in the total
self-insured retention of up to $4.0 million per occurrence in the
$5.0 million layer until the $4.0 million aggregate threshold is
reached.
On July 15, 2002, we received a binder for $48.0 million of excess insurance
coverage over our $2.0 million primary layer of casualty insurance.
Subsequently, we were forced to seek replacement excess coverage after the
insurance agent retained the premium and failed to produce proof of insurance
coverage. In November 2002, we obtained replacement coverage of $4.0 million in
primary coverage with a $1.0 million self-insured retention and $16.0 million in
excess coverage with a $3.0 million self-insured retention. We recognized the
premium expense for the policy of excess coverage that was not delivered in 2002
and have filed a lawsuit to recover the premiums paid and to seek coverage from
the insurance agency and its errors and omissions policy, on any claims that may
exceed $2.0 million in exposure for the July through November period. Currently,
we are not aware of any such claims. If one or more claims from this period were
to exceed the then-effective coverage limits, our financial condition and
results of operations could be materially and adversely affected.
Regulation
We are a common and contract motor carrier of general commodities. The United
States Department of Transportation ("DOT") and various state and local agencies
exercise broad powers over our business, generally governing such activities as
authorization to engage in motor carrier operations, safety, and insurance
requirements. The DOT adopted revised hours-of-service regulations on April 28,
2003 and carriers were required to comply with these regulations starting on
January 4, 2004.
There are several hours of service changes that may have a positive or negative
effect on driver hours (and miles). The new rules allow drivers to drive up to
11 hours instead of the 10 hours permitted under prior regulations, subject to
the new 14-hour on-duty maximum described below. The rules will require a
driver's off-duty period to be 10 hours, compared to 8 hours under prior
regulations. In general, drivers may not drive beyond 14 hours in a 24-hour
period, compared to not being permitted to drive after 15 hours on-duty under
the prior rules. During the new 14-hour consecutive on-duty period, the only way
to extend the on-duty period is by the use of a sleeper berth period of at least
two hours that is later coupled with a second sleeper berth break to equal 10
hours. Under the prior rules, during the 15-hour on-duty period, drivers were
allowed to take multiple breaks of varying lengths of time, which could be
either off-duty time or sleeper berth time, that did not count against the
15-hour period. There was no change to the rule that precludes drivers from
driving after being on-duty for a maximum of 70 hours in 8
7
consecutive days. However, under the new rules, drivers can "restart" their
8-day clock by taking at least 34 consecutive hours off duty.
While we believe the 11-hour and the 34-hour restart rules may have a slight
positive effect on driving hours, we anticipate that the 15-hour to 14-hour rule
change likely will have a more significant negative impact on driving hours for
the truckload industry. The prior 15-hour rule worked like a stopwatch and
allowed drivers to stop and start their on-duty time as they chose. The new
14-hour rule is like a running clock. Once the driver goes on-duty and the clock
starts, the driver is limited to one timeout, or the clock keeps running. As a
result of this change, issues that cause driver delays such as multiple stop
shipments, unloading/loading delays, and equipment maintenance could result in a
reduction in driver miles.
We expect that the new rules could initially reduce our and other truckload
carrier's average miles per truck. As time goes on, and the Company and its
drivers gain more experience with the new rules, we anticipate that we will be
able to gradually reduce any decline in average miles per truck. We believe that
we are well equipped to minimize the economic impact of the new hours-of-service
rules on our business. We believe that historically we have been one of the more
successful carriers in identifying, assessing, and collecting charges for
additional services that our drivers perform for our customers. In addition, we
conducted intensive training programs for our driver and non-driver personnel
regarding the new hours-of-service requirements in anticipation of their
effectiveness. Prior to the effectiveness of the new rules, we also initiated
discussions with many of our customers regarding steps that they can take to
assist us in managing our drivers' non-driving activities, such as loading,
unloading, or waiting, and we plan to continue to actively communicate with our
customers regarding these matters in the future. In situations where shippers
are unable or unwilling to take these steps, we expect to assess detention and
other charges to offset losses in productivity resulting from the new
hours-of-service regulations. Although it is still too early to ascertain the
ultimate effect of these rules, based on our initial experience, our preliminary
expectation is that the rules will not significantly disrupt our operations or
materially affect our results of operations.
We also may become subject to new or more restrictive regulations relating to
matters such as fuel emissions and ergonomics. Our company drivers and
independent contractors also must comply with the safety and fitness regulations
promulgated by the DOT, including those relating to drug and alcohol testing.
The DOT has rated us "satisfactory" which is the highest safety and fitness
rating. Additional changes in the laws and regulations governing our industry
could affect the economics of the industry by requiring changes in operating
practices or by influencing the demand for, and the costs of providing, services
to shippers.
Our operations are subject to various federal, state, and local environmental
laws and regulations, implemented principally by the Federal Environmental
Protection Agency ("EPA") and similar state regulatory agencies, governing the
management of hazardous wastes, other discharge of pollutants into the air and
surface and underground waters, and the disposal of certain substances. If we
should be involved in a spill or other accident involving hazardous substances,
if any such substances were found on our property, or if we were found to be in
violation of applicable laws and regulations, we could be responsible for
clean-up costs, property damage, and fines or other penalties, any one of which
could have a materially adverse effect on us. We believe that our operations are
in material compliance with current laws and regulations.
The engines used in our newer tractors are subject to new emissions control
regulations. The EPA recently adopted new emissions control regulations, which
require progressive reductions in exhaust emissions from diesel engines through
2007, for engines manufactured in October 2002, and thereafter. The new
regulations decrease the amount of emissions that can be released by truck
engines and affect tractors produced after the effective date of the
regulations. Compliance with such regulations has increased the cost of our new
tractors and could substantially impair equipment productivity, lower fuel
mileage, and increase our operating expenses. Some manufacturers have
significantly increased new equipment prices, in part to meet new engine design
requirements, and have eliminated or sharply reduced the price of repurchase
commitments. These adverse effects combined with the uncertainty as to the
reliability of the vehicles equipped with the newly designed diesel engines and
the residual values that will be realized from the disposition of these vehicles
could increase our costs or otherwise adversely affect our business or
operations.
8
Fuel Availability and Cost
We actively manage our fuel costs by routing our drivers through fuel centers
with which we have negotiated volume discounts. During 2003, the cost of fuel
was in the range at which we received fuel surcharges. Even with the fuel
surcharges, the high price of fuel decreased our profitability. Although we
historically have been able to pass through a substantial part of increases in
fuel prices and taxes to customers in the form of higher rates and surcharges,
the increases usually are not fully recovered. We do not collect surcharges on
fuel used for non-revenue miles, out-of-route miles, or fuel used while the
tractor is idling.
Additional Information
At December 31, 2003, our corporate structure included Covenant Transport, Inc.,
a Nevada holding company organized in May 1994 and its wholly owned
subsidiaries: Covenant Transport, Inc., a Tennessee corporation organized in
November 1985; Covenant Asset Management, Inc., a Nevada corporation; CIP, Inc.,
a Nevada corporation; Covenant.com, Inc., a Nevada corporation; Southern
Refrigerated Transport, Inc. ("SRT"), an Arkansas corporation; Tony Smith
Trucking, Inc., an Arkansas corporation; Harold Ives Trucking Co., an Arkansas
corporation; CVTI Receivables Corp. ("CRC"), a Nevada corporation, and Volunteer
Insurance Limited, a Cayman Island company. Terminal Truck Broker, Inc., an
Arkansas corporation and a former subsidiary, was dissolved in September 2003.
Our headquarters are located at 400 Birmingham Highway, Chattanooga, Tennessee
37419, and our website address is www.covenanttransport.com. Information on our
website is not incorporated by reference into this annual report. Our Annual
Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and all other reports we file with the SEC pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 are available free of charge
through our website.
This report contains forward-looking statements. Additional written or oral
forward-looking statements may be made by us from time to time in our filings
with the Securities and Exchange Commission or otherwise. The words "believes,"
"expects," "anticipates," "estimates," and "projects," and similar expressions
identify forward-looking statements, which speak only as of the date the
statement was made. Such forward-looking statements are within the meaning of
that term in Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements are inherently subject to risks and uncertainties, some of which
cannot be predicted or quantified. Future events and actual results could differ
materially from those set forth in, contemplated by, or underlying the
forward-looking statements. Statements in this report, including the Notes to
the Consolidated Financial Statements and "Management's Discussion and Analysis
of Financial Condition and Results of Operations," describe factors, among
others, that could contribute to or cause such differences. Additional factors
that could cause actual results to differ materially from those expressed in
such forward-looking statements are set forth in "Business" in this report. We
undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events, or otherwise.
9
ITEM 2. PROPERTIES
Our headquarters and main terminal are located on approximately 180 acres of
property in Chattanooga, Tennessee, that include an office building of
approximately 182,000 square feet, our approximately 65,000 square-foot
principal maintenance facility, a body shop of approximately 16,600 square feet,
and a truck wash. We maintain sixteen terminals located on our major traffic
lanes in the cities listed below. These terminals provide a base for drivers in
proximity to their homes, a transfer location for trailer relays on
transcontinental routes, parking space for equipment dispatch, and the other
uses indicated below.
Recruiting/
Terminal Locations Maintenance Orientation Sales Ownership
------------------ ----------- ----------- ----- ---------
Chattanooga, Tennessee x x x Owned
Dalton, Georgia x x Owned
Greensboro, North Carolina Leased
Dayton, Ohio Leased
Sayreville, New Jersey Leased
Indianapolis, Indiana Leased
Ashdown, Arkansas x x x Owned
Little Rock, Arkansas x Owned
Oklahoma City, Oklahoma Owned
Hutchins, Texas x x Owned
El Paso, Texas Leased
Columbus, Ohio Leased
French Camp, California Leased
Fontana, California x Leased
Long Beach, California Owned
Pomona, California x x Owned
ITEM 3. LEGAL PROCEEDINGS
From time to time we are a party to litigation arising in the ordinary course of
business, most of which involves claims for personal injury and property damage
incurred in the transportation of freight.
On October 26, 2003, a pickup truck collided with a trailer being operating by
Southern Refrigerated Transport, Inc. ("SRT"), one of our subsidiaries, while
the SRT truck was turning left into a truck stop. A lawsuit was filed in the
United States District Court for the Southern District of Mississippi on
February 4, 2004 on behalf of Donald J. Byrd, an injured passenger in the pickup
truck, and an amended complaint was filed on February 18, 2004 on behalf of Mr.
Byrd and Marilyn S. Byrd, his wife. The relief sought in the lawsuit is judgment
against SRT and the driver of the SRT truck in excess of one million dollars. In
addition, the Company has received demands in the form of letters seeking a
total of $27.0 million from attorneys representing potential beneficiaries of
two decedents who occupied the pickup truck. We are defending the case and
expect all matters involving the occurrence to be resolved at a level
substantially below our aggregate coverage limits of our insurance policies.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the year ended December 31, 2003, no matters were
submitted to a vote of security holders.
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock
Our Class A Common Stock is traded on the Nasdaq National Market, under the
symbol "CVTI." The following table sets forth for the calendar periods indicated
the range of high and low bid price for our Class A Common Stock as reported by
Nasdaq from January 1, 2002 to December 31, 2003.
Period High Low
------ ---- ---
Calendar Year 2002
1st Quarter $ 17.20 $ 14.31
2nd Quarter $ 21.96 $ 14.25
3rd Quarter $ 22.90 $ 15.40
4th Quarter $ 19.03 $ 15.26
Calendar Year 2003
1st Quarter $ 19.42 $ 14.70
2nd Quarter $ 19.99 $ 15.65
3rd Quarter $ 20.30 $ 15.91
4th Quarter $ 21.21 $ 17.25
As of March 1, 2004, we had approximately 42 stockholders of record of our Class
A Common Stock. However, we estimate that we have approximately 2,200
stockholders because a substantial number of our shares are held of record by
brokers or dealers for their customers in street names.
Dividend Policy
We have never declared and paid a cash dividend on our common stock. It is the
current intention of our Board of Directors to continue to retain earnings to
finance our growth and reduce our indebtedness rather than to pay dividends. The
payment of cash dividends is currently limited by agreements relating to our
credit agreements. Future payments of cash dividends will depend upon our
financial condition, results of operations, and capital commitments,
restrictions under then-existing agreements, and other factors deemed relevant
by our Board of Directors.
See "Equity Compensation Plan Information" under Item 12 in Part III of this
Annual Report for certain information concerning shares of our common stock
authorized for issuance under our equity compensation plans.
11
ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
(In thousands, except per share and operating data amounts)
Years Ended December 31,
2003 2002 2001 2000 1999
----------------------------------------------------------------------------
Statement of Operations Data:
Freight revenue $546,766 $541,830 $ 547,028 $ 552,429 $ 472,741
Fuel and accessorial surcharges 35,691 22,588 26,593 31,561 6,626
----------------------------------------------------------------------------
Total revenue $582,457 $564,418 $ 573,621 $ 583,990 $ 479,367
Operating expenses:
Salaries, wages, and related expenses 220,665 227,332 244,849 244,704 205,686
Fuel expense 109,231 96,332 103,894 104,154 74,150
Operations and maintenance 39,822 39,625 39,410 36,267 29,985
Revenue equipment rentals and
purchased transportation 69,997 59,265 65,104 76,200 49,330
Operating taxes and licenses 14,354 13,934 14,358 14,940 11,777
Insurance and claims 35,454 31,761 27,838 18,907 14,096
Communications and utilities 7,177 7,021 7,439 7,189 5,682
General supplies and expenses 14,495 14,677 14,468 13,970 10,380
Depreciation and amortization, including
gains (losses) on disposition of
equipment and impairment of assets (1) 43,041 49,497 56,324 38,879 35,591
----------------------------------------------------------------------------
Total operating expenses 554,236 539,444 573,684 555,210 436,677
----------------------------------------------------------------------------
Operating income (loss) 28,221 24,974 (63) 28,780 42,690
Other (income) expense:
Interest expense 2,332 3,542 7,855 9,894 5,993
Interest income (114) (63) (328) (520) (480)
Other (468) 916 799 (368) -
Early extinguishment of debt - 1,434 - - -
----------------------------------------------------------------------------
Other (income) expenses, net 1,750 5,829 8,326 9,006 5,513
----------------------------------------------------------------------------
Income (loss) before income taxes 26,471 19,145 (8,389) 19,774 37,177
Income tax expense (benefit) 14,315 10,871 (1,727) 7,899 14,900
----------------------------------------------------------------------------
Net income (loss) $ 12,156 $ 8,274 $ (6,662) $ 11,875 $ 22,277
============================================================================
(1) Includes a $3.3 million and a $15.4 million pre-tax impairment charge in
2002 and 2001, respectively.
Basic earnings per share $ 0.84 $ 0.58 $ (0.48) $ 0.82 $ 1.49
Diluted earnings per share 0.83 0.57 (0.48) 0.82 1.48
Weighted average common shares
outstanding 14,467 14,223 13,987 14,404 14,912
Weighted average common shares
outstanding adjusted for assumed
conversions 14,709 14,519 13,987 14,533 15,028
12
Years Ended December 31,
Selected Balance Sheet Data 2003 2002 2001 2000 1999
-----------------------------------------------------------------------------
Net property and equipment $ 221,734 $ 238,488 $ 231,536 $ 256,049 $ 269,034
Total assets 354,281 361,541 349,782 390,513 383,974
Long-term debt, less current maturities 12,000 1,300 29,000 74,295 140,497
Stockholders' equity 192,142 175,588 161,902 167,822 163,852
Selected Operating Data:
Average revenue per loaded mile $ 1.25 $ 1.22 $ 1.21 $ 1.23 $ 1.20
Average revenue per total mile $ 1.15 $ 1.13 $ 1.12 $ 1.13 $ 1.11
Average revenue per tractor per week $ 2,852 $ 2,812 $ 2,737 $ 2,790 $ 3,078
Average miles per tractor per year 129,656 129,906 127,714 128,754 144,601
Weighted average tractors for year (1) 3,667 3,680 3,791 3,759 2,929
Total tractors at end of period (1) 3,752 3,738 3,700 3,829 3,521
Total trailers at end of period (2) 9,255 7,485 7,702 7,571 6,199
(1) Includes monthly rental tractors.
(2) Excludes monthly rental trailers.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except for the historical information contained herein, the discussion in this
annual report contains forward-looking statements that involve risk,
assumptions, and uncertainties that are difficult to predict. Statements that
constitute forward-looking statements are usually identified by words such as
"anticipates," "believes," "estimates," "projects," "expects," "plans,"
"intends," or similar expressions. These statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Such statements are based upon the current beliefs and expectations of our
management and are subject to significant risks and uncertainties. Actual
results may differ from those set forth in the forward-looking statements. The
following factors, among others, could cause actual results to differ materially
from those in forward-looking statements: excess tractor and trailer capacity in
the trucking industry; decreased demand for our services or loss of one or more
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 public filings, as well as the
factors explained in greater detail under "Factors that May Affect Future
Results" herein.
Executive Overview
We are one of the ten largest truckload carriers in the United States measured
by revenue. We focus on longer lengths of haul in targeted markets where we
believe our service standards can provide a competitive advantage. We are a
major carrier for traditional truckload customers such as manufacturers and
retailers, as well as for
13
transportation companies such as freight forwarders, less-than-truckload
carriers, and third-party logistics providers that require a high level of
service to support their businesses.
Between 1991 and 1999, we grew our revenue before fuel and other surcharges from
$41.2 million to $472.7 million through internal growth and acquisitions. Over
the same period, we grew net income from $823,000, or $.08 per diluted share, to
$22.3 million, or $1.48 per diluted share. We believe this rapid growth was
strategically important, as we gained the size and equipment capacity to cover
additional traffic lanes and geographic areas for customers, participate in
competitive bids to transport freight for major shippers and develop a
substantial dedicated service business.
Beginning in 2000, the combination of softening freight demand and our rapid
expansion affected our profitability, as we were unable to obtain the freight
rates and levels of asset utilization we expected. At the same time, rising
insurance premiums and depressed used truck prices increased our operating
costs. As a result, our freight revenue declined slightly and our net income
declined to $11.9 million in 2000. We experienced a net loss of $6.7 million in
2001, including a $15.4 million pre-tax impairment charge relating to the
reduced market value of our used tractors.
Following the setbacks in 2000 and early 2001, we adopted several business
practices in 2001 that were designed to improve our profitability and
particularly, our average revenue per tractor, our chief measure of asset
utilization. The most significant of these practices were constraining the size
of our tractor and trailer fleets until profit margins justify expansion,
increasing freight volumes within our existing traffic lanes, replacing lower
yielding freight, implementing selective rate increases, and reinforcing our
cost control efforts. We believe that a combination of these business practices
and an improved freight environment contributed to substantial improvement in
our operating performance between 2001 and 2003. For 2003, our freight revenue
increased to $546.8 million and our net income improved to $12.2 million.
For 2004, the key factors that we expect to affect our profitability are our
revenue per mile, our miles per tractor, our compensation of drivers, our
capital cost of revenue equipment, and our costs of maintenance and insurance
and claims. We expect our costs for driver compensation and the ownership and
financing of our equipment to increase significantly. On March 15, we are
implementing a three cent per mile increase in the compensation of our employee
and independent contractor drivers, and we also added compensation for detention
time effective January 4, 2004. We also expect our revenue equipment capital
cost (whether in the form of interest and depreciation or payments under
operating leases) to increase by approximately two cents per mile. To overcome
these cost increases and improve our margins we will need to achieve significant
increases in revenue per tractor, particularly in revenue per mile. Other areas
we expect to have a significant impact include maintenance costs, which we
expect to decrease because of a newer tractor fleet, insurance and claims, which
can be volatile due to our large self-insured retention, and miles per tractor,
which will be affected by our ability to attract and retain drivers in an
increasingly tight driver market, our success with improving the utilization of
our solo driver fleet, and our success in addressing utilization challenges
imposed by the new hours-of-service regulations. In evaluating these factors, it
may be useful to note that each one cent per mile difference in revenue or cost
per mile has an impact of approximately $.23 per share on our earnings per share
and each one percent increase or decrease in miles per tractor has an impact of
approximately $.07 per share on earnings per share.
Revenue
We generate substantially all of our revenue by transporting freight for our
customers. Generally, we are paid by the mile or by the load for our services.
The main factors that affect our revenue are the revenue per mile we receive
from our customers, the percentage of miles for which we are compensated, and
the number 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.
We also derive revenue from fuel surcharges, loading and unloading activities,
equipment detention, and other accessorial services. Freight revenue, which is
our revenue before fuel and accessorial surcharges, has accounted for
approximately 94% to 95% of our total revenue over the past three years. We
expect accessorial revenue, primarily
14
for equipment detention and stop offs, to increase with the new hours-of-service
regulations that became effective January 4, 2004.
Since 2000 we have held our fleet size relatively constant. An overcapacity of
trucks in our fleet and the industry generally as the economy slowed has
contributed to lower equipment utilization and pricing pressure. The main
constraints on our internal growth are the ability to recruit and retain a
sufficient number of qualified drivers and in times of slower growth, to add
profitable freight.
In addition to constraining fleet size, we reduced our number of two-person
driver teams during 2001 and have since held the percentage relatively constant
to better match the demand for expedited long-haul service. Our single driver
fleets generally operate in shorter lengths of haul, generate fewer miles per
tractor, and experience more non-revenue miles, but the additional expenses and
lower productive miles are expected to be offset by generally higher revenue per
loaded mile and the reduced employee expense of compensating only one driver. We
expect operating statistics and expenses to shift with the mix of single and
team operations.
During 2003 we conducted an intense evaluation of the freight in what we call
"in-between" movements. In-between movements generally have lengths of haul
between 550 and 850 miles. They are longer than one-day regional moves but not
long enough for expedited team service or two full days with a single driver. In
many instances, 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 examined each
in-between movement and negotiated with our customers to raise rates, obtain
more favorable loads, or cease hauling the in-between loads. During the period
of our evaluation in 2003, these in-between movements represented approximately
one quarter of our total loads, and we believe they have been significantly less
profitable than our longer or shorter lengths of haul. Based on the initial
results of these efforts, we believe that we have significant opportunities to
improve our profitability over time as we continue to focus on our in-between
loads.
Expenses and Profitability
Over the past four years the trucking industry has experienced a significant
increase in operating costs. The main factors for the industry as well as for us
have been an increased annual cost of tractors due to higher initial prices and
lower used truck values, 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 declined as a percentage of
revenue. Going forward, however, we expect driver and independent contractor
compensation to increase as a result of the three cent increase in compensation
to our drivers.
Looking forward, our profitability goal is to return to an operating ratio of
approximately 90%. We expect this to require additional improvements in revenue
per tractor per week, particularly in revenue per mile, to overcome expected
additional cost increases to expand our margins. Because a large percentage of
our costs are variable, changes in revenue per mile affect our profitability to
a greater extent than changes in miles per tractor.
Revenue Equipment
We operate approximately 3,752 tractors and 9,255 trailers. Of our tractors, at
December 31, 2003, approximately 2,314 were owned, 1,025 were financed under
operating leases, and 413 were provided by independent contractors, who own and
drive their own tractors. Of our trailers, at December 31, 2003, approximately
2,644 were owned and approximately 6,611 were financed under operating leases.
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 and decreased salvage values on our remaining tractors to
reflect our expectations concerning market value at disposition. In June 2003 we
entered into a trade-in agreement with an equipment manufacturer with trade-in
values which approximate the expected disposition value of the model year 2001
tractors. Our assumptions represent our best estimate, and actual values could
differ by the time those tractors are scheduled for trade.
15
Because of the increases in 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
the 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 in the revenue equipment rentals and purchased transportation
discussion.
Independent contractors (owner operators) provide a tractor and a driver and are
responsible for all operating expenses in exchange for a fixed payment per mile.
We do not have the capital outlay of purchasing the tractor. The payments to
independent contractors and the financing of equipment under operating leases
are recorded in revenue equipment rentals and purchased transportation. Expenses
associated with owned equipment, such as interest and depreciation, are not
incurred, and for independent contractor tractors, driver compensation, fuel,
and other expenses are not incurred. Because obtaining equipment from
independent contractors and under operating leases effectively shifts financing
expenses from interest to "above the line" operating expenses, we evaluate our
efficiency using net margin rather than operating ratio.
Results of Operations
For comparison purposes in the table below, we use freight revenue in addition
to total 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. Freight
revenue (total revenue less fuel surcharge and accessorial revenue) excludes
$35.7 million, $22.6 million and $26.6 million of fuel and accessorial surcharge
revenue in the three years-ended December 31, 2003, 2002, and 2001,
respectively. With the new hours-of-service regulations that became effective
January 4, 2004, we expect accessorial revenue, primarily for equipment
detention and stop offs, to increase significantly. Under the new regulatory
requirements, we may reclassify accessorial revenue into freight revenue in
future periods.
16
The following table sets forth the percentage relationship of certain items to
total revenue and freight revenue:
2003 2002 2001 2003 2002 2001
-------- -------- -------- -------- -------- --------
Total revenue 100.0% 100.0% 100.0% Freight revenue (1) 100.0% 100.0% 100.0%
------------- -------- -------- -------- --------------- -------- -------- --------
Operating expenses: Operating expenses:
Salaries, wages, and related Salaries, wages, and
expenses 37.9 40.3 42.7 related expenses (1) 39.1 40.7 43.8
Fuel expense 18.8 17.1 18.1 Fuel expense (1) 15.1 15.2 15.4
Operations and maintenance 6.8 7.0 6.9 Operations and maintenance (1) 6.9 6.9 6.9
Revenue equipment rentals Revenue equipment rentals
and purchased and purchased
transportation 12.0 10.5 11.3 transportation 12.8 10.9 11.9
Operating taxes and licenses 2.5 2.5 2.5 Operating taxes and licenses 2.6 2.6 2.6
Insurance and claims 6.1 5.6 4.9 Insurance and claims 6.5 5.9 5.1
Communications and utilities 1.2 1.2 1.3 Communications and utilities 1.3 1.4 1.4
General supplies and General supplies and
expenses 2.5 2.6 2.5 expenses 2.7 2.7 2.6
Depreciation and Depreciation and
amortization, including amortization, including
gains (losses) on gains (losses) on
disposition of equipment disposition of equipment
and impairment of assets 7.4 8.8 9.8 and impairment of assets (2) 7.9 9.1 10.3
-------- -------- -------- -------- -------- --------
Total operating expenses 95.2 95.6 100.0 Total operating expenses 94.8 95.4 100.0
-------- -------- -------- -------- -------- --------
Operating income 4.8 4.4 0.0 Operating income 5.2 4.6 0.0
Other (income) expense, net 0.3 1.0 1.5 Other (income) expense, net 0.3 1.1 1.5
-------- -------- -------- -------- -------- --------
Income (loss) before Income (loss) before
income taxes 4.5 3.4 (1.5) income taxes 4.8 3.5 (1.5)
Income tax expense (benefit) 2.4 1.9 (0.3) Income tax expense (benefit) 2.6 2.0 (0.3)
-------- -------- -------- -------- -------- --------
Net Income (loss) 2.1% 1.5% (1.2%) Net Income (loss) 2.2% 1.5% (1.2%)
======== ======== ======== ======== ======== ========
(1) Freight revenue is total revenue less fuel surcharge and accessorial
revenue. In this table, fuel surcharge and accessorial revenue are
shown netted against the appropriate expense category. Salaries,
wages, and related expenses, $6.7 million, $6.7 million, and $5.4
million; fuel expense, $26.8 million, $13.8 million, and $19.5
million; operations and maintenance, $2.0 million, $2.0 million, and
$1.6 million in 2003, 2002 and 2001, respectively.
(2) Includes a $3.3 million and a $15.4 million pre-tax impairment charge
or 0.6% and 2.8% of freight revenue in 2002 and 2001, respectively.
COMPARISON OF YEAR ENDED DECEMBER 31, 2003 TO YEAR ENDED DECEMBER 31, 2002
Total revenue increased $18.0 million, or 3.2%, to $582.5 million in 2003, from
$564.4 million in 2002. Freight revenue excludes $35.7 million of fuel and
accessorial surcharge revenue in 2003 and $22.6 million in 2002. 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 $4.9 million (0.9%), to $546.8 million in 2003, from $541.8 million in
2002. Revenue per tractor per week increased 1.4% to $2,852 in 2003 from $2,812
in 2002. The revenue per tractor per week increase was primarily generated by a
2.5% higher rate per loaded mile which was partially offset by an increase in
non revenue miles. Weighted average tractors decreased 0.4% to 3,667 in 2003
from 3,680 in 2002. We have elected to constrain the size of our tractor fleet
until fleet production and profitability improve.
17
Salaries, wages, and related expenses, net of accessorial revenue of $6.7
million in 2003 and 2002, decreased $6.7 million (3.0%), to $213.9 million in
2003, from $220.7 million in 2002. As a percentage of freight revenue, salaries,
wages, and related expenses decreased to 39.1% in 2003, from 40.7% in 2002. 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. Driver wages are expected to increase
as a percentage of revenue in future periods, due to a pay increase that will go
into effect March 15, 2004. Management expects wages to increase approximately
three cents per mile or approximately $13 million pre-tax on an annualized
basis. Our payroll expense for employees other than over the road drivers
remained relatively constant at 7.3% of freight revenue in 2003 and 7.2% of
freight revenue in 2002. Health insurance, employer paid taxes, workers'
compensation, and other employee benefits decreased to 5.8% of freight revenue
in 2003 from 6.4% of freight revenue in 2002, 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 during the
year 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 $26.8 million in 2003 and $13.8
million in 2002, remained constant at $82.5 million in 2003 and 2002. As a
percentage of freight revenue, net fuel expense remained relatively constant at
15.1% in 2003 and 15.2% in 2002. Fuel prices increased sharply during 2003 due
to unrest in Venezuela and the Middle East and low inventories. However, fuel
surcharges amounted to $.060 per loaded mile in 2003 compared to $.031 per
loaded mile in 2002, which partially offset the increased fuel expense. Higher
fuel prices will increase our operating expenses. Fuel costs may be affected in
the future by volume purchase commitments, the collectibility of fuel
surcharges, and lower fuel mileage due to government mandated emissions
standards that were effective October 1, 2002, and have resulted in less fuel
efficient engines.
Operations and maintenance consist primarily of vehicle maintenance, repairs and
driver recruitment expenses. Net of accessorial revenue of $2.0 million in 2003
and 2002, operations and maintenance increased $0.2 million to $37.8 million in
2003 from $37.6 million in 2002. As a percentage of freight revenue, net
operations and maintenance expense remained relatively constant at 6.9% in 2003
and 2002. 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, and we expect
maintenance costs to decrease as the reduced maintenance cost of the new
tractors is no longer offset by the high cost of preparing used tractors for
disposition. The average age of our tractor and trailer fleets decreased to 19
and 34 months at December 2003, from 26 and 55 months as of December 2002,
respectively. Driver recruiting expense is expected to increase because of
greater demand for trucking services and a tighter supply of drivers.
Revenue equipment rentals and purchased transportation increased $10.7 million
(18.0%), to $69.8 million in 2003, from $59.2 million in 2002. As a percentage
of freight revenue, revenue equipment rentals and purchased transportation
increased to 12.8% in 2003 from 10.9% in 2002. The increase is due principally
to two factors. First, the revenue equipment rental expense increased $7.7
million, or 43.1%, to $25.4 million in 2003, from $17.7 million in 2002. As of
December 2003, we had financed approximately 1,025 tractors and 6,611 trailers
under operating leases as compared to 891 tractors and 2,628 trailers under
operating leases as of December 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,
which will be partially offset by no longer recognizing 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. The increase in revenue equipment rentals and
purchased transportation is also due to the payments to
18
independent contractors increasing $3.1 million to $44.6 million in 2003 from
$41.5 million in 2002, mainly due to an increase in the independent contractor
fleet to an average of 390 in 2003 versus an average of 355 in 2002. Payments
due to independent contractors are expected to increase as a percentage of
revenue in future periods, due to the approximately three cents per mile
increase in compensation to independent contractors that will go into effect
March 15, 2004. The financial impact will be approximately $1.5 million pretax
on an annualized basis.
Operating taxes and licenses increased $0.4 million (3.0%), to $14.4 million in
2003, from $13.9 million in 2002. As a percentage of freight revenue, operating
taxes and licenses remained essentially constant at 2.6% in 2003 and 2002.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, increased
$3.7 million (11.6%), to $35.5 million in 2003 from $31.8 million in 2002. As a
percentage of freight revenue, insurance and claims expense increased to 6.5% in
2003 from 5.9% in 2002. Insurance and claims 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 our unfavorable accident experience over the past three
years. 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 another increase in self-insured retentions, effective
March 1, 2004, our future expenses of insurance and claims may be higher or more
volatile than in historical periods.
Communications and utilities increased $0.2 million (2.2%), to $7.2 million in
2003, from $7.0 million in 2002. As a percentage of freight revenue,
communications and utilities remained essentially constant at 1.3% in 2003 and
2002.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses, decreased $0.2 million (1.2%), to $14.5 million in
2003, from $14.7 million in 2002. As a percentage of freight revenue, general
supplies and expenses remained essentially constant at 2.7% in 2003 and 2002.
Depreciation, amortization and impairment charge, consisting primarily of
depreciation of revenue equipment, decreased $6.5 million (13.0%), to $43.0
million in 2003 from $49.5 million in 2002. As a percentage of freight revenue,
depreciation and amortization decreased to 7.9% in 2003 from 9.1% in 2002. The
decrease in part resulted because we did not have an impairment charge in the
2003 period, as we recorded a $3.3 million impairment charge in the 2002 period.
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 2003 compared to a loss of $2.4 million in 2002.
In addition, we executed the April 2003 sale-leaseback transaction, discussed
under the revenue equipment rentals and purchased transportation discussion
above. These factors were partially offset by increased depreciation expense on
our 2001 tractors and on our new tractors. 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
expense 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.
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 $4.1 million (70.0%), to $1.8 million in 2003,
from $5.8 million in 2002. As a percentage of freight revenue, other expense
decreased to 0.3% in 2003 from 1.1% in 2002. The decrease was the result of
lower debt balances and more favorable interest rates. Included in the other
expense category are interest
19
expense, interest income, and pre-tax non-cash adjustments related to the
accounting for interest rate derivatives under SFAS No. 133, which amounted to a
$0.4 million gain in 2003 and a $0.9 million loss in 2002.
During the first quarter of 2002, we prepaid the remaining $20.0 million in
previously outstanding 7.39% ten year, private placement notes with borrowings
from the Credit Agreement. In conjunction with the prepayment of the borrowings,
we recognized an approximate $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 loss and it is no
longer classified as an extraordinary item.
Income tax expense increased $3.4 million (31.7%) to $14.3 million in 2003 from
$10.9 million in 2002. 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.
As a result of the factors described above, net income increased $3.9 million,
or 46.9%, to $12.2 million in 2003 from $8.3 million in 2002. As a result of the
foregoing, our net margin increased to 2.2% in 2003 from 1.5% in 2002.
COMPARISON OF YEAR ENDED DECEMBER 31, 2002 TO YEAR ENDED DECEMBER 31, 2001
Freight revenue (total revenue less fuel surcharge and accessorial revenue)
decreased $5.2 million (1.0%), to $541.8 million in 2002, from $547.0 million in
2001. Our revenue was affected by a 2.9% decrease in weighted average number of
tractors partially offset by a 2.7% increase in revenue per tractor per week to
$2,812 in 2002 from $2,737 in 2001. The revenue per tractor per week increase
was primarily generated by a 1.7% higher utilization of equipment and a 1.0%
higher rate per total mile. Weighted average tractors decreased 2.9% to 3,680 in
2002 from 3,791 in 2001. 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 $6.7
million in 2002 and $5.4 million in 2001, decreased $18.8 million (7.9%), to
$220.7 million in 2002, from $239.5 million in 2001. As a percentage of freight
revenue, salaries, wages, and related expenses decreased to 40.7% in 2002, from
43.8% in 2001. Wages for over the road drivers as a percentage of freight
revenue decreased to 27.2% in 2002 from 30.1% in 2001. The decrease was largely
attributable to us utilizing a larger percentage of single-driver tractors, with
only one driver per tractor to be compensated, implementing changes in our pay
structure and implementing a per diem pay program for our drivers during August
2001. As a percentage of freight revenue, our payroll expense for employees
other than over the road drivers increased to 7.2% in 2002 from 6.7% in 2001 due
to growth in headcount and local drivers in the dedicated fleet. Health
insurance, employer-paid taxes, workers' compensation, and other employee
benefits decreased to 6.4% in 2002 from 6.9% in 2001. The decrease was primarily
due to lower employer-paid taxes related to lower wage levels and was partially
offset by increases in workers' compensation and health insurance costs related
to rising medical expenses, which are expected to continue to increase in future
periods.
Fuel expense, net of fuel surcharge revenue of $13.8 million in 2002 and $19.5
million in 2001, decreased $1.9 million (2.2%), to $82.5 million in 2002, from
$84.4 million in 2001. As a percentage of freight revenue, net fuel expense
remained relatively constant at 15.2% in 2002 and 15.4% in 2001. Fuel surcharges
amounted to $.031 per loaded mile in 2002 compared to $.043 per loaded mile in
2001. Fuel prices have increased sharply during the first two months of 2003
because of reasons such as unrest in Venezuela and the Middle East and low
inventories. Higher fuel prices will increase our operating expenses. Fuel costs
may be affected in the future by volume purchase commitments, the collectibility
of fuel surcharges, and lower fuel mileage due to government mandated emissions
standards that were effective October 1, 2002, and will result in less fuel
efficient engines. We did not have any fuel hedging contracts at December 31,
2002.
Operations and maintenance consist primarily of vehicle maintenance, repairs and
driver recruitment expenses. Net of accessorial revenue of $2.0 million in 2002
and $1.6 million in 2001, operations and maintenance decreased $0.2
20
million to $37.6 million in 2002 from $37.8 million in 2001. As a percentage of
freight revenue, operations and maintenance remained essentially constant at
6.9% in 2002 and 2001. We extended the trade cycle on our tractor fleet from
three years to four years, which resulted in an increase in the number of
required repairs. However, the increased repair costs were offset by reduced
driver recruitment expenses. We expect maintenance costs to decrease as we take
delivery of new tractors. Driver recruiting expense may increase if shipping
volumes increase and create greater demand for trucking services.
Revenue equipment rentals and purchased transportation decreased $5.8 million
(9.0%), to $59.2 million in 2002, from $65.1 million in 2001. As a percentage of
freight revenue, revenue equipment rentals and purchased transportation
decreased to 10.9% in 2002 from 11.9% in 2001. The decrease was the result of
lower lease payments (3.2% of freight revenue in 2002 compared to 3.9% of
freight revenue in 2001) and a smaller fleet of owner-operators during 2002 (an
average of 355 in 2002 compared to an average of 360 in 2001). The smaller fleet
of owner-operators resulted in lower payments to owner-operators (7.7% of
freight revenue in 2002 compared to 8.0% of freight revenue in 2001). 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.
Operating taxes and licenses decreased $0.4 million (3.0%), to $13.9 million in
2002, from $14.4 million in 2001. As a percentage of freight revenue, operating
taxes and licenses remained essentially constant at 2.6% in 2002 and 2001.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, increased
$3.9 million (14.1%), to $31.8 million in 2002 from $27.8 million in 2001. As a
percentage of freight revenue, insurance and claims expense increased to 5.9% in
2002 from 5.1% in 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 self insured retention exposure that is partially offset by
lower premium rates. The retention level for our primary insurance layer
increased from $12,500 in 2000 to $250,000 in 2001 to $500,000 in March of 2002,
to $1.0 million in November of 2002, and to $2.0 million on March 1, 2003. From
July 15, 2002 to November 10, 2002, our excess insurance coverage over the $2.0
million primary layer we had in effect ($4.0 million from November 11 to
November 22, 2002) was determined to be invalid. Although we are not aware of
any claim that is expected to exceed our primary coverage, any such claim would
be uninsured unless the agent's errors and omissions policy provides coverage.
In the event of an uninsured claim our financial condition and results of
operations could be materially and adversely affected.
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. 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 decreased $0.4 million (5.6%), to $7.0 million in
2002, from $7.4 million in 2001. As a percentage of freight revenue,
communications and utilities remained essentially constant at 1.4% in 2002 and
2001.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses, increased $0.2 million (1.4%), to $14.7 million in
2002, from $14.5 million in 2001. As a percentage of freight revenue, general
supplies and expenses remained essentially constant at 2.7% in 2002 and 2.6% in
2001.
21
Depreciation, amortization and impairment charge, consisting primarily of
depreciation of revenue equipment, decreased $6.8 million (12.1%), to $49.5
million in 2002 from $56.3 million in 2001. As a percentage of freight revenue,
depreciation and amortization decreased to 9.1% in 2002 from 10.3% in 2001. The
decrease is the result of impairment charges, partially offset by increased
depreciation expense and losses on the sale of equipment. We recognized pre-tax
charges of approximately $3.3 million and $15.4 million, in 2002 and 2001,
respectively, to reflect an impairment in tractor values. Depreciation and
amortization expense is net of any gain or loss on the sale of tractors and
trailers. Loss on the sale of tractors and trailers was approximately $2.4
million in 2002 and $217,000 in 2001. 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. Amortization expense relates to deferred debt costs
incurred and covenants not to compete from five acquisitions. Goodwill
amortization ceased beginning January 1, 2002, in accordance with SFAS No. 142,
and we evaluate goodwill and certain intangibles for impairment, annually.
During the second quarter of 2002, we tested our goodwill for impairment and
found no impairment. The positive impact of goodwill no longer being amortized
was approximately $310,000 for 2002.
Other expense, net, decreased $2.5 million (30.0%), to $5.8 million in 2002,
from $8.3 million in 2001. As a percentage of freight revenue, other expense
decreased to 1.1% in 2002 from 1.5% in 2001. The decrease was the result of
lower debt balances and more favorable interest rates. Included in the other
expense category are interest expense, interest income, and pre-tax non-cash
losses related to the accounting for interest rate derivatives under SFAS No.
133, which amounted to $0.9 million in 2002 and $0.7 million in 2001.
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 loss and it is no
longer classified as an extraordinary item.
Our income tax expense in 2002 was $10.9 million or 56.8% of income before
taxes. Our income tax benefit for 2001 was $1.7 million or 20.6% of loss before
income taxes. The effective tax rate is different from the expected combined tax
rate due to permanent differences related to a per diem pay structure
implemented during the third quarter of 2001. Due to the nondeductible effect of
per diem, our tax rate will fluctuate in future periods as income fluctuates.
As a result of the factors described above, net earnings increased $14.9 million
(224.2%), to $8.3 million income in 2002 (1.5% of revenue), from $6.7 million
loss in 2001 (1.2% of revenue). Prior to the $3.3 million and $15.4 million
pre-tax charges for impairment, net income for 2002 and 2001 would have been
$11.2 million ($0.77 diluted earnings per share) and $2.9 million ($0.21 diluted
earnings per share) respectively.
As a result of the foregoing, our net margin increased to 1.5% in 2002 from
(1.2%) in 2001.
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 December 31, 2003, were funds provided by operations, proceeds
under the Securitization Facility (as defined below), borrowings under our
primary credit agreement, which had maximum available borrowing of $100.0
million at December 31, 2003 (the "Credit Agreement"), the April 2003 trailer
transactions, and operating
22
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. On a
longer term basis, based on anticipated future cash flows, current availability
under our credit facility, and sources of equipment lease financing that we
expect will be available to us, management does not expect that the Company will
experience significant liquidity constraints in the foreseeable future.
Net cash provided by operating activities was $47.7 million in 2003, $67.2
million in 2002 and $73.8 million in 2001. Our primary sources of cash flow from
operations in 2003 were net income and depreciation and amortization.
Depreciation and amortization in 2002 and 2001 included a $3.3 million and a
$15.4 million pre-tax impairment charge, respectively. The 2001 period also
included an unusually large collection of receivables that had resulted from
billing problems during 2000. Our number of days sales in accounts receivable
decreased to 40 days in 2003 from 43 days in 2002.
Net cash used in investing activities was $ 25.9 million in 2003, $56.4 million
in 2002, and $31.3 million in 2001. In 2003, the net cash was used primarily for
the purchase of revenue equipment. In 2002, net cash used in investing
activities related to the purchase of tractors, which were previously financed
through operating leases, and the acquisition of new revenue equipment (net of
trade-ins) using proceeds from the Credit Agreement. During 2001, capital
expenditures were lower than in previous years due to our planned slower fleet
growth as well as our decision to lengthen our tractor trade cycle. In 2001,
approximately $15 million was related to the financing of our headquarters
facility, which was previously financed through an operating lease that expired
in March 2001. We financed the facility using proceeds from the Credit
Agreement. We expect capital expenditures, primarily for revenue equipment (net
of trade-ins), to be approximately $45.0 million in 2004, exclusive of
acquisitions, as we transition back to a three year trade cycle for tractors and
a seven year trade cycle on dry van trailers.
Net cash used in financing activities was $18.6 million in 2003, $11.2 million
in 2002 and $44.3 million in 2001. During 2003, we reduced outstanding balance
sheet debt by $21.9 million. Approximately $15.6 million of this reduction was
from proceeds of the April 2003 sale-leaseback transaction. At December 31,
2003, we had outstanding debt of $61.7 million, primarily consisting of $48.4
million in the Securitization Facility, $12.0 million drawn under the Credit
Agreement, and a $1.3 million interest bearing note to the former primary
stockholder of SRT. Interest rates on this debt range from 1.0% 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.
The facility matures in December 2005. Borrowings under the Credit Agreement are
based on the banks' base rate, which floats daily, or LIBOR, which accrues
interest based on one, two, three, or six month LIBOR rates plus an applicable
margin that is adjusted quarterly between 0.75% and 1.25% based on cash flow
coverage. At December 31, 2003 and 2002, the margin was 1.0% and 0.875%,
respectively. At December 31, 2003, we had $12.0 million outstanding on which
the interest rate was 2.4%. The Credit Agreement is guaranteed by us and all of
our subsidiaries except CVTI Receivables Corp. and Volunteer Insurance Limited.
The Credit Agreement has a maximum borrowing limit of $100.0 million with an
accordion feature which permits an increase up to a maximum borrowing limit of
$140.0 million. Borrowings related to revenue equipment are limited to the
lesser of 90% of net book value of revenue equipment or the maximum borrowing
limit. Letters of credit are limited to an aggregate commitment of $70.0
million. The Credit Agreement includes a "security agreement" such that the
Credit Agreement may be collateralized by virtually all of our assets if a
covenant violation occurs. A commitment fee, that is adjusted quarterly between
0.15% and 0.25% per annum based on cash flow coverage, is due on the daily
unused portion of the Credit Agreement. At December 31, 2003 and 2002, we had
undrawn letters of credit outstanding of approximately $51.2 million and $19.2
million, respectively.
23
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. As discussed in
the financial statement footnotes, 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 December 2003 and 2002, there
were $48.4 million and $39.2 million in proceeds received. CRC does not meet the
requirements for off-balance sheet accounting; therefore, it is reflected in our
consolidated 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 and are
cross-defaulted. We are in compliance with the Credit Agreement and
Securitization Facility as of December 31, 2003.
Contractual Obligations and Commitments - We had commitments outstanding related
to equipment, debt obligations, and diesel fuel purchases as of December 31,
2003.
The following table sets forth our contractual cash obligations and commitments
as of December 31, 2003.
Payments Due By Period There-
(in thousands) Total 2004 2005 2006 2007 2008 after
-------------------------------------------------------------------------------------
Long Term Debt $ 12,000 $ - $12,000 $ - $ - $ - $ -
Short Term Debt (1) 49,653 49,653 - - - - -
Operating Leases 128,367 32,045 30,854 23,863 14,778 12,676 14,151
Lease residual value guarantees 42,656 - 9,486 8,462 5,590 18,151 967
Purchase Obligations:
Diesel fuel (2) 5,561 5,561 - - - - -
Equipment (3) 90,373 90,373 - - - - -
-------------------------------------------------------------------------------------
Total Contractual Cash Obligations $328,610 $177,632 $52,340 $32,325 $20,368 $30,827 $15,118
=====================================================================================
(1) In 2003, approximately $48 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 2004.
(2) This amount represents volume purchase commitments for the 2004 period
through our truck stop network. We estimate that this amount represents
approximately 5% of our fuel needs for the 2004 period.
(3) Amount reflects the total purchase price or lease commitment of tractors
and trailers scheduled for delivery throughout 2004. Net of estimated
trade-in values and other dispositions, the estimated amount due under
these commitments is approximately $45.0 million. These purchases are
expected to be financed by debt, proceeds from sales of existing equipment,
and cash flows from operations. We have the option to cancel
24
commitments relating to equipment with 60 days notice. Historically, we
have financed a significant portion of our revenue equipment through
operating leases.
OFF BALANCE SHEET ARRANGEMENTS
Operating leases have been an important source of financing for our revenue
equipment. 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. At December 31, 2003, we had financed
approximately 1,025 tractors and 6,611 trailers under operating leases. Vehicles
held under operating leases are not carried on our balance sheet, and lease
payments in respect of such vehicles are reflected in our income statements in
the line item "Revenue equipment rentals and purchased transportation." Our
revenue equipment rental expense was $25.4 million in 2003, compared to $17.7
million in 2002. The total amount of remaining payments under operating leases
as of December 31, 2003, was $128.4 million. In connection with various
operating leases, we issued residual value guarantees, which provide that if we
do not purchase the leased equipment from the lessor at the end of the lease
term, then we are liable to the lessor for an amount equal to the shortage (if
any) between the proceeds from the sale of the equipment and an agreed value. As
of December 31, 2003, the maximum amount of the residual value guarantees was
approximately $42.7 million. To the extent the expected value at the lease
termination date is lower than the residual value guarantee, we would accrue for
the difference over the remaining lease term. We believe that proceeds from the
sale of equipment under operating leases would exceed the payment obligation on
all operating leases except those operating leases relating to 2001 model year
equipment. The amount accrued on the 2001 model year equipment is approximately
$1.5 million pre-tax.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make decisions
based upon estimates, assumptions, and factors we consider as relevant to the
circumstances. Such decisions include the selection of applicable accounting
principles and the use of judgment in their application, the results of which
impact reported amounts and disclosures. Changes in future economic conditions
or other business circumstances may affect the outcomes of our estimates and
assumptions. Accordingly, actual results could differ from those anticipated. A
summary of the significant accounting policies followed in preparation of the
financial statements is contained in Note 1 of the financial statements attached
hereto. The following discussion addresses our most critical accounting
policies, which are those that are both important to the portrayal of our
financial condition and results of operations and that require significant
judgment or use of complex estimates.
Property and Equipment - Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. The annual depreciation on
tractors and trailers is approximately $43.0 million. We have previously
recorded impairment charges for the 1998 through 2000 model year tractors
related to the reduced market value of those units. We also adjusted our
depreciation rate and estimates of salvage values for the 2001 model year
tractors for the estimated reduced disposition values. We depreciate revenue
equipment excluding day cabs over five to ten years with salvage values ranging
from 9% to 33%. We evaluate the salvage value, useful life, and annual
depreciation of tractors and trailers annually based on the current market
environment and our recent experience with disposition values. We also evaluate
the carrying value of long-lived assets for impairment by analyzing the
operating performance and future cash flows for those assets, whenever events or
changes in circumstances indicate that the carrying amounts of such assets may
not be recoverable. We evaluate the need to adjust the carrying value of the
underlying assets if the sum of the expected cash flows is less than the
carrying value. Impairment can be impacted by our projection of future cash
flows, the level of actual cash flows and salvage values, the methods of
estimation used for determining fair values and the impact of guaranteed
residuals. Any changes in management's judgments could result in greater or
lesser annual depreciation expense or additional impairment charges in the
future.
Insurance and Other Claims - Our insurance program for liability, property
damage, and cargo loss and damage, involves self-insurance with high risk
retention levels. We accrue the estimated cost of the uninsured portion of
25
pending claims. These accruals are based on our evaluation of the nature and
severity of the claim and estimates of future claims development based on
historical trends, as well as the legal and other costs to settle or defend the
claims. Because of our significant self-insured retention amounts, we have
significant exposure to fluctuations in the number and severity of claims. If
there is an increase in the frequency and severity of claims, or we are required
to accrue or pay additional amounts if the claims prove to be more severe than
originally assessed, our profitability would be adversely affected. The rapid
and substantial increase in our self-insured retention makes these estimates an
important accounting judgment.
In addition to estimates within our self-insured retention layers, we also must
make judgments concerning our aggregate coverage limits. From 1999 to present,
we carried excess coverage in amounts that have ranged from $15.0 million to
$49.0 million in addition to our primary insurance coverage, although for the
period from July through November 2002, our aggregate coverage limit was $2.0
million because of a fraudulently issued binder for our excess coverage. If any
claim occurrence were to exceed our aggregate coverage limits, we would have to
accrue for the excess amount, and our critical estimates include evaluating
whether a claim may exceed such limits and, if so, by how much. Currently, we
are not aware of any such claims. If one or more claims from this period were to
exceed the then effective coverage limits, our financial condition and results
of operations could be materially and adversely affected.
Lease Accounting and Off-Balance Sheet Transactions - Operating leases have been
an important source of financing for our revenue equipment. 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. At December 31, 2003, we had financed approximately
1,025 tractors and 6,611 trailers under operating leases. Vehicles held under
operating leases are not carried on our balance sheet, and lease payments in
respect of such vehicles are reflected in our income statements in the line item
"Revenue equipment rentals and purchased transportation." Our revenue equipment
rental expense was $25.4 million in 2003, compared to $17.7 million in 2002. The
total amount of remaining payments under operating leases as of December 31,
2003, was $128.4 million. In connection with various operating leases, we issued
residual value guarantees, which provide that if we do not purchase the leased
equipment from the lessor at the end of the lease term, then we are liable to
the lessor for an amount equal to the shortage (if any) between the proceeds
from the sale of the equipment and an agreed value. As of December 31, 2003, the
maximum amount of the residual value guarantees was approximately $42.7 million.
To the extent the expected value at the lease termination date is lower than the
residual value guarantee, we would accrue for the difference over the remaining
lease term. We believe that proceeds from the sale of equipment under operating
leases would exceed the payment obligation on all operating leases except those
operating leases relating to 2001 model year equipment. The amount accrued on
the 2001 model year equipment is approximately $1.5 million pre-tax. The
estimated values at lease termination involve management judgments. As leases
are entered into, determination as to the classification as an operating or
capital lease involves management judgments on residual values and useful lives.
Accounting for Income Taxes - In this area, we make important judgments
concerning a variety of factors, including, the appropriateness of tax
strategies, expected future tax consequences based on future company
performance, and to the extent tax strategies are challenged by taxing
authorities, our likelihood of success. The Company utilizes certain income tax
planning strategies to reduce its overall cost of income taxes. Upon audit, it
is possible that certain strategies might be disallowed resulting in an
increased liability for income taxes. To date, we have received notices of
disallowance asserting that three of our tax planning strategies have been
disallowed. We are contesting the disallowance and have provided for our
estimated exposure attributable to income tax planning strategies. We believe
that the provision for liabilities resulting from the implementation of income
tax planning strategies is appropriate.
Deferred income taxes represent a substantial liability on our consolidated
balance sheet. Deferred income taxes are determined in accordance with SFAS No.
109, "Accounting for Income Taxes." Deferred tax assets and liabilities are
recognized for the expected future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases, and operating loss and tax credit
carryforwards. We evaluate our tax assets and liabilities on a periodic basis
and adjust these balances as
26
appropriate. We believe that we have adequately provided for our future tax
consequences based upon current facts and circumstances and current tax law. For
the year ended December 31, 2003, we made no material changes in our assumptions
regarding the determination of deferred income taxes. However, should these tax
positions be challenged and not prevail, different outcomes could result and
have a significant impact on the amounts reported through our Consolidated
Statement of Operations.
The carrying value of our deferred tax assets (tax benefits expected to be
realized in the future) assumes that we will be able to generate, based on
certain estimates and assumptions, sufficient future taxable income in certain
tax jurisdictions to utilize these deferred tax benefits. If these estimates and
related assumptions change in the future, we may be required to reduce the value
of the deferred tax assets resulting in additional income tax expense. We
believe that it is more likely than not that the deferred tax assets, net of
valuation allowance, will be realized, based on forecasted income. However,
there can be no assurance that we will meet our forecasts of future income. We
evaluate the deferred tax assets on a periodic basis and assess the need for
additional valuation allowances.
INFLATION, NEW EMISSIONS CONTROL REGULATIONS AND FUEL COSTS
Most of our operating expenses are inflation-sensitive, with inflation generally
producing increased costs of operations. During the past three years, the most
significant effects of inflation have been on revenue equipment prices and the
compensation paid to the drivers. Also, new emissions control regulations have
resulted in higher tractor prices, and there has been an industry-wide increase
in wages paid to attract and retain qualified drivers. We historically have
limited the effects of inflation through increases in freight rates and certain
cost control efforts.
The engines used in our newer tractors are subject to new emissions control
regulations, which may substantially increase our operating expense. The Federal
Environmental Protection Agency ("EPA") recently adopted new emissions control
regulations, which require progressive reductions in exhaust emissions from
diesel engines through 2007, for engines manufactured in October 2002, and
thereafter. The new regulations decrease the amount of emissions that can be
released by truck engines and affect tractors produced after the effective date
of the regulations. Compliance with such regulations has increased the cost of
our new tractors and could substantially impair equipment productivity, lower
fuel mileage, and increase our operating expenses. Some manufacturers have
significantly increased new equipment prices, in part to meet new engine design
requirements, and have eliminated or sharply reduced the price of repurchase
commitments. These adverse effects combined with the uncertainty as to the
reliability of the vehicles equipped with the newly designed diesel engines and
the residual values that will be realized from the disposition of these vehicles
could increase our costs or otherwise adversely affect our business or
operations.
Fluctuations in the price or availability of fuel, as well as hedging
activities, surcharge collection, and the volume and terms of diesel fuel
purchase commitments, may increase our cost of operation, which could materially
and adversely affect our profitability. Fuel is one of our largest operating
expenses. Fuel prices tend to fluctuate, and from time-to-time we have used fuel
surcharges, hedging contracts, and volume purchase arrangements to attempt to
limit the effect of price fluctuations. We impose fuel surcharges on
substantially all accounts. These arrangements may not fully protect us from
fuel price increases and also may result in us not receiving the full benefit of
any fuel price decreases. We currently do not have any fuel hedging contracts in
place. If we do hedge, we may be forced to make cash payments under the hedging
arrangements. A small portion of our fuel requirements for 2004 are covered by
volume purchase commitments. Based on current market conditions, we have decided
to limit our hedging and purchase commitments, but we continue to evaluate such
measures. The absence of meaningful fuel price protection through these measures
could adversely affect our profitability.
SEASONALITY
In the trucking industry, revenue generally decreases as customers reduce
shipments during the winter holiday season and as inclement weather impedes
operations. At the same time, operating expenses generally increase, with fuel
efficiency declining because of engine idling and weather creating more
equipment repairs. For the reasons stated, first quarter net income historically
has been lower than net income in each of the other three quarters of the year.
Our equipment utilization typically improves substantially between May and
October of each year because of
27
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.
The table below sets forth quarterly information reflecting our equipment
utilization (miles per tractor per period) during 2003, 2002, and 2001. We
believe that equipment utilization more accurately demonstrates the seasonality
for our business than changes in revenue, which are affected by the timing of
deliveries of new revenue equipment. Results of any one or more quarters are not
necessarily indicative of annual results or continuing trends.
Equipment Utilization Table
(Miles Per Tractor Per Period)
First Quarter Second Quarter Third Quarter Fourth Quarter
---------------------------------------------------------------------------------
2003 30,308 32,612 33,568 33,214
2002 30,986 33,461 32,664 32,801
2001 30,860 32,073 32,496 32,286
FACTORS THAT MAY AFFECT FUTURE RESULTS
A number of factors, over which we have little or no control, may affect our
future results. Factors that might cause such a difference include, but are not
limited to, the following:
o Significant increases or rapid fluctuations in fuel price and the prices
and volumes of our fuel hedging and volume purchase requirements, if any.
o Excess tractor and trailer capacity in the trucking industry.
o Declines in the resale value of used equipment.
o Strikes or other work stoppages.
o Increases in interest rates, fuel taxes, and license and registration fees.
o Rising costs of healthcare.
o Increases in insurance costs, liability claims, and self-insurance levels.
o Difficulty in attracting and retaining qualified drivers, including
independent contractors.
o Regulatory changes, including the new hours-of-service requirements for
drivers that became effective in January 2004.
We also are affected by recessionary economic cycles and downturns in customers'
business cycles, particularly in market segments and industries, such as retail
and manufacturing, where we have a significant concentration of customers, and
regions of the country, such as California, Texas, and the Southeast, where we
have a significant amount of business. Economic conditions may adversely affect
our customers and their ability to pay for our services. Customers encountering
adverse economic conditions represent a greater potential for loss and we may be
required to increase our allowance for doubtful accounts.
In addition, it is not possible to predict the effects of actual or threatened
terrorist attacks, efforts to combat terrorism, military action against any
foreign state, heightened security requirements, or other related events. Such
events, however, could negatively impact the economy and consumer confidence in
the United States. Such events could also have a materially adverse effect on
our future results of operations. Moreover, our results of operations may be
affected by seasonal factors. Customers tend to reduce shipments after the
winter holiday season and our operating expenses tend to be higher in the winter
months primarily due to colder weather, which causes higher fuel consumption
from increased idle time and higher repairs and maintenance costs.
28
We self-insure for a significant portion of our claims exposure, which could
significantly increase the volatility of, and decrease the amount of, our
earnings. Our future insurance and claims expense could reduce our earnings and
make our earnings more volatile. We currently self-insure for a portion of our
claims exposure and accrue amounts for liabilities based on our assessment of
claims that arise and our insurance coverage for the periods in which the claims
arise. Our current insurance policy generally provides that we are self-insured
for personal injury and property damage claims for amounts up to $2.0 million
per occurrence for the first $5.0 million of exposure. However, the policy also
provides for an additional $4.0 million self-insured aggregate amount, with a
limit of $2.0 million per occurrence until the $4.0 million aggregate threshold
is reached. 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
responsible for a pro rata portion of legal expenses relating to such claims. We
also are 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 stop loss amount of $275,000 for each group
medical claim. Because of our significant self-insured retention amounts, we
have significant exposure to fluctuations in the number and severity of claims.
If there is an increase in the frequency and severity of claims, or we are
required to accrue or pay additional amounts if the claims prove to be more
severe than originally assessed, our profitability would be adversely affected
and could vary significantly from period to period.
We maintain insurance above the amounts for which we self-insure with licensed
insurance carriers. Since 2001, insurance carriers have been raising premiums
for many businesses, including trucking companies. As a result, our insurance
and claims expense could increase when our current primary casualty and workers'
compensation coverages expire in March 2005, or we could raise our self-insured
retention. If these expenses increase, our earnings could be materially and
adversely affected.
Our current aggregate primary and excess casualty insurance provides coverage up
to a maximum per claim amount of $20.0 million. We do not maintain directors and
officers insurance coverage, although we are obligated to indemnify them against
certain liabilities they may incur while serving in such capacities. If any
claim were to exceed our coverage, we would bear the excess, in addition to our
other self-insured amounts. Any such claim could materially and adversely affect
our financial condition and results of operations.
Ongoing insurance requirements could constrain our borrowing capacity. The
increase in our self-insured retention has caused our outstanding undrawn
letters of credit in favor of insurance companies to increase. At December 31,
2003, our revolving line of credit had a maximum borrowing limit of $100.0
million, outstanding borrowings of $12.0 million, and outstanding letters of
credit of $51.2 million. We expect outstanding letters of credit to increase in
the future. Outstanding letters of credit reduce the available borrowings under
our credit agreement, which could negatively affect our liquidity should we need
to increase our borrowings in the future.
Our casualty insurance coverage may have been limited to $2.0 million between
July and November 2002; accordingly, a significant claim relating to that period
could adversely affect our profitability. On July 15, 2002, we received a binder
for $48.0 million of excess insurance coverage over our $2.0 million primary
layer of accident insurance. Subsequently, we were forced to seek replacement
coverage after the insurance agent retained the premium and failed to produce
proof of insurance coverage. In November 2002, we obtained replacement coverage
of $4.0 million in primary coverage with a $1.0 million self-insured retention
and $16.0 million in excess coverage with a $3.0 million self-insured retention.
In March 2004, we obtained our current program, which has an aggregate $20.0
million in coverage per occurrence, subject to applicable deductibles. We
recognized the premium expense in 2002 and have filed a lawsuit to recover our
premiums paid and to seek coverage from the insurance agency and its errors and
omissions policy on any claims that may exceed $2.0 million in exposure for the
July through November period. Currently, we are not aware of any claims that are
expected to exceed either $2.0 million during the July through November period
or $4.0 million during the November through March period. If one or more claims
from these periods were to exceed the then-effective coverage limits, our
financial condition and results of operations could be materially and adversely
affected.
29
We operate in a highly competitive and fragmented industry, and numerous
competitive factors could impair our ability to maintain or improve our current
profitability.
These factors include:
o We compete with many other truckload carriers of varying sizes and, to a
lesser extent, with less-than-truckload carriers, railroads, and other
transportation companies, many of which have more equipment and greater
capital resources than we do.
o Many of our competitors periodically reduce their freight rates to gain
business, especially during times of reduced growth rates in the economy,
which may limit our ability to maintain or increase freight rates or
maintain significant growth in our business.
o Many of our customers are other transportation companies, and they may
decide to transport their own freight.
o Many customers reduce the number of carriers they use by selecting
so-called "core carriers" as approved service providers, and in some
instances we may not be selected.
o Many customers periodically accept bids from multiple carriers for their
shipping needs, and this process may depress freight rates or result in the
loss of some business to competitors.
o The trend toward consolidation in the trucking industry may create other
large carriers with greater financial resources and other competitive
advantages relating to their size.
o Advances in technology require increased investments to remain competitive,
and our customers may not be willing to accept higher freight rates to
cover the cost of these investments.
o Competition from non-asset-based logistics and freight brokerage companies
may adversely affect our customer relationships and freight rates.
o Economies of scale that may be passed on to smaller carriers by procurement
aggregation providers may improve their ability to compete with us.
We derive a significant portion of our revenue from our major customers, the
loss of one or more of which could have a materially adverse effect on our
business. A significant portion of our revenue is generated from our major
customers. For 2003, our top 25 customers, based on revenue, accounted for
approximately 54% of our revenue; and our top 10 customers, approximately 38% of
our revenue. In the aggregate, subsidiaries of CNF, Inc. accounted for
approximately 11% of our revenue in 2003. We do not expect these percentages to
change materially for 2004. Generally, we do not have long term contractual
relationships with our major customers, and we cannot assure you that our
customers will continue to use our services or that they will continue at the
same levels. For some of our customers, we have entered into multi-year
contracts and we cannot assure you that the rates will remain advantageous. A
reduction in or termination of our services by one or more of our major
customers could have a materially adverse effect on our business and operating
results.
Increases in compensation or difficulty in attracting drivers could affect our
profitability and ability to grow. Periodically, the trucking industry
experiences substantial difficulty in attracting and retaining qualified
drivers, including independent contractors. Our ability to attract and retain
drivers could be adversely affected by increased availability of alternative
employment opportunities in an economic expansion and by the potential need for
more drivers due to more restrictive driver hours-of-service requirements
imposed by the U.S. Department of Transportation effective January 4, 2004. If
we are unable to continue to attract drivers and contract with independent
contractors, we could be required to adjust our driver compensation package, let
trucks sit idle, or operate with fewer independent contractors and face
difficulty meeting shipper demands, all of which could adversely affect our
growth and profitability.
We may not be successful in improving our profitability. From 1994 through 1999,
we achieved an average annual net margin of 4.8%. In 2000, our net margin
declined to 2.1%, and in 2001, we experienced a net loss of $6.7 million,
including a $9.5 million after-tax impairment charge relating to the value of
our tractors. We have implemented certain initiatives designed to improve our
profitability, and in 2003, our net margin improved. However, we face
significant cost increases in 2004 and we cannot assure you that we will be
successful in continuing to improve our profitability. If we fail to sustain or
improve our profitability, our stock price could decline.
30
Our growth may not return to historical rates, which could adversely affect our
stock price. We experienced significant growth in revenue between our founding
in 1986 and 1999. Since 2000, however, our revenue base has remained relatively
constant. There can be no assurance that our revenue growth rate will return to
historical levels or that we can effectively adapt our management,
administrative, and operational systems to respond to any future growth. We can
provide no assurance that our operating margins will not be adversely affected
by future changes in and expansion of our business or by changes in economic
conditions. Slower or less profitable growth could adversely affect our stock
price.
The Department of Transportation adopted revised hours-of-service regulations
that could reduce the amount of allowable driving time, and increased costs of
compliance with, or liability for violation of, these and other regulations
could have a materially adverse effect on our business. The United States
Department of Transportation ("DOT") and various state and local agencies
exercise broad powers over our business, generally governing such activities as
authorization to engage in motor carrier operations, safety, and insurance
requirements. The DOT adopted revised hours-of-service regulations on April 28,
2003, and carriers were required to comply with the regulations beginning
January 4, 2004. This change could reduce the potential or practical amount of
time that drivers can spend driving, if we are unable to limit their other
on-duty activities. These changes could adversely affect our profitability if
shippers are unwilling to assist in managing the drivers' non-driving
activities, such as loading, unloading, and waiting. If these changes increase
our costs and we cannot pass the additional costs through to shippers, our
operating results could be materially and adversely affected. We also may become
subject to new or more restrictive regulations relating to matters such as fuel
emissions and ergonomics. Our company drivers and independent contractors also
must comply with the safety and fitness regulations promulgated by the DOT,
including those relating to drug and alcohol testing. Additional changes in the
laws and regulations governing our industry could affect the economics of the
industry by requiring changes in operating practices or by influencing the
demand for, and the costs of providing, services to shippers.
The IRS is auditing our 2001 and 2002 tax returns and reviewing certain of our
tax planning structures, which, if successfully challenged, would subject us to
increased tax payments. Federal, state, and local taxes comprise a significant
part of our expenses. As such, we actively manage these expenses when executing
our business strategy, and we use a number of structures to permanently decrease
our overall tax liability, or to defer cash tax payments when we believe it is
appropriate. We have disclosed to the IRS the basic elements of two transactions
related to taxes that were implemented in 2001, which we understand are of a
type that have been subject to heightened IRS scrutiny. In the first of these
structures, we formed a contested liability trust to fund the payment of certain
contested third-party claims. We deduct on our federal income tax return the
contributions to the trust in the form of our right to receive payment on
certain notes issued by our subsidiaries. We intend to make further deductions
if we make future contributions in respect of additional third-party claims. In
the second of these structures, we changed our 401(k) plan year to end on
December 29, and as a result deducted our 2002 plan year contribution on our
2001 federal income tax return. Both of these structures were designed to
accelerate deductions to an earlier date than when they otherwise would be
available. We estimate that the combined deductions from these two structures
generated combined cash federal and state tax deferrals to us of approximately
$3.9 million for 2001 and 2002. The tax deferrals did not affect our marginal
tax rate for financial reporting purposes.
As part of its ongoing audit of our 2001 and 2002 tax returns, the IRS has
proposed the disallowance of the deductions relating to the 401(k) plan
structure, and the deductions relating to the contested liability trust. The IRS
also reviewed a captive insurance company that we established in 2002 and that
also was disclosed, and has proposed the disallowance of deductions relating to
the captive insurance company. We are prepared to defend these challenges. If
the IRS successfully challenges the 401(k) plan and contested liability trust
structures, we estimate that we would have to repay the net federal and state
tax deferrals of approximately $3.9 million, plus tax deductible interest. We
would, however, be able to deduct the payments to satisfy third-party claims as
they become fixed and the 401(k) contributions at a later date. If the IRS
successfully challenges the captive insurance company, we would have to pay
approximately $400,000 in additional taxes for 2002 because the deduction would
not be allowed. Because we did not change our marginal tax rate for financial
reporting purposes when we took the deductions, we do not believe our marginal
tax rate will be affected if the structures are disallowed. In the event of a
successful challenge, we also could owe penalties if our disclosures were deemed
inadequate. Likewise, if the IRS were to
31
successfully challenge other structures we have utilized or may utilize or
expand the scope of the audit of our 2002 tax returns, we also could have to
make additional tax payments and perhaps payments of penalties or interest.
We have significant ongoing capital requirements that could affect our
profitability if we are unable to generate sufficient cash from operations and
obtain financing on favorable terms. The truckload industry is capital
intensive. Historically, we have depended on cash from operations and our credit
facility to expand the size of our fleet and maintain modern revenue equipment.
We review our tractor and trailer trade cycle from time-to-time. In 2001, we
extended our trade cycle for tractors from three years to four years because of
a depressed market for used equipment. We are in the process of returning to a
tractor trade cycle of approximately three years. In addition, we are increasing
the ratio of trailers to tractors in our fleet and are replacing many of our
older trailers with new ones. These changes will increase our capital
expenditures and borrowing requirements, or, depending on the method of
financing, our leasing requirements. Our budget for capital expenditures, net of
any offsets from sales or trades of equipment, is $45.0 million in 2004,
exclusive of acquisitions. We expect to pay for the projected capital
expenditures with cash flows from operations, borrowings under our line of
credit, and proceeds under the securitization facility. If we are unable to
generate sufficient cash from operations and obtain financing on favorable terms
in the future, we may have to limit our growth, enter into less favorable
financing arrangements, or operate our revenue equipment for longer periods, any
of which could have a materially adverse effect on our profitability.
We currently have trade-in or fixed residual agreements with certain equipment
suppliers concerning the substantial majority of our tractor fleet. If the
suppliers refuse or are unable to meet their financial obligations under these
agreements, or if we decline to purchase the relevant number of replacement
units from the suppliers, we may suffer a financial loss upon the disposition of
our equipment.
Fluctuations in the price or availability of fuel, as well as hedging
activities, surcharge collection, and the volume and terms of diesel fuel
purchase commitments, may increase our cost of operation, which could materially
and adversely affect our profitability. Fuel is one of our largest operating
expenses. Diesel fuel prices fluctuate greatly due to economic, political, and
other factors beyond our control. For example, our average price for diesel fuel
was $1.43 per gallon in 2003, as compared to $1.25 per gallon in 2002. From
time-to-time we have used fuel surcharges, hedging contracts, and volume
purchase arrangements to attempt to limit the effect of price fluctuations. We
impose fuel surcharges on substantially all accounts. These arrangements may not
fully protect us from fuel price increases and also may result in us not
receiving the full benefit of any fuel price decreases. We currently do not have
any fuel hedging contracts in place. If we do hedge, we may be forced to make
cash payments under the hedging arrangements. A small portion of our fuel
requirements for 2004 are covered by volume purchase commitments. Based on
current market conditions, we have decided to limit our hedging and purchase
commitments, but we continue to evaluate such measures. The absence of
meaningful fuel price protection through these measures could adversely affect
our profitability. We require large amounts of diesel fuel, particularly on the
West Coast and in Texas. Fluctuations in fuel prices, or a shortage of diesel
fuel, could materially and adversely affect our results of operations.
We may not make acquisitions in the future, or if we do, we may not be
successful in our acquisition strategy. We made nine acquisitions between 1996
and 2000, including four between September 1999 and August 2000. Accordingly,
acquisitions have provided a substantial portion of our growth. There is no
assurance that we will be successful in identifying, negotiating, or
consummating any future acquisitions. If we fail to make any future
acquisitions, our growth rate could be materially and adversely affected. Any
acquisitions we undertake could involve the dilutive issuance of equity
securities and/or incurring indebtedness. In addition, acquisitions involve
numerous risks, including difficulties in assimilating the acquired company's
operations, the diversion of our management's attention from other business
concerns, risks of entering into markets in which we have had no or only limited
direct experience, and the potential loss of customers, key employees, and
drivers of the acquired company, all of which could have a materially adverse
effect on our business and operating results. If we make acquisitions in the
future, we cannot assure you that we will be able to successfully integrate the
acquired companies or assets into our business.
Our operations are subject to various environmental laws and regulations, the
violation of which could result in substantial fines or penalties. We are
subject to various environmental laws and regulations dealing with the
32
hauling and handling of hazardous materials, fuel storage tanks, air emissions
from our vehicles and facilities, and discharge and retention of stormwater. We
operate in industrial areas, where truck terminals and other industrial
activities are located, and where groundwater or other forms of environmental
contamination have occurred. Our operations involve the risks of fuel spillage
or seepage, environmental damage, and hazardous waste disposal, among others. We
also maintain above-ground bulk fuel storage tanks and fueling islands at two of
our facilities. A small percentage of our freight consists of low-grade
hazardous substances, which subjects us to a wide array of regulations. If we
are involved in a spill or other accident involving hazardous substances, if
there are releases of hazardous substances we transport, or if we are found to
be in violation of applicable laws or regulations, we could be subject to
liabilities that could have a materially adverse effect on our business and
operating results. If we should fail to comply with applicable environmental
regulations, we could be subject to substantial fines or penalties and to civil
and criminal liability.
The engines used in our newer tractors are subject to new emissions control
regulations, which may substantially increase our operating expense. The Federal
Environmental Protection Agency ("EPA") recently adopted new emissions control
regulations, which require progressive reductions in exhaust emissions from
diesel engines through 2007, for engines manufactured in October 2002, and
thereafter. The new regulations decrease the amount of emissions that can be
released by truck engines and affect tractors produced after the effective date
of the regulations. Compliance with such regulations has increased the cost of
our new tractors and could substantially impair equipment productivity, lower
fuel mileage, and increase our operating expenses. Some manufacturers have
significantly increased new equipment prices, in part to meet new engine design
requirements, and have eliminated or sharply reduced the price of repurchase
commitments. These adverse effects combined with the uncertainty as to the
reliability of the vehicles equipped with the newly designed diesel engines and
the residual values that will be realized from the disposition of these vehicles
could increase our costs or otherwise adversely affect our business or
operations.
New Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS 143 provides new guidance on the recognition and measurement
of an asset retirement obligation and its associated asset retirement cost. It
also provides accounting guidance for obligations associated with the retirement
of tangible long-lived assets. This pronouncement was effective January 1, 2003.
We adopted SFAS 143 effective January 1, 2003. The adoption of this statement
did not have a material impact on our financial condition or results of
operations.
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. We 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 our financial statements. The disclosure requirements
are effective for financial statements of interim or annual periods ending after
December 15, 2002. We have guarantees which are included in the notes to our
consolidated financial statements.
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In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation/Transition and Disclosure, an amendment of FASB Statement No. 123.
SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for a voluntary change to the fair value
method of accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of SFAS 123 to require prominent
disclosures in both annual and interim financial statements. Certain of the
disclosure modifications are required for fiscal years and interim periods
ending after December 15, 2002 and are included in the notes to our consolidated
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. 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. Our adoption of this
statement will not have any significant impact on our 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 our balance sheet
presentation of our debt and equity financial instruments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks from changes in (i) certain commodity prices and
(ii) certain interest rates on our 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
2003 diesel fuel expenses net of fuel surcharge represented 14.9% of our total
operating expenses and 15.1% of freight revenue. At December 31, 2003 we had no
derivative financial instruments to reduce our exposure to fuel price
fluctuations.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
INTEREST RATE RISK
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.
34
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
floats daily, or LIBOR, which accrues interest based on one, two, three, or six
month LIBOR rates plus an applicable margin that is adjusted quarterly between
0.75% and 1.25% based on cash flow coverage (the applicable margin was 1.0% at
December 31, 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
December 31, 2003, the fair value of these interest rate swap agreements was a
liability of $1.2 million. At December 31, 2003, we had variable, base rate
borrowings of $12.0 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 December 31, 2003, borrowings
of $48.4 million had been drawn on the Securitization Facility. Assuming
variable rate borrowings under the Credit Agreement and Securitization Facility
at December 31, 2003 levels, a one percentage point increase in interest rates
would increase our annual interest expense by $604,000.
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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our audited consolidated balance sheets, statements of operations, cash flows,
stockholders' equity and comprehensive loss, and notes related thereto, are
contained at Pages 43 to 62 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There has been no change in accountants during our two most recent fiscal years.
ITEM 9A. 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. During the
Company's fourth fiscal quarter, there were no changes in our internal control
over financial reporting that have materially affected, or that are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in the Company's
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include controls and procedures designed to ensure that information required to
be disclosed in Company reports filed under the Exchange Act is accumulated and
communicated to management, including the Company's Chief Executive Officer 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
35
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.
36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information respecting executive officers and directors set forth under the
captions "Election of Directors - Information Concerning Directors and Executive
Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in our
Proxy Statement for the 2004 annual meeting of stockholders, which will be filed
with the Securities and Exchange Commission in accordance with Rule 14a-6
promulgated under the Securities Exchange Act of 1934, as amended (the "Proxy
Statement") is incorporated by reference; provided, that the "Audit Committee
Report for 2003" and the Stock Performance Graph contained in the Proxy
Statement are not incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information respecting executive compensation set forth under the caption
"Executive Compensation" in our Proxy Statement for the 2004 annual meeting of
stockholders is incorporated herein by reference; provided, that the
"Compensation Committee Report on Executive Compensation" contained in the Proxy
Statement is not incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information respecting security ownership of certain beneficial owners and
management set forth under the caption "Security Ownership of Certain Beneficial
Owners and Management" in our Proxy Statement for the 2004 annual meeting of
stockholders is incorporated herein by reference. The following table provides
certain information as of December 31, 2003, with respect to our compensation
plans and other arrangements under which shares of our Common Stock are
authorized for issuance.
Equity Compensation Plan Information
- --------------------------------------------------------------------------------------------------------------------------
Number of securities
Number of securities remaining available for
to be issued upon Weighted-average future issuance under
exercise of exercise price of equity compensation plans
outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
- --------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- --------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders(1) 1,172,640 $13.55 1,225,000
- --------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders(2) 56,750 $12.03 0
- --------------------------------------------------------------------------------------------------------------------------
Total 1,229,390 $13.45 1,225,000
- --------------------------------------------------------------------------------------------------------------------------
(1) Includes 1994 Incentive Stock Plan, Outside Director Stock Option Plan, and
2003 Incentive Stock Plan.
(2) Includes 1998 Non-Officer Incentive Stock Plan, and shares reserved for
issuance pursuant to grants outside any plan.
Summary Description of Equity Compensation Plans Not Approved by Security
Holders
Summary of 1998 Non-Officer Incentive Stock Plan
In October 1998, the Company's Board of Directors adopted the Non-Officer Plan
to attract and retain executive personnel and other key employees and motivate
them through incentives that were aligned with the Company's
37
goals of increased profitability and stockholder value and authorized 200,000
shares of the Company's Class A Common Stock for grants or awards pursuant to
the Non-Officer Plan. Awards under the Plan could be in the form of incentive
stock options, non-qualified stock options, restricted stock awards, or any
other awards of stock consistent with the Non-Officer Plan's purpose. The
Non-Officer Plan was to be administered by the Board of Directors or a committee
that could be appointed by the Board of Directors. All non-officer employees
were eligible for participation, and actual participants in the Non-Officer Plan
were selected from time-to-time by the administrator. The administrator could
substitute new stock options for previously granted options. In conjunction with
adopting the 2003 Plan, the Board of Directors voted to terminate the
Non-Officer Plan effective as of May 31, 2003. Option grants previously issued
continue in effect and may be exercised on the terms and conditions under which
the grants were made.
Summary of Grants Outside the Plan
On August 31, 1998, the Company's Board of Directors approved the grant of an
option to purchase 5,000 shares of the Company's Class A Common Stock to each of
the four outside directors of the Company. The exercise price of the stock was
equal to the mean between the lowest reported bid price and the highest reported
asked price on the date of the grant. The options have a term of ten years from
the date of grant, and the options vest 20% on each of the first through fifth
anniversaries of the grant.
On September 23, 1998, the Company's Board of Directors approved the grant of an
option to purchase 20,000 shares of the Company's Class A Common Stock to Tony
Smith upon closing of the acquisition of Southern Refrigerated Transport, Inc.
and Tony Smith Trucking, Inc. The exercise price was the mean between the low
bid price and the high asked price on the closing date. The options have a term
of ten years from the date of grant, and the options vest 20% on each of the
first through fifth anniversaries of the grant.
On May 20, 1999, the Company's Board of Directors approved the grant of an
option to purchase 2,500 shares of the Company's Class A Common Stock to each of
the four outside directors of the Company. The exercise price of the stock was
equal to the mean between the lowest reported bid price and the highest reported
asked price on the date of the grant. The options have a term of ten years from
the date of grant, and the options vest 20% on each of the first through fifth
anniversaries of the grant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information respecting certain relationships and transactions of management
set forth under the captions "Compensation Committee Interlocks and Insider
Participation" and "Certain and Relationships and Related Transactions" in our
Proxy Statement for the 2004 annual meeting of stockholders is incorporated
herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information respecting accounting fees and services set forth under the
caption "Principal Accounting Fees and Services" in our Proxy Statement for the
2004 annual meeting of stockholders is incorporated herein by reference.
38
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements.
Our audited consolidated financial statements are set forth at the following
pages of this report:
Independent Auditors' Report - KPMG LLP..........................................................................43
Consolidated Balance Sheets......................................................................................44
Consolidated Statements of Operations............................................................................45
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)..................................46
Consolidated Statements of Cash Flows............................................................................47
Notes to Consolidated Financial Statements.......................................................................48
2. Financial Statement Schedules.
Financial statement schedules are not required because all required information
is included in the financial statements.
3. Exhibits.
See list under Item 15(c) below, with management compensatory plans and
arrangements being listed under Exhibits 10.1, 10.2, 10.3, 10.8, and 10.10.
(b) Reports on Form 8-K during the fourth quarter ended December 31, 2003.
Forms 8-K were filed on October 24, 2003, to report operating results for the
quarter and nine months ended September 30, 2003, and October 28, 2003, to
report the filing of a registration statement with the Securities and Exchange
Commission.
(c) Exhibits
Exhibit
Number Reference Description
3.1 (1) Restated Articles of Incorporation.
3.2 (1) Amended Bylaws dated September 27, 1994.
4.1 (1) Restated Articles of Incorporation.
4.2 (1) Amended Bylaws dated September 27, 1994.
10.1 (1) 401(k) Plan filed as Exhibit 10.10.
10.2 (2) Outside Director Stock Option Plan, filed as Appendix A.
10.3 (3) Amendment No. 1 to the Outside Director Stock Option Plan, filed as
Exhibit 10.11.
10.4 (4) Credit Agreement by and among Covenant Asset Management, Inc.,
Covenant Transport, Inc., Bank of America, N.A., and each other
financial institution which is a party to the Credit Agreement, dated
December 13, 2000, filed as Exhibit 10.9.
10.5 (4) Loan Agreement dated December 12, 2000, among CVTI Receivables Corp.,
Covenant Transport, Inc., Three Pillars Funding Corporation, and
SunTrust Equitable Securities Corporation, filed as Exhibit 10.10.
10.6 (4) Receivables Purchase Agreement dated as of December 12, 2000, among
CVTI Receivables Corp., Covenant Transport, Inc., and Southern
Refrigerated Transport, Inc., filed as Exhibit 10.11.
39
10.7 (5) Clarification of Intent and Amendment No. 1 to Loan Agreement dated
March 7, 2001, among CVTI Receivables Corp., Covenant Transport, Inc.,
Three Pillars Funding Corporation, and SunTrust Equitable Securities
Corporation, filed as Exhibit 10.12.
10.8 (6) Incentive Stock Plan, Amended and Restated as of May 17, 2001, filed
as Appendix B.
10.9 (7) Amendment No. 1 to Credit Agreement dated August 28, 2001, among
Covenant Asset Management, Inc., Covenant Transport, Inc., Bank of
America, N.A., and each other financial institution which is a party
to the Credit Agreement, filed as Exhibit 10.11.
10.10 (8) Covenant Transport, Inc. 2003 Incentive Stock Plan, filed as Appendix
B.
10.11 (9) Amendment No. 2 to Credit Agreement dated February 26, 2003, among
Covenant Asset Management, Inc., Covenant Transport, Inc., Bank of
America, N.A., and each other financial institution which is a party
to the Credit Agreement, filed as Exhibit 10.1.
10.12 (10) Amendment No. 3 to Credit Agreement dated June 11, 2003, among
Covenant Asset Management, Inc., Covenant Transport, Inc., Bank of
America, N.A., and each other financial institution which is a party
to the Credit Agreement, filed as Exhibit 10.1.
10.13 (10) Consolidating Amendment No. 1 to Loan Agreement effective May 2, 2003,
among CVTI Receivables Corp., Covenant Transport, Inc., Three Pillars
Funding Corporation, and SunTrust Capital Markets, Inc. (formerly
SunTrust Equitable Securities Corporation), filed as Exhibit 10.3.
10.14 (11) Master Lease Agreement dated April 15, 2003, between Transport
International Pool, Inc. and Covenant Transport, Inc., filed as
Exhibit 10.4.
10.15 # Amendment No. 4 to Credit Agreement dated December 1, 2003, among
Covenant Asset Management, Inc., Covenant Transport, Inc., Bank of
America, N.A., and each other financial institution which is a party
to the Credit Agreement.
10.16 # Amendment No. 5 to Loan Agreement dated December 9, 2003, among CVTI
Receivables Corp., Covenant Transport, Inc., Three Pillars Funding LLC
(successor to Three Pillars Funding Corporation), and SunTrust Capital
Markets, Inc. (formerly SunTrust Equitable Securities Corporation)
(Three other amendments were consolidated into Consolidating Amendment
No. 1, filed with the Form 10-Q for the quarter ended June 30, 2003).
21 # List of Subsidiaries.
23 # Independent Auditors' Consent - KPMG LLP.
31.1 # Certification pursuant to Item 601(b)(31) of Regulation S-K, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by
David R. Parker, the Company's Chief Executive Officer.
31.2 # Certification pursuant to Item 601(b)(31) of Regulation S-K, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by
Joey B. Hogan, the Company's Chief Financial Officer.
32 # Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, by David R. Parker,
the Company's Chief Executive Officer, and Joey B. Hogan, the
Company's Chief Financial Officer.
- -------------------------------------------------------------------------------------------------------------------
40
References:
# Filed herewith
All other footnotes indicate a document previously filed as an exhibit to and
incorporated by reference from the following:
(1) Form S-1, Registration No. 33-82978, effective October 28, 1994.
(2) Schedule 14A, filed April 13, 2000.
(3) Form 10-Q for the quarter ended September 30, 2000, filed November 13,
2000.
(4) Form 10-K for the year ended December 31, 2000, filed March 29, 2001.
(5) Form 10-Q for the quarter ended March 31, 2001, filed May 14, 2001.
(6) Schedule 14A, filed April 5, 2001.
(7) Form 10-Q/A for the quarter ended September 30, 2001, filed July 30, 2002.
(8) Schedule 14A, filed April 16, 2003.
(9) Form 10-Q for the quarter ended March 31, 2003, filed May 14, 2003.
(10) Form 10-Q for the quarter ended June 30, 2003, filed August 11, 2003.
(11) Form 10-Q/A for the quarter ended June 30, 2003, filed October 31, 2003.
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 11, 2004 By: /s/ Joey B. Hogan
------------------ -------------------------------------
Joey B. Hogan
Executive Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature and Title Date
/s/ David R. Parker March 11, 2004
- -----------------------------------------------------
David R. Parker
Chairman of the Board, President, and Chief Executive
Officer (principal executive officer)
/s/ Michael W. Miller March 11, 2004
- -----------------------------------------------------
Michael W. Miller
Director
/s/ Joey B. Hogan March 11, 2004
- -----------------------------------------------------
Joey B. Hogan
Executive Vice President and Chief Financial Officer
(principal financial and accounting officer)
/s/ Brad A. Moline March 11, 2004
- -----------------------------------------------------
Brad A. Moline
Director
/s/ William T. Alt March 11, 2004
- -----------------------------------------------------
William T. Alt
Director
/s/ Robert E. Bosworth March 11, 2004
- -----------------------------------------------------
Robert E. Bosworth
Director
/s/ Hugh O. Maclellan, Jr. March 11, 2004
- -----------------------------------------------------
Hugh O. Maclellan, Jr.
Director
/s/ Mark A. Scudder March 11, 2004
- -----------------------------------------------------
Mark A. Scudder
Director
/s/ Niel B. Nielson March 11, 2004
- -----------------------------------------------------
Niel B. Nielson
Director
42
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Covenant Transport, Inc.
We have audited the accompanying consolidated balance sheets of Covenant
Transport, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income (loss), and cash flows for each of the years in the
three-year period ended December 31, 2003. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Covenant
Transport, Inc. and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with the accounting
principles generally accepted in the United States of America.
As discussed in note 1 to the consolidated financial statements, effective
January 1, 2002, the Company adopted Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets.
/s/ KPMG LLP
Atlanta, Georgia
January 27, 2004
43
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
(In thousands, except share data)
2003 2002
----------------- -----------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 3,306 $ 42
Accounts receivable, net of allowance of $1,350 in 2003
and $1,800 in 2002 62,998 65,041
Drivers advances and other receivables 9,622 3,480
Inventory and supplies 3,581 3,226
Prepaid expenses 16,185 14,450
Deferred income taxes 13,462 11,105
Income taxes receivable 278 2,585
----------------- -----------------
Total current assets 109,432 99,929
Property and equipment, at cost 320,909 392,498
Less accumulated depreciation and amortization (99,175) (154,010)
----------------- -----------------
Net property and equipment 221,734 238,488
Other assets 23,115 23,124
----------------- -----------------
Total assets $354,281 $361,541
================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt 1,300 43,000
Securitization facility 48,353 39,230
Accounts payable 8,822 6,921
Accrued expenses 14,420 17,220
Insurance and claims 27,420 21,210
----------------- -----------------
Total current liabilities 100,315 127,581
Long-term debt, less current maturities 12,000 1,300
Deferred income taxes 49,824 57,072
----------------- -----------------
Total liabilities 162,139 185,953
Commitments and contingent liabilities
Stockholders' equity:
Class A common stock, $.01 par value; 20,000,000 shares
authorized; 13,295,026 and 12,999,315 shares issued; 12,323,526 and
12,027,815 outstanding as of December 31, 2003 and 2002, respectively 133 130
Class B common stock, $.01 par value; 5,000,000 shares authorized;
2,350,000 shares issued and outstanding as of December 31, 2003 and 2002 24 24
Additional paid-in-capital 88,888 84,493
Treasury Stock at cost; 971,500 shares as of December 31, 2003 and 2002 (7,935) (7,935)
Retained earnings 111,032 98,876
----------------- -----------------
Total stockholders' equity 192,142 175,588
----------------- -----------------
Total liabilities and stockholders' equity $354,281 $361,541
================= =================
See accompanying notes to consolidated financial statements.
44
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(In thousands, except per share data)
2003 2002 2001
---------------- ---------------- ---------------
Freight revenue $ 546,766 $ 541,830 $ 547,028
Fuel and accessorial surcharges 35,691 22,588 26,593
---------------- ---------------- ---------------
Total revenue 582,457 564,418 573,621
Operating expenses:
Salaries, wages, and related expenses 220,665 227,332 244,849
Fuel expense 109,231 96,332 103,894
Operations and maintenance 39,822 39,625 39,410
Revenue equipment rentals and purchased
transportation 69,997 59,265 65,104
Operating taxes and licenses 14,354 13,934 14,358
Insurance and claims 35,454 31,761 27,838
Communications and utilities 7,177 7,021 7,439
General supplies and expenses 14,495 14,677 14,468
Depreciation, amortization and impairment charge, including
gains (losses) on disposition of equipment (1) 43,041 49,497 56,324
---------------- ---------------- ---------------
Total operating expenses 554,236 539,444 573,684
---------------- ---------------- ---------------
Operating income (loss) 28,221 24,974 (63)
Other (income) expenses:
Interest expense 2,332 3,542 7,855
Interest income (114) (63) (328)
Other (468) 916 799
Loss on early extinguishment of debt - 1,434 -
---------------- ---------------- ---------------
Other (income) expenses, net 1,750 5,829 8,326
---------------- ---------------- ---------------
Income (loss) before income taxes 26,471 19,145 (8,389)
Income tax expense (benefit) 14,315 10,871 (1,727)
---------------- ---------------- ---------------
Net income (loss) $ 12,156 $ 8,274 $ (6,662)
================ ================ ===============
Net income (loss) per share:
Basic earnings (loss) per share: $0.84 $0.58 ($0.48)
Diluted earnings (loss) per share: $0.83 $0.57 ($0.48)
Basic weighted average shares outstanding 14,467 14,223 13,987
Diluted weighted average shares outstanding 14,709 14,519 13,987
(1) Includes a $3.3 million and a $15.4 million pre-tax impairment charge in 2002 and 2001 respectively.
See accompanying notes to consolidated financial statements.
45
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(In thousands)
Additional Accumulated Total
Common Stock Paid-In Treasury Other Retained Stockholders' Comprehensive
----------------- Capital Stock Comprehensive Earnings Equity Income (Loss)
Class A Class B Income (Loss)
------------------------------------------------------------------------------------------------
Balances at December 31, 2000 $ 126 $ 24 $ 78,343 $ (7,935) -- $ 97,264 $ 167,822
====================================================================================
Exercise of employee stock options 1 -- 1,270 -- -- -- 1,271
Income tax benefit arising from the
exercise of stock options -- -- 219 -- -- -- 219
Comprehensive loss:
Unrealized loss on cash flow
hedging derivatives, net of taxes -- -- -- -- (748) -- (748) (748)
Net loss -- -- -- -- -- (6,662) (6,662) (6,662)
------------
Comprehensive loss for 2001 $(7,410)
--------------------------------------------------------------------------------------============
Balances at December 31, 2001 $ 127 $ 24 $ 79,832 $ (7,935) $(748) $ 90,602 $ 161,902
=====================================================================================
Exercise of employee stock options 3 -- 3,878 -- -- -- 3,881
Income tax benefit arising from the
exercise of stock options -- -- 783 -- -- -- 783
Unrealized gain on cash flow
hedging derivatives, net of taxes -- -- -- -- 748 -- 748 748
Net income -- -- -- -- -- 8,274 8,274 8,274
------------
Comprehensive income for 2002 $9,022
--------------------------------------------------------------------------------------============
Balances at December 31, 2002 $ 130 $ 24 $ 84,493 $(7,935) $ -- $ 98,876 $ 175,588
======================================================================================
Exercise of employee stock options 3 -- 3,615 -- -- -- 3,618
Income tax benefit arising from the
exercise of stock options -- -- 780 -- -- -- 780
Net income -- -- -- -- -- 12,156 12,156 12,156
------------
Comprehensive income for 2003 $12,156
--------------------------------------------------------------------------------------============
Balances at December 31, 2003 $ 133 $ 24 $ 88,888 $(7,935) $ -- $111,032 $ 192,142
======================================================================================
See accompanying notes to consolidated financial statements.
46
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(In thousands)
2003 2002 2001
---------------- ---------------- ----------------
Cash flows from operating activities:
Net income (loss) $12,156 $8,274 ($6,662)
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for losses on accounts receivable 94 852 722
Loss on early extinguishment of debt -- 1,434 --
Depreciation, amortization, and impairment of assets (1) 43,909 47,090 56,107
Provision for losses on guaranteed residuals -- 324 --
Equity in earnings of affiliate -- -- 140
Income tax benefit from exercise of stock options 780 783 219
Deferred income taxes (9,605) (1,537) (5,674)
(Gain) loss on disposition of property and equipment (867) 2,407 217
Changes in operating assets and liabilities:
Receivables and advances (4,193) (1,317) 16,610
Prepaid expenses (1,735) (2,625) 2,090
Inventory and supplies (356) 245 (522)
Insurance and claims 6,210 9,356 10,597
Accounts payable and accrued expenses 1,343 1,881 (80)
---------------- ---------------- ----------------
Net cash flows provided by operating activities 47,716 67,167 73,764
Cash flows from investing activities:
Acquisition of property and equipment (94,362) (70,720) (55,466)
Proceeds from disposition of property and equipment 68,487 14,369 24,705
Acquisition of business -- -- (564)
---------------- ---------------- ----------------
Net cash used in investing activities (25,875) (56,351) (31,325)
Cash flows from financing activities:
Exercise of stock options 3,615 3,881 1,271
Proceeds from issuance of debt 72,000 85,000 54,000
Repayments of long-term debt (93,877) (100,038) (99,519)
Deferred costs (315) -- --
Other -- -- (95)
---------------- ---------------- ----------------
Net cash used in financing activities (18,577) (11,157) (44,343)
---------------- ---------------- ----------------
Net change in cash and cash equivalents 3,264 (341) (1,904)
Cash and cash equivalents at beginning of period 42 383 2,287
---------------- ---------------- ----------------
Cash and cash equivalents at end of period $3,306 $42 $383
================ ================ ================
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $2,332 $4,016 $7,880
================ ================ ================
Income taxes $22,795 $12,389 $967
================ ================ ================
(1) Includes a $3.3 million and a $15.4 million pre-tax impairment charge in 2002 and 2001 respectively.
See accompanying notes to consolidated financial statements.
47
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business - Covenant Transport, Inc. (the "Company") is a long-haul
truckload carrier that offers premium transportation services, such as team,
refrigerated and dedicated contract services, to customers throughout the United
States. The Company operations comprise a single segment for financial reporting
purposes.
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company, a holding company incorporated in the state of Nevada
in 1994, and its wholly-owned operating subsidiaries, Covenant Transport, Inc.,
a Tennessee corporation; Harold Ives Trucking Co., an Arkansas corporation;
Terminal Truck Broker, Inc., an Arkansas corporation (Harold Ives Trucking Co.
and Terminal Truck Broker, Inc. referred together as "Harold Ives"); Southern
Refrigerated Transport, Inc., an Arkansas corporation; Tony Smith Trucking,
Inc., an Arkansas corporation (Southern Refrigerated Transport, Inc. and Tony
Smith Trucking, Inc. referred together as "SRT"); Covenant.com, Inc., a Nevada
corporation; Covenant Asset Management, Inc., a Nevada corporation; CIP, Inc., a
Nevada corporation; CVTI Receivables Corp., ("CRC") a Nevada corporation and
Volunteer Insurance Limited, a Cayman Islands company. Terminal Truck Broker,
Inc., an Arkansas corporation was dissolved in September 2003. All significant
intercompany balances and transactions have been eliminated in consolidation.
Revenue Recognition - Revenue, drivers' wages and other direct operating
expenses are recognized on the date shipments are delivered to the customer. The
Company includes fuel surcharges and accessorial revenue in total revenue in the
statement of operations.
Cash and Cash Equivalents - The Company considers all highly liquid investments
with a maturity of three months or less to be cash equivalents.
Inventories and supplies- Inventories and supplies consist of parts, tires, fuel
and supplies. Tires on new revenue equipment are capitalized as a component of
the related equipment cost when the vehicle is placed in service and recovered
through depreciation over the life of the vehicle. Replacement tires and parts
on hand at year end are recorded at the lower of cost or market with cost
determined using the first-in, first-out (FIFO) method. Replacement tires are
expensed when placed in service.
Property and Equipment - Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. We depreciate revenue
equipment excluding day cabs over five to ten years with salvage values ranging
from 9% to 33%. We 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 operations. During the fourth quarter of 2001 and the first
quarter of 2002, the Company recognized pre-tax charges of approximately $15.4
million and $3.3 million, respectively, to reflect an impairment in tractor
values. The charges related to the Company's approximately 2,100 model year 1998
through 2000 in-use tractors. The Company also 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.
Impairment of Long-Lived Assets - The Company evaluates the carrying value of
long-lived assets by analyzing the operating performance and future cash flows
for those assets or whenever events or changes in circumstances indicate that
the carrying amounts of such assets may not be recoverable. The carrying value
of the underlying assets is adjusted if the sum of the expected cash flows is
less than the carrying value on an undiscounted basis. Impairment can be
impacted by our projection of the actual level of cash flows, future cash flows
and salvage values, the methods of estimation used for determining fair values.
48
Intangible Assets - The Company periodically evaluates the net realizability of
the carrying amount of intangible assets. Non-compete agreements are amortized
over the life of the agreement and deferred loan costs are amortized over the
life of the loan.
Goodwill - Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards (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 being amortized after January 1, 2002. During the
second quarter of 2003 and 2002, the Company completed its annual evaluation of
its goodwill for impairment and determined that there was no impairment. At
December 31, 2003, the Company has approximately $11.5 million of goodwill. Had
goodwill not been amortized in 2001, the Company's net loss and net loss per
share would have been as follows for the year ended December 31, 2001:
(in thousands except per share data) December 31, 2001
----------------------
Net loss as reported $(6,662)
Add back goodwill amortization, net of tax 248
----------------------
Adjusted net loss $(6,414)
======================
Basic and diluted earnings (losses) per share:
As reported ($0.48)
Goodwill amortization, net of tax 0.02
----------------------
As adjusted ($0.46)
======================
Fair Value of Financial Instruments - The Company's financial instruments
consist primarily of cash, accounts receivable, accounts payable and long term
debt. The carrying amount of cash, accounts receivable and accounts payable
approximates their fair value because of the short term maturity of these
instruments. Interest rates that are currently available to the Company for
issuance of long term debt with similar terms and remaining maturities are used
to estimate the fair value of the Company's long term debt. The carrying amount
of the Company's long term debt at December 31, 2003 and 2002 was approximately
$61.7 million and $83.5 million, respectively, including the accounts receivable
securitization borrowings and approximates the estimated fair value, due to the
variable interest rates on these instruments.
Capital Structure - The shares of Class A and B Common Stock are substantially
identical except that the Class B shares are entitled to two votes per share and
Class A only one vote per share. The terms of any future issuances of preferred
shares will be set by the Board of Directors.
Insurance and Claims - The Company's insurance program for liability, property
damage, and cargo loss and damage, involves self-insurance with high retention
levels. Under the casualty program, the Company is self-insured for personal
injury and property damage claims for varying amounts depending on the date the
claim was incurred. In addition, the insurance retention also provides for an
additional self-insured aggregate amount, with a limit per occurrence until an
aggregate threshold is reached. The deductible amount increased from $250,000 in
2001, to $500,000 in March of 2002. From November 2002 to March 2003, the
deductible amount increased to $1.0 million per claim, and from March 2003 to
December 31, 2003 the deductible increased to $2.0 million per claim. In
November 2003, the excess coverage was renewed, which will expire in March 2005.
Cargo loss and damage claims are also self-insured for amounts up to $1.0
million per occurrence. The Company is self-insured for workers' compensation
and group medical claims incurred for employees with a deductible amount of $1.0
million for each workers' compensation claim and a stop loss amount of $275,000
for each group medical claim. The Company accrues the estimated cost of the
retained portion of incurred 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. Insurance and claims expense will vary
based on the frequency and severity of claims, the premium expense and
self-insured retention levels.
49
From 1999 to present, the Company carried excess coverage in amounts that have
ranged from $15.0 million to $49.0 million in addition to its primary insurance
coverage. On July 15, 2002, the Company received a binder for $48.0 million of
excess insurance coverage over its $2.0 million primary layer. Subsequently, the
Company was 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, the
Company would accrue for the potential or actual loss and its financial
condition and results of operations could be materially and adversely affected.
Concentrations of Credit Risk - The Company performs ongoing credit evaluations
of its customers and does not require collateral for its accounts receivable.
The Company maintains reserves which management believes are adequate to provide
for potential credit losses. The Company's customer base spans the continental
United States. Three of the Company's customers, which are autonomously managed
and operated are wholly owned subsidiaries of a public entity and when added
together amount to approximately 11% of revenue in 2003 and 2002 and
approximately 13% of revenue in 2001.
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
Income Taxes - Income taxes are accounted for using the asset and liability
method. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Derivative Instruments and Hedging Activities - The Company engages in
activities that expose it to market risks, including the effects in changes in
interest rates and fuel prices. Financial exposures are evaluated as an integral
part of the Company's risk management program, which seeks, from time to time,
to reduce potentially adverse effects that the volatility of the interest rate
and fuel markets may have on operating results. The Company does not regularly
engage in speculative transactions, nor does it regularly hold or issue
financial instruments for trading purposes.
All derivatives are recognized on the balance sheet at their fair values. On the
date the derivative contract is entered into, the Company designates the
derivative a hedge of a forecasted transaction or of the variability of cash
flows to be received or paid related to a recognized asset or liability ("cash
flow" hedge). The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as cash-flow hedges to specific
assets and liabilities on the balance sheet or to specific firm commitments or
forecasted transactions.
The Company also formally assesses, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items.
Changes in the fair value of a derivative that is highly effective and that is
designated and qualifies as a fair-value hedge, along with the loss or gain on
the hedged asset or liability or unrecognized firm commitment of the hedged item
that is attributable to the hedged risk are recorded in earnings. Changes in the
fair value of a derivative that is highly effective and that is designated and
qualifies as a cash-flow hedge are recorded in other comprehensive income, until
earnings are affected by the variability in cash flows or unrecognized firm
commitment of the designated hedged item.
50
The Company discontinues hedge accounting prospectively when it is determined
that the derivative is no longer effective in offsetting changes in the fair
value or cash flows of the hedged item, the derivative expires or is sold,
terminated, or exercised, the derivative is undesignated as a hedging
instrument, because it is unlikely that a forecasted transaction will occur, a
hedged firm commitment no longer meets the definition of a firm commitment, or
management determines that designation of the derivative as a hedging instrument
is no longer appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair-value hedge, the Company
continues to carry the derivative on the balance sheet at its fair value, and no
longer adjusts the hedged asset or liability for changes in fair value. The
adjustment of the carrying amount of the hedged asset or liability is accounted
for in the same manner as other components of the carrying amount of that asset
or liability. When hedge accounting is discontinued because the hedged item no
longer meets the definition of a firm commitment, the Company continues to carry
the derivative on the balance sheet at its fair value, removes any asset or
liability that was recorded pursuant to recognition of the firm commitment from
the balance sheet and recognizes any gain or loss in earnings. When hedge
accounting is discontinued because it is probable that a forecasted transaction
will not occur, the Company continues to carry the derivative on the balance
sheet at its fair value, and gains and losses that were accumulated in other
comprehensive income are recognized immediately in earnings. In all other
situations in which hedge accounting is discontinued, the Company continues to
carry the derivative at its fair value on the balance sheet, and recognizes any
changes in its fair value in earnings.
Effect of New Accounting Pronouncements - In June 2001, the FASB issued SFAS No.
143, Accounting for Asset Retirement Obligations. SFAS 143 provides new guidance
on the recognition and measurement of an asset retirement obligation and its
associated asset retirement cost. It also provides accounting guidance for
obligations associated with the retirement of tangible long-lived assets. This
pronouncement was effective January 1, 2003. The Company adopted SFAS 143
effective January 1, 2003. The adoption of this statement did not have a
material impact on the Company's financial condition or results of operations.
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 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. The Company has guarantees which are described
in the notes to these consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation/Transition and Disclosure, an amendment of FASB Statement No. 123.
SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for a voluntary change to the fair value
method of accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of SFAS 123 to require prominent
disclosures in both annual and interim financial statements. Certain of the
disclosure modifications are required for fiscal years and interim periods
ending after December 15, 2002 and are included in the notes to these
consolidated financial statements.
51
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. 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.
Earnings per Share ("EPS") - The Company applies the provisions of FASB SFAS No.
128, Earnings per Share, which requires companies to present basic EPS and
diluted EPS. Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the dilution that could occur
if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company.
Dilutive common stock options are included in the diluted EPS calculation using
the treasury stock method. Common stock options were not included in the diluted
EPS computation for 2001 because the options were anti-dilutive.
The following table sets forth for the periods indicated the weighed average
shares outstanding used in the calculation of net income (loss) per share
included in the Company's Consolidated Statement of Operations:
(in thousands except per share data) 2003 2002 2001
---------------- ---------------- ----------------
Denominator for basic earnings
per share - weighted-average shares 14,467 14,223 13,987
Effect of dilutive securities:
Employee stock options 242 296 -
---------------- ---------------- ----------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and
assumed conversions 14,709 14,519 13,987
================ ================ ================
At December 31, 2003, the Company had four stock-based employee compensation
plans, which are described more fully in Note 12. The Company accounts for those
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. The following table
illustrates the effect on
52
net income and earnings per share if the Company had applied the fair value
recognition provisions of FASB Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation.
(in thousands except per share data) 2003 2002 2001
----------------- ----------------- ----------------
Net income (loss), as reported: $12,156 $8,274 $(6,662)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (1,743) (1,894) (2,300)
----------------- ----------------- ----------------
Pro forma net income (loss) $10,413 $6,380 $(8,962)
================= ================= ================
Basic earnings (loss) per share:
As reported $0.84 $0.58 $(0.48)
Pro forma $0.72 $0.45 $(0.64)
Diluted earnings (loss) per share:
As reported $0.83 $0.57 $(0.48)
Pro forma $0.71 $0.44 $(0.64)
Reclassifications - Certain prior period financial statement balances have been
reclassified to conform to the current period's classification.
2. INVESTMENT IN TRANSPLACE
Effective July 1, 2000, the Company combined its logistics business with the
logistics businesses of five other transportation companies into a company
called Transplace, Inc. ("TPC"). TPC operates a global transportation logistics
service. In the transaction, Covenant contributed its logistics customer list,
logistics business software and software licenses, certain intellectual
property, intangible assets totaling approximately $5.1 million, and $5.0
million in cash for the initial funding of the venture. In exchange, Covenant
received 12.4% ownership in TPC. Upon completion of the transaction, Covenant
ceased operating its own transportation logistics and brokerage business, which
consisted primarily of the Terminal Truck Broker, Inc. business acquired in
November 1999. The contributed operation generated approximately $5.0 million in
net brokerage revenue (gross revenue less purchased transportation expense)
annually. Until 2001, the Company accounted for its 12.4% investment in TPC
using the equity method of accounting. During the third quarter of 2001, TPC
changed its filing status to a C corporation and as a result management
determined it appropriate to account for its investment using the cost method of
accounting effective July 1, 2001.
3. ACQUISITIONS
In August 2000, the Company purchased certain assets of Con-Way Truckload
Services, Inc. ("CTS") for approximately $7.7 million, which included
approximately $5.2 million for property and equipment. The acquisition has been
accounted for using the purchase method of accounting. In 2001, the Company made
a $564,000 earnout payment related to this acquisition.
53
4. PROPERTY AND EQUIPMENT
A summary of property and equipment, at cost, as of December 31, 2003 and 2002
is as follows:
(in thousands) 2003 2002
------------------------ ------------------------
Revenue equipment $237,890 $311,280
Communications equipment 16,271 15,949
Land and improvements 14,392 14,000
Buildings and leasehold improvements 40,039 39,794
Construction in progress 51 17
Other 12,266 11,458
------------------------ ------------------------
$320,909 $392,498
======================== ========================
Depreciation expense amounts were $43.6 million, $46.7 million and $55.1 million
in 2003, 2002 and 2001, respectively. The 2002 and 2001 amounts included a $3.3
million pre-tax impairment charge ($2.0 million after taxes) and a $15.4 million
pre-tax impairment charge ($9.6 million after taxes), respectively. The charges
related to approximately 2,100 model year 1998 through 2000 in use tractors.
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.
54
5. OTHER ASSETS
A summary of other assets as of December 31, 2003 and 2002 is as follows:
(in thousands) 2003 2002
----------------- -----------------
Covenants not to compete $1,690 $1,690
Trade name 330 330
Goodwill 12,416 12,416
Less accumulated amortization of intangibles (2,507) (2,466)
----------------- -----------------
Net intangible assets 11,929 11,970
Investment in TPC 10,666 10,666
Other 520 488
----------------- -----------------
$23,115 $23,124
================= =================
6. LONG-TERM DEBT
Long-term debt consists of the following at December 31, 2003 and 2002:
(in thousands) 2003 2002
------------------ ------------------
Borrowings under $100 million credit agreement $ 12,000 $ 43,000
Note payable to former SRT shareholder, bearing
interest at 6.5% with interest payable quarterly 1,300 1,300
------------------ ------------------
13,300 44,300
Less current maturities 1,300 43,000
------------------ ------------------
$12,000 $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, three, or six 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 1.0% at December 31, 2003). At
December 31, 2003, the Company had only base rate borrowings in the amount of
$12.0 million 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.
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 $70.0
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 December 31, 2003, the
Company had $12.0 million of borrowings outstanding under the Credit Agreement
with approximately $36.8 million of available borrowing capacity. At December
31, 2003 and December 31, 2002, the Company had undrawn letters of credit
outstanding of approximately $51.2 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
$1.4 million pre-tax loss to reflect the early extinguishment of this debt.
55
Maturities of long term debt at December 31, 2003 are as follows (in thousands):
2004 $1,300
2005 12,000
The Credit Agreement contains 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.
7. ACCOUNTS RECEIVABLE SECURITIZATION AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
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 December 31, 2003 and
December 31, 2002, the Company had received $48.4 million and $39.2 million,
respectively, in proceeds, with a weighted average interest rate of 1.0% and
1.5%, respectively.
The Securitization Facility contains 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 December
31, 2003, the Company was in compliance with the Securitization Facility
covenants.
The activity in allowance for doubtful accounts (in thousands) is as follows:
Years ended December 31: Beginning Additional Write-offs Ending
Balance provisions and other Balance
January 1, to allowance deductions December 31,
-------------------------------------------------------------------
2003 $1,800 $94 $544 $1,350
====== === ==== ======
2002 $1,623 $852 $675 $1,800
====== ==== ==== ======
2001 $1,263 $722 $362 $1,623
====== ==== ==== ======
8. LEASES
The Company has operating lease commitments for office and terminal properties,
revenue equipment, computer and office equipment, exclusive of owner/operator
rentals, and month-to-month equipment rentals, summarized for the following
fiscal years (in thousands):
2004 $ 32,046
2005 30,854
2006 23,863
2007 14,778
2008 12,676
Thereafter 14,151
56
The Company's operating leases of tractors and trailers contain residual value
guarantees under which the Company guarantees a certain minimum cash value
payment to the leasing company at the expiration of the lease. The Company
estimates that the residual guarantees are approximately $42.7 million and $56.8
million at December 31, 2003 and December 31, 2002.
Rental expense is summarized as follows for each of the three years ended
December 31:
(in thousands) 2003 2002 2001
---------------- ---------------- ----------------
Revenue equipment rentals $25,625 $16,877 $19,819
Terminal rentals 1,041 1,115 1,055
Other equipment rentals 3,201 2,943 3,198
---------------- ---------------- ----------------
$29,867 $ 20,934 $ 24,072
================ ================ ================
During April 1996, the Company entered into an agreement to lease its
headquarters and terminal in Chattanooga under an operating lease. The lease
provided for rental payments to be variable based upon LIBOR interest rates for
five years. This operating lease expired March 2001 and the Company purchased
the building.
9. INCOME TAX
Income tax expense (benefit) for the years ended December 31, 2003, 2002, and
2001 is comprised of:
(in thousands) 2003 2002 2001
---------------- ---------------- ----------------
Federal, current $20,011 $11,116 $3,498
Federal, deferred (7,771) (387) (5,355)
State, current 3,909 1,251 449
State, deferred (1,834) (1,109) (319)
---------------- ---------------- ----------------
$14,315 $10,871 ($1,727)
================ ================ ================
Income tax expense varies from the amount computed by applying the federal
corporate income tax rate of 35% to income before income taxes for the years
ended December 31, 2003, 2002 and 2001 as follows:
(in thousands) 2003 2002 2001
---------------- ---------------- ----------------
Computed "expected" income tax expense $9,265 $6,701 ($2,936)
State income taxes, net of federal income tax
effect 1,349 91 85
Change in valuation allowance - (392) 392
Per diem allowances 3,487 3,471 1,346
Other, net 214 1,000 (614)
---------------- ---------------- ----------------
Actual income tax expense (benefit) $14,315 $10,871 ($1,727)
================ ================ ================
57
The temporary differences and the approximate tax effects that give rise to the
Company's net deferred tax liability at December 31, 2003 and 2002 are as
follows:
(in thousands) 2003 2002
---------------------- ----------------------
Deferred tax assets:
Accounts receivable $351 $605
Insurance and claims 10,836 8,949
Intangible assets - 113
State net operating loss carryovers 1,815 1,013
Deferred gain 300 265
Investments 160 160
---------------------- ----------------------
Total gross deferred tax assets 13,462 11,105
---------------------- ----------------------
Deferred tax liability:
Property and equipment 48,001 53,167
Intangible assets 76 -
Accrued salaries and wages 605 605
Prepaid liabilities 1,142 3,300
---------------------- ----------------------
Total deferred tax liabilities 49,824 57,072
---------------------- ----------------------
Net deferred tax liability $36,362 $45,967
====================== ======================
Based upon the expected reversal of deferred tax liabilities and the level of
historical and projected taxable income over periods in which the deferred tax
assets are deductible, the Company's management believes it is more likely than
not the Company will realize the benefits of the deductible differences at
December 31, 2003. In the normal course of business, we are subject to audits
from the Federal, state, and other tax authorities regarding various tax
liabilities. Currently, the IRS is auditing our federal income tax returns for
years 2001 and 2002. These audits may alter the timing or amount of taxable
income or deductions, or the allocation of income among tax jurisdictions. The
amount ultimately paid upon resolution of issues raised may differ from the
amount accrued. We believe that the amounts accrued on the Consolidated Balance
Sheet represent an adequate accrual for our tax liabilities at December 31,
2003.
10. STOCK REPURCHASE PLAN
During 2000, the Company authorized a stock repurchase plan for up to 1.5
million Company shares to be purchased in the open market or through negotiated
transactions. During 2000, 971,500 shares were purchased at an average price of
$8.17. The Company has not purchased any additional shares through the
repurchase plan since 2000. The stock repurchase program has no expiration date.
11. DEFERRED PROFIT SHARING EMPLOYEE BENEFIT PLAN
The Company has a deferred profit sharing and savings plan that covers
substantially all employees of the Company with at least six months of service.
Employees may contribute up to 17% of their annual compensation subject to
Internal Revenue Code maximum limitations. The Company may make discretionary
contributions as determined by a committee of the Board of Directors. The
Company contributed approximately $0.8 million, $1.0 million and $1.1 million in
2003, 2002 and 2001, respectively, to the profit sharing and savings plan.
12. STOCK OPTION PLANS
The Company has adopted option plans for employees and directors. Awards may be
in the form of incentive stock awards or other forms. The Company has reserved
2,165,269 shares of Class A Common Stock for distribution at the discretion of
the Board of Directors. In July 2000, the Board of Directors accelerated the
vesting schedule of
58
certain stock options granted in the years 1998, 1999 and 2000 to vest ratably
over 3 years and expire 10 years from the date of grant. Certain options granted
prior to 1998 vest ratably over 5 years and expire 10 years from the date of
grant. The following table details the activity of the incentive stock option
plan:
Weighted Options
Average Exercisable at
Shares Exercise Price Year End
-------------------------------------------------------
Under option at December 31, 2000 1,425,326 $11.99 613,026
Options granted in 2001 308,000 $16.71
Options exercised in 2001 (113,633) $11.19
Options canceled in 2001 (37,248) $10.54
-------------------
Under option at December 31, 2001 1,582,445 $12.99 856,486
Options granted in 2002 186,250 $15.61
Options exercised in 2002 (318,832) $12.22
Options canceled in 2002 (68,323) $14.29
-------------------
Under option at December 31, 2002 1,381,540 $13.48 855,685
Options granted in 2003 196,664 $17.51
Options exercised in 2003 (295,711) $12.24
Options canceled in 2003 (53,103) $15.19
-------------------
Under option at December 31, 2003 1,229,390 $14.37 891,813
===================
Options Outstanding Options Exercisable
-------------------------------------------------------------------------------------------
Weighted-
Number Average Weighted- Number Weighted-
Range of Exercise Outstanding at Remaining Average Exercisable At Average
Prices 12/31/03 Contractual Life Exercise Price 12/31/03 Exercise Price
- ------------------------------------------------------------------------------------------------------------------
$ 8.00 to $13.00 401,894 72 $10.00 401,894 $10.00
$13.01 to $16.50 388,939 54 $15.50 296,727 $15.54
$16.51 to $20.00 438,557 95 $17.37 193,192 $17.43
----------------- ----------------
1,229,390 891,813
================= ================
The Company accounts for its stock-based compensation plans under APB No. 25,
under which no compensation expense has been recognized because all employee
stock options have been granted with the exercise price equal to the fair value
of the Company's Class A Common Stock on the date of grant. Under SFAS No. 123,
fair value of options granted are estimated as of the date of grant using the
Black-Scholes option pricing model and the following weighted average
assumptions: risk-free interest rates ranging from 1.7% to 4.8%; expected life
of 5 years; dividend rate of zero percent; and expected volatility of 55.3% for
2001, 53.3% for 2002 and 40.8% for 2003. Using these assumptions, the fair value
of the employee stock options which would have been expensed in 2001, 2002 and
2003 is $2.3 million, $1.8 million and $1.7 million respectively.
59
13. RELATED PARTY TRANSACTIONS
Transactions involving related parties, not otherwise disclosed herein, are as
follows:
In February 2000, the Company sold approximately 2.5 acres of land to a
significant shareholder in the amount of $88,000 in the form of a non-interest
bearing promissory note with an 18-month term. The note was paid in full in
September 2001.
Tenn-Ga Truck Sales, Inc., a corporation wholly owned by a significant
shareholder, purchased used tractors and trailers from the Company for
approximately $3.0 million and $600,000 during 2002 and 2001, respectively. In
2003 and 2002, the Company purchased equipment from Tenn-Ga Truck Sales for
approximately $286,000 and $37,000, respectively. Also in 2003, the Company was
retained to repair certain equipment owned by Tenn-Ga Truck Sales for
approximately $223,000.
In connection with the TPC investment, the Company made several cash advances to
fund the operations of TPC. The balance as of December 31, 2000 was
approximately $3.2 million, which included a $2.6 million, 8% interest-bearing
promissory note from TPC, which was paid in full in the month of February 2001.
The Company also provides transportation services for TPC. During 2003, 2002 and
2001, gross revenue from TPC was $9.6 million, $7.4 million and $9.0 million,
respectively. The accounts receivable balance as of December 31, 2003 was
approximately $1.2 million.
A company wholly owned by a relative of a significant shareholder and executive
officer operates a "Company Store" on a rent-free basis in the Company's
headquarters building, and uses Covenant service marks on its products at no
cost. The Company made purchases from this store totaling approximately
$350,000, $390,000, and $310,000 in 2003, 2002, and 2001, respectively.
14. DERIVATIVE INSTRUMENTS
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
million notional amount cancelable interest rate swap agreements to manage the
risk of variability in cash flows associated with floating-rate debt. Due to the
counter-parties' imbedded options to cancel, these derivatives did not qualify,
and are not designated as hedging instruments under SFAS No. 133. Consequently,
these derivatives are marked to fair value through earnings, in other expense in
the accompanying statement of operations. At December 31, 2003 and 2002, the
fair value of these interest rate swap agreements was a liability of $1.2
million and $1.6 million, respectively, which are included in accrued expenses
on the consolidated balance sheets.
The Company uses purchase commitments through suppliers to reduce a portion of
its cash flow exposure to fuel price fluctuations. At December 31, 2003, the
notional amount for purchase commitments for 2004 is approximately 12 million
gallons. In addition, 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 on floating rate diesel fuel purchase
commitments. 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. Each called for 6 million gallons of fuel purchases at a
fixed price of $0.695 and $0.629 per gallon, respectively. The contracts expired
December 31, 2002.
60
The derivative activity as reported in the Company's financial statements for
the years ended December 31, 2003 and 2002 is summarized in the following:
(in thousands): 2003 2002
--------------- ----------------
Net liability for derivatives at January 1, $ (1,645) $ (1,932)
Changes in statements of operations:
Gain (loss) on derivative instruments:
Gain (loss) in value of derivative instruments that do
not qualify
as hedging instruments 444 (919)
Other comprehensive income:
Gain on fuel hedge contracts that qualify as cash flow hedges - 1,206
Tax expense - 458
Net other comprehensive gain - 748
--------------- ----------------
Net liability for derivatives at December 31, $ (1,201) $ (1,645)
=============== ================
15. COMMITMENTS AND CONTINGENT LIABILITIES
The Company, in the normal course of business, is involved in certain legal
matters for which it carries liability insurance, subject to certain exclusions
and deductibles. It is management's belief that the losses, if any, from these
matters will not have a materially adverse impact on the financial condition,
operations, or cash flows of the Company.
Financial risks which potentially subject the Company to concentrations of
credit risk consist of deposits in banks in excess of the Federal Deposit
Insurance Corporation limits. The Company's sales are generally made on account
without collateral. Repayment terms vary based on certain conditions. The
Company maintains reserves which management believes are adequate to provide for
potential credit losses. The majority of the Company's customer base spans the
United States. The Company monitors these risks and believes the risk of
incurring material losses is remote.
61
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(In thousands except per share amounts)
Quarters ended March 31, 2003 June 30, 2003 Sept. 30, 2003 Dec. 31, 2003
----------------------------------------------------------------------------------
Operating Revenue $137,875 $145,942 $146,483 $152,157
Operating income 3,514 7,449 8,486 8,773
Net earnings 839 3,164 4,050 4,104
Basic earnings per share 0.06 0.22 0.28 0.28
Diluted earnings per share 0.06 0.22 0.28 0.28
Quarters ended March 31, 2002 June 30, 2002 Sept. 30, 2002 Dec. 31, 2002
(1)
----------------------------------------------------------------------------------
Operating Revenue $132,219 $144,312 $141,223 $146,664
Operating income 851 7,563 8,780 7,779
Net earnings (loss) (1,667) 2,982 3,611 3,350
Basic earnings (loss) per share (0.12) 0.21 0.25 0.23
Diluted earnings (loss) per share (0.12) 0.21 0.25 0.23
(1) Includes a $3.3 million pre-tax impairment charge and a $1.4 million pre-tax loss on early extinguishment of debt in the
quarter ended March 31, 2002.
62