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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number 0-24960
COVENANT TRANSPORT, INC.
(Exact name of registrant as specified in its charter)
Nevada 88-0320154
- ---------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
400 Birmingham Hwy.
Chattanooga, TN 37419 37419
- --------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
423-821-1212
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date (May 3, 2004).
Class A Common Stock, $.01 par value: 12,329,209 shares
Class B Common Stock, $.01 par value: 2,350,000 shares
Page 1
PART I
FINANCIAL INFORMATION
Page Number
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2004 (Unaudited) and December 31,
2003 3
Consolidated Statements of Operations for the three months ended March 31, 2004
and 2003 (Unaudited) 4
Consolidated Statements of Cash Flows for the three months ended March 31, 2004
and 2003 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
Item 4. Controls and Procedures 21
PART II
OTHER INFORMATION
Page Number
Item 1. Legal Proceedings 23
Items 2, 3, 4, and 5. Not applicable 23
Item 6. Exhibits and reports on Form 8-K 23
Page 2
ITEM 1. FINANCIAL STATEMENTS
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
March 31, 2004 December 31, 2003
ASSETS (unaudited)
------ --------------------- ----------------------
Current assets:
Cash and cash equivalents $ 2,194 $ 3,306
Accounts receivable, net of allowance of $1,350 in 2004
and 2003 62,772 62,998
Drivers advances and other receivables 4,949 9,622
Inventory and supplies 3,170 3,581
Prepaid expenses 17,800 16,185
Deferred income taxes 13,462 13,462
Income taxes receivable 278 278
--------------------- ----------------------
Total current assets 104,625 109,432
Property and equipment, at cost 298,296 320,909
Less accumulated depreciation and amortization (90,656) (99,175)
--------------------- ----------------------
Net property and equipment 207,640 221,734
Other assets 23,066 23,115
--------------------- ----------------------
Total assets $ 335,331 $ 354,281
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt 1,300 1,300
Securitization facility 39,153 48,353
Accounts payable 10,766 8,822
Accrued expenses 15,266 14,420
Insurance and claims accrual 27,609 27,420
--------------------- ----------------------
Total current liabilities 94,094 100,315
Long-term debt, less current maturities - 12,000
Deferred income taxes 48,324 49,824
--------------------- ----------------------
Total liabilities 142,418 162,139
Commitments and contingent liabilities
Stockholders' equity:
Class A common stock, $.01 par value; 20,000,000 shares
authorized; 13,299,193 and 13,295,026 shares issued;
12,327,693 and 12,323,526 outstanding as of March 31, 2004
and December 31, 2003, respectively 133 133
Class B common stock, $.01 par value; 5,000,000 shares
authorized; 2,350,000 shares issued and outstanding as of
March 31, 2004 and December 31, 2003 24 24
Additional paid-in-capital 88,938 88,888
Treasury Stock at cost; 971,500 shares as of March 31, 2004
and December 31, 2003 (7,935) (7,935)
Retained earnings 111,753 111,032
--------------------- ----------------------
Total stockholders' equity 192,913 192,142
--------------------- ----------------------
Total liabilities and stockholders' equity $ 335,331 $ 354,281
===================== ======================
The accompanying notes are an integral part of these consolidated financial statements.
Page 3
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(In thousands except per share data)
Three months ended March 31,
(unaudited)
2004 2003
---- ----
Freight revenue $ 130,590 $ 130,353
Fuel surcharges 7,077 7,522
---------------------- ---------------------
Total revenue $ 137,667 $ 137,875
Operating expenses:
Salaries, wages, and related expenses 51,958 53,810
Fuel expense 27,551 28,788
Operations and maintenance 7,711 9,994
Revenue equipment rentals and purchased
transportation 18,564 14,818
Operating taxes and licenses 3,479 3,431
Insurance and claims 8,265 8,039
Communications and utilities 1,781 1,708
General supplies and expenses 3,497 3,173
Depreciation and amortization, including gains
(losses) on disposition of equipment 11,803 10,600
---------------------- ---------------------
Total operating expenses 134,609 134,361
---------------------- ---------------------
Operating income 3,058 3,514
Other (income) expenses:
Interest expense 608 651
Interest income (11) (38)
Other 20 (15)
---------------------- ---------------------
Other (income) expenses, net 617 598
---------------------- ---------------------
Income before income taxes 2,441 2,916
Income tax expense 1,720 2,077
---------------------- ---------------------
Net income $ 721 $ 839
====================== =====================
Net income per share:
Basic and diluted earnings per share: $ 0.05 $ 0.06
Basic weighted average shares outstanding 14,676 14,381
Diluted weighted average shares outstanding 14,858 14,670
The accompanying notes are an integral part of these consolidated financial statements.
Page 4
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(In thousands)
Three months ended March 31,
(unaudited)
--------------------------------------------
2004 2003
---- ----
Cash flows from operating activities:
Net income $ 721 $ 839
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for losses on accounts receivable - (162)
Depreciation and amortization 10,845 10,833
Deferred income taxes (1,500) (4)
(Gain) loss on disposition of property and equipment 958 (234)
Changes in operating assets and liabilities:
Receivables and advances 4,899 (264)
Prepaid expenses (1,615) (3,012)
Inventory and supplies 411 46
Insurance and claims 189 901
Accounts payable and accrued expenses 2,790 2,742
-------------- --------------
Net cash flows provided by operating activities 17,698 11,685
Cash flows from investing activities:
Acquisition of property and equipment (9,473) (2,103)
Proceeds from disposition of property and equipment 11,813 8,231
-------------- --------------
Net cash provided by investing activities 2,340 6,128
Cash flows from financing activities:
Exercise of stock options 50 53
Proceeds from issuance of debt 6,000 5,000
Repayments of long-term debt (27,200) (21,000)
Deferred costs - (315)
-------------- --------------
Net cash used in financing activities (21,150) (16,262)
-------------- --------------
Net change in cash and cash equivalents (1,112) 1,551
Cash and cash equivalents at beginning of period 3,306 42
Cash and cash equivalents at end of period $ 2,194 $ 1,593
============== ==============
The accompanying notes are an integral part of these consolidated financial statements.
Page 5
COVENANT TRANSPORT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned
subsidiaries ("Covenant" or the "Company"). All significant intercompany
balances and transactions have been eliminated in consolidation.
The financial statements have been prepared, without audit, in accordance
with accounting principles generally accepted in the United States of
America, pursuant to the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the accompanying
financial statements include all adjustments which are necessary for a fair
presentation of the results for the interim periods presented, such
adjustments being of a normal recurring nature. Certain information and
footnote disclosures have been condensed or omitted pursuant to such rules
and regulations. The December 31, 2003 consolidated balance sheet was
derived from the audited balance sheet of the Company for the year then
ended. It is suggested that these consolidated financial statements and
notes thereto be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Form 10-K for the
year ended December 31, 2003. Results of operations in interim periods are
not necessarily indicative of results to be expected for a full year.
Note 2. Comprehensive Earnings
Comprehensive earnings generally include all changes in equity during a
period except those resulting from investments by owners and distributions
to owners. Comprehensive earnings for the three-month periods ended March
31, 2004 and 2003 equalled net income.
Note 3. Basic and Diluted Earnings per Share
The following table sets forth for the periods indicated the calculation of
net earnings per share included in the Company's consolidated statements of
operations:
(in thousands except per share data) Three months ended
March 31,
2004 2003
---- ----
Numerator:
Net earnings $ 721 $ 839
Denominator:
Denominator for basic earnings
per share - weighted-average share 14,676 14,381
Effect of dilutive securities:
Employee stock options 182 289
---------- ----------
Denominator for diluted earnings per share -
adjusted weighted-average shares and assumed
conversions 14,858 14,670
========== ==========
Net income per share:
Basic and diluted earnings per share: $0.05 $0.06
Page 6
Dilutive common stock options are included in the diluted EPS calculation
using the treasury stock method. Employee stock options in the table above
exclude 60,000 and 70,462 in the three months ended March 31, 2004 and
2003, respectively, from the computation of diluted earnings per share
because their effect would have been anti-dilutive. The Company accounts
for the plans under the recognition and measurement principles of APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost is reflected in
net income, as all options granted under those plans had an exercise price
equal to the market value of the underlying common stock on the date of
grant. Under SFAS No. 123, Accounting for Stock-Based Compensation, fair
value of options granted are estimated as of the date of grant using the
Black-Scholes option pricing model and the following weighted average
assumptions: risk-free interest rates ranging from 2.3% to 3.5%; expected
life of 5 years; dividend rate of zero percent; and expected volatility of
52.5% for the 2004 period, and 53.2% for the 2003 period. Using these
assumptions, the fair value of the employee stock options granted, net of
the related tax effects, in the three months ended March 31, 2004 and 2003
periods are $0.3 million and $0.5 million, respectively. The following
table illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of SFAS No. 123
to stock-based employee compensation.
(in thousands except per share data) Three months ended
March 31,
2004 2003
---- ----
Net income, as reported: $ 721 $ 839
Deduct: Total stock-based employee compensation
expense determined under fair value based method for all
awards, net of related tax effects (332) (539)
----------- ------------
Pro forma net income $ 389 $ 300
Basic and diluted earnings per share:
As reported $0.05 $0.06
Pro forma $0.03 $0.02
Note 4. Income Taxes
Income tax expense varies from the amount computed by applying the federal
corporate income tax rate of 34% to income before income taxes primarily
due to state income taxes, net of federal income tax effect, adjusted for
permanent differences, the most significant of which is the effect of the
per diem pay structure for drivers.
Note 5. Derivative Instruments and Other Comprehensive Income
The FASB issued SFAS No. 133 ("SFAS 133"), Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133, as amended, requires that
all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or in other comprehensive income, depending on whether a
derivative is designated as part of a hedging relationship and, if it is,
depending on the type of hedging relationship.
The Company adopted SFAS No. 133 effective January 1, 2001 but had no
instruments in place on that date. In 2001, the Company entered into two
$10.0 million notional amount cancelable interest rate swap agreements to
manage the risk of variability in cash flows associated with floating-rate
debt. Due to the counter-parties' imbedded options to cancel, these
derivatives did not qualify, and are not designated as hedging instruments
under SFAS No. 133. Consequently, these derivatives are marked to fair
value through earnings, in other expense in the accompanying statements of
operations. At March 31, 2004 and 2003, 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.
Page 7
The derivative activity, as reported in the Company's financial statements
for the three months ended March 31, is summarized in the following:
(in thousands) Three months ended
March 31,
2004 2003
---- ----
Net liability for derivatives at January 1 $ (1,201) $ (1,645)
Gain (loss) in value of derivative instruments that do not
qualify as hedging instruments (28) 20
---------- ----------
Net liability for derivatives at March 31 $ (1,229) $ (1,625)
========== ==========
Note 6. Property and Equipment
Depreciation is calculated using the straight-line method over the
estimated useful lives of the assets. For the quarter ended March 31, 2004,
the annualized depreciation expense on tractors and trailers is
approximately $38.4 million. We depreciate revenue equipment excluding day
cabs over five to ten years with salvage values ranging from 9% to 33%. We
evaluate the salvage value, useful life, and annual depreciation of
tractors and trailers annually based on the current market environment and
our recent experience with disposition values. We also evaluate the
carrying value of long-lived assets for impairment by analyzing the
operating performance and future cash flows for those assets, whenever
events or changes in circumstances indicate that the carrying amounts of
such assets may not be recoverable. We evaluate the need to adjust the
carrying value of the underlying assets if the sum of the expected cash
flows is less than the carrying value. Impairment can be impacted by our
projection of future cash flows, the level of actual cash flows and salvage
values, the methods of estimation used for determining fair values and the
impact of guaranteed residuals. Any changes in management's judgments could
result in greater or lesser annual depreciation expense or additional
impairment charges in the future.
Note 7. Securitization facility and long-term debt
Outstanding debt consisted of the following at March 31, 2004 and December
31, 2003:
(in thousands) March 31, 2004 December 31, 2003
--------------------- ---------------------
Securitization facility $ 39,153 $ 48,353
===================== =====================
Borrowings under credit agreement $ - $ 12,000
Note payable to former SRT shareholder, bearing
interest at 6.5% with interest payable quarterly 1,300 1,300
--------------------- ----------------------
Total long-term debt 1,300 13,300
Less current maturities 1,300 1,300
--------------------- ----------------------
Long-term debt, less current portion $ - $ 12,000
===================== ======================
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 a Consolidated Leverage Ratio which is generally defined
as the ratio of borrowings, letters of credit, and the present value of
operating lease obligations to our earnings before interest, income taxes,
depreciation, amortization, and rental payments under operating leases. The
applicable margin was 1.125% at March 31, 2004. At March 31, 2004, the
Company had no borrowings outstanding under the Credit Agreement. The
Credit Agreement is guaranteed by the Company and all of the Company's
subsidiaries except CVTI Receivables Corp. ("CRC") and Volunteer Insurance
Limited.
Page 8
The Credit Agreement has a maximum borrowing limit of $100.0 million, with
a feature which permits an increase up to a maximum borrowing limit of
$140.0 million. Borrowings related to revenue equipment are limited to the
lesser of 90% of net book value of revenue equipment or the maximum
borrowing limit. Letters of credit are limited to an aggregate commitment
of $70.0 million. The Credit Agreement includes a "security agreement" such
that the Credit Agreement may be collateralized by virtually all 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 the
Consolidated Leverage Ratio, is due on the daily unused portion of the
Credit Agreement. At March 31, 2004 and December 31, 2003, the Company had
undrawn letters of credit outstanding of approximately $57.2 million and
$51.2 million, respectively. As of March 31, 2004, we had approximately
$42.8 million of borrowing capacity under the Credit Agreement.
In December 2000, the Company entered into an accounts receivable
securitization facility (the "Securitization facility"). On a revolving
basis, the Company sells its interests in its 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. The Company can receive up to $62.0 million of
proceeds, subject to eligible receivables and will pay a service fee
recorded as interest expense, based on commercial paper interest rates plus
an applicable margin of 0.41% per annum and a commitment fee of 0.10% per
annum on the daily unused portion of the facility. The net proceeds under
the Securitization facility are required to be shown as a current liability
because the term, subject to annual renewals, is 364 days. As of March 31,
2004 and December 31, 2003, the Company had received $39.2 million and
$48.4 million, respectively, in proceeds, with a weighted average interest
rate of 1.1% and 1.0%, respectively. The transaction does not meet the
requirements for off-balance sheet accounting; therefore, it is reflected
in the Company's consolidated financial statements.
The Credit Agreement and Securitization facility contain certain
restrictions and covenants relating to, among other things, dividends,
tangible net worth, Consolidated Leverage Ratio, acquisitions and
dispositions, and total indebtedness. All of these agreements are
cross-defaulted. The Company was in compliance with these agreements as of
March 31, 2004.
Note 8. Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board issued FIN 46-R
Consolidation of Variable Interest Entities. This Interpretation of
Accounting Research Bulletin No. 51, Consolidated Financial Statements,
addresses consolidation by business enterprises of variable interest
entities. For enterprises that are not small business issuers, FIN 46-R is
to be applied to all variable interest entities by the end of the first
reporting period ending after March 15, 2004. Our adoption of FIN 46-R did
not have an impact on our financial condition or results of operations.
Page 9
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The consolidated financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned subsidiaries.
References in this report to "we," "us," "our," the "Company," and similar
expressions refer to Covenant Transport, Inc. and its consolidated subsidiaries.
All significant intercompany balances and transactions have been eliminated in
consolidation.
Except for the historical information contained herein, the discussion in this
quarterly report contains forward-looking statements that involve risk,
assumptions, and uncertainties that are difficult to predict. Statements that
constitute forward-looking statements are usually identified by words such as
"anticipates," "believes," "estimates," "projects," "expects," "plans,"
"intends," or similar expressions. These statements are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Such statements are based upon the current beliefs and expectations of our
management and are subject to significant risks and uncertainties. Actual
results may differ from those set forth in the forward-looking statements. The
following factors, among others, could cause actual results to differ materially
from those in forward-looking statements: excess tractor and trailer capacity in
the trucking industry; decreased demand for our services or loss of one or more
of our major customers; surplus inventories; recessionary economic cycles and
downturns in customers' business cycles; strikes, work slow downs, or work
stoppages at our facilities, or at customer, port, or other shipping related
facilities; increases or rapid fluctuations in fuel prices as well as
fluctuations in hedging activities and surcharge collection, the volume and
terms of diesel purchase commitments, interest rates, fuel taxes, tolls, and
license and registration fees; increases in the prices paid for new revenue
equipment; the resale value of our used equipment and the price of new
equipment; increases in compensation for and difficulty in attracting and
retaining qualified drivers and independent contractors; elevated experience in
the frequency and severity of claims relating to accident, cargo, workers'
compensation, health, and other matters; high insurance premiums and deductible
amounts; seasonal factors such as harsh weather conditions that increase
operating costs; competition from trucking, rail, and intermodal competitors;
regulatory requirements that increase costs or decrease efficiency, including
revised hours-of-service requirements for drivers; 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 with the
Securities and Exchange Commission.
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 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.
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 the quarter ended March 31, 2004, total revenue remained essentially
constant at $137.7 million, compared with $137.9 million in the 2003 period. Net
income decreased to $721,000, or $.05 per diluted share, from $839,000, or $.06
per diluted share, for the first quarter of 2003. Higher revenue per mile in the
first quarter was more than offset by increases in equipment-related costs.
Page 10
Revenue
We generate substantially all of our revenue by transporting freight for our
customers. Generally, we are paid by the mile or by the load for our services.
The main factors that affect our revenue are the revenue per mile we receive
from our customers, the percentage of miles for which we are compensated, the
number of tractors operating and the number of miles we generate with our
equipment. These factors relate, 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. Historically, we have
measured freight revenue, before fuel and accessorial surcharges, in addition to
total revenue. However with the new hours-of-service regulations that became
effective January 4, 2004, accessorial revenue, primarily for equipment
detention and stop offs, has increased significantly. Under the new regulatory
requirements, we have determined it to be appropriate to reclassify accessorial
revenue, excluding fuel surcharges, into freight revenue, and our historical
financial statements have been conformed to this presentation. We continue to
report fuel surcharge revenue separately.
Since 2000 we have held our fleet size relatively constant. An overcapacity of
trucks in our fleet and the industry generally as the economy slowed has
contributed to lower equipment utilization and pricing pressure. The main
constraints on our internal growth are the ability to recruit and retain a
sufficient number of qualified drivers and in times of slower economic growth,
to add profitable freight.
In addition to constraining fleet size, we reduced our number of two-person
driver teams during 2001 and have since held the percentage relatively constant
to better match the demand for expedited long-haul service. Our single driver
fleets generally operate in shorter lengths of haul, generate fewer miles per
tractor, and experience more non-revenue miles, but the additional expenses and
lower productive miles are expected to be offset by generally higher revenue per
loaded mile and the reduced employee expense of compensating only one driver. We
expect operating statistics and expenses to shift with the mix of single and
team operations.
Since the middle of 2003, we have been conducting an evaluation of the freight
in what we call "in-between" movements. 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 have been examining each in-between movement and negotiating
with our customers to raise rates, obtain more favorable loads, or cease hauling
the in-between loads. During the period of our evaluation in 2003, these
in-between movements represented approximately 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. In-between movements
represented 21% of our total loads as of the quarter ended March 31, 2004.
Expenses and Profitability
For 2004, the key factors that we expect to affect our profitability are our
revenue per mile, our miles per tractor, our compensation of drivers, our
capital cost of revenue equipment, 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, 2004 we
implemented 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 competitive 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
Page 11
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.
Looking forward, our profitability goal is to return to an operating ratio of
approximately 90%. We expect this to require additional improvements in revenue
per tractor per week, particularly in revenue per mile, to overcome expected
additional cost increases to expand our margins. Because a large percentage of
our costs are variable, changes in revenue per mile affect our profitability to
a greater extent than changes in miles per tractor.
Revenue Equipment
At March 31, 2004, we operated approximately 3,589 tractors and 9,048 trailers.
Of our tractors, approximately 2,260 were owned, 966 were financed under
operating leases, and 363 were provided by independent contractors, who own and
drive their own tractors. Of our trailers, at March 31, 2004, approximately
1,381 were owned and approximately 7,667 were financed under operating leases.
Currently, substantially all of our tractors are covered by arrangements under
which we may trade back or cause equipment manufacturers to repurchase the
tractor for a specified value. The trade-in or buy-back values approximate our
expected disposition values of the tractors. Our assumptions represent our best
estimate, and actual values could differ by the time those tractors are
scheduled for trade.
Because of the increases in purchase prices and lower residual values, the
annual expense per tractor on model year 2003 and 2004 tractors is expected to
be higher than the annual expense on the units being replaced. The timing of
these expenses could be affected in future periods, 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.
Independent contractors (owner operators) provide a tractor and a driver and are
responsible for all operating expenses in exchange for a fixed payment per mile.
We do not have the capital outlay of purchasing the tractor. The payments to
independent contractors and the financing of equipment under operating leases
are recorded in revenue equipment rentals and purchased transportation. Expenses
associated with owned equipment, such as interest and depreciation, are not
incurred, and for independent contractor tractors, driver compensation, fuel,
and other expenses are not incurred. Because obtaining equipment from
independent contractors and under operating leases effectively shifts financing
expenses from interest to "above the line" operating expenses, we evaluate our
efficiency using net margin rather than operating ratio.
Results of Operations
Historically, we have measured freight revenue, before fuel and accessorial
surcharges, in addition to total revenue. However with the new hours-of-service
regulations that became effective January 4, 2004, accessorial revenue,
primarily for equipment detention and stop offs, has increased significantly.
Under the new regulatory requirements, we have determined it to be appropriate
to reclassify accessorial revenue, excluding fuel surcharges, into freight
revenue, and our historical financial statements have been conformed to this
presentation. We continue to report fuel surcharge revenue separately. For
comparison purposes in the table below, we use freight revenue when discussing
changes as a percentage of revenue. We believe excluding sometimes volatile fuel
surcharge revenue affords a more consistent basis for comparing the results of
operations from period to period.
Page 12
The following table sets forth the percentage relationship of certain items to
total revenue and freight revenue:
Three Months Ended Three Months Ended
March 31, March 31,
-------------------- ---------------------
2004 2003 2004 2003
-------- -------- --------- ---------
Total revenue 100.0% 100.0% Freight revenue (1) 100.0% 100.0%
- ------------- -------- -------- --------------- --------- ---------
Operating expenses: Operating expenses:
Salaries, wages, and related Salaries, wages, and related
expenses 37.7 39.0 expenses 39.8 41.3
Fuel expense 20.0 20.9 Fuel expense (1) 15.7 16.3
Operations and maintenance 5.6 7.2 Operations and maintenance 5.9 7.7
Revenue equipment rentals Revenue equipment rentals
and purchased and purchased
transportation 13.5 10.7 transportation 14.2 11.4
Operating taxes and licenses 2.5 2.5 Operating taxes and licenses 2.7 2.6
Insurance and claims 6.0 5.8 Insurance and claims 6.3 6.2
Communications and utilities 1.3 1.2 Communications and utilities 1.4 1.3
General supplies and General supplies and
expenses 2.5 2.3 expenses 2.7 2.4
Depreciation and amortization 8.6 7.7 Depreciation and amortization 9.0 8.1
-------- -------- --------- ---------
Total operating expenses 97.8 97.5 Total operating expenses 97.7 97.3
-------- -------- --------- ---------
Operating income 2.2 2.5 Operating income 2.3 2.7
Other (income) expense, net 0.4 0.4 Other (income) expense, net 0.5 0.5
-------- -------- --------- ---------
Income before income Income before income
taxes 1.8 2.1 taxes 1.9 2.2
Income tax expense 1.2 1.5 Income tax expense 1.3 1.6
-------- -------- --------- ---------
Net Income 0.5% 0.6% Net Income 0.6% 0.6%
======== ======== ========= =========
(1) Freight revenue is total revenue less fuel surcharge revenue. In this
table, fuel surcharge revenue is shown netted against the fuel expense
category ($7.1 million and $7.5 million in the three months ended March 31,
2004, and 2003, respectively).
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2004 TO THREE MONTHS ENDED
MARCH 31, 2003
For the quarter ended March 31, 2004, total revenue remained essentially
constant at $137.7 million, compared with $137.9 million in the 2003 period.
Total revenue includes $7.1 million of fuel surcharge revenue in the 2004 period
and $7.5 million in the 2003 period. For comparison purposes in the discussion
below, we use freight revenue (total revenue less fuel surcharge revenue) when
discussing changes as a percentage of revenue. We believe removing this
sometimes volatile source of revenue affords a more consistent basis for
comparing the results of operations from period to period.
Freight revenue (total revenue less fuel surcharge revenue) remained essentially
constant at $130.6 million in the three months ended March 31, 2004, compared
with $130.4 million in the same period of 2003. Revenue per tractor per week
increased to $2,749 in the 2004 period from $2,712 in the 2003 period, primarily
attributable to a 5.3% increase in rate per loaded mile partially offset by a
1.8% decrease in average miles per tractor. Weighted average tractors decreased
to 3,646 in the 2004 period from 3,726 in the 2003 period. We have elected to
constrain the size of our tractor fleet until fleet utilization and
profitability improve.
Salaries, wages, and related expenses decreased $1.9 million, or 3.4%, to $52.0
million in the 2004 period, from $53.8 million in the 2003 period. As a
percentage of freight revenue, salaries, wages, and related expenses decreased
to 39.8% in the 2004 period, from 41.3% in the 2003 period. Driver pay decreased
to 26.5% of freight revenue in the 2004 period from 27.1% of freight revenue in
the 2003 period. The decrease was largely attributable to our utilizing a larger
percentage of single-driver tractors, where only one driver per tractor is
compensated. Driver wages are expected to increase as a percentage of revenue in
future periods, due to a pay increase that went into effect March 15, 2004.
Management expects driver wages to increase approximately three cents per mile,
excluding
Page 13
benefits, or approximately $13.0 million pre-tax on an annualized basis. Our
payroll expense for employees other than over the road drivers remained
relatively constant at 7.2% of freight revenue in the 2004 period and 7.4% of
freight revenue in the 2003 period. Health insurance, employer paid taxes,
workers' compensation, and other employee benefits decreased to 6.1% of freight
revenue in the 2004 period from 6.8% of freight revenue in the 2003 period,
mainly due to improving claims experience in the Company's group health
insurance plan.
Fuel expense, net of fuel surcharge revenue of $7.1 million in the 2004 period
and $7.5 million in the 2003 period, decreased $0.8 million, or 3.7%, to $20.5
million in the 2004 period, from $21.3 million in the 2003 period. As a
percentage of freight revenue, net fuel expense decreased to 15.7% in the 2004
period from 16.3% in the 2003 period, primarily because of higher freight rates
and lower miles per tractor. Fuel prices increased sharply during 2003 due to
unrest in Venezuela and the Middle East and low inventories and have remained at
high levels into the first quarter of 2004. Fuel surcharges amounted to $0.072
per revenue mile in the 2003 and 2004 periods, which partially offset the
increased fuel expense. Higher fuel prices will increase our operating expenses.
Fuel costs may be affected in the future by volume purchase commitments, the
collectibility of fuel surcharges, the percentage of miles driven by independent
contractors, and lower fuel mileage due to government mandated emissions
standards that have resulted in less fuel efficient engines.
Operations and maintenance, consisting primarily of vehicle maintenance, repairs
and driver recruitment expenses, decreased $2.3 million to $7.7 million in the
2004 period from $10.0 million in the 2003 period. As a percentage of freight
revenue, operations and maintenance decreased to 5.9% in the 2004 period from
7.7% in the 2003 period. We extended the trade cycle on our tractor fleet from
three years to four years in 2001, which resulted in an older fleet that
required more repairs for tractors. We are changing our tractor trade cycle back
to a period of approximately three years, and we have also reduced the average
age of our trailer fleet. Accordingly, maintenance costs have decreased. The
average age of our tractor and trailer fleets decreased to 18 and 29 months at
March 2004, from 27 and 55 months as of March 2003, respectively. The savings
are expected to be offset somewhat by higher driver recruiting expense due to
the greater demand for trucking services and a tighter supply of drivers.
Revenue equipment rentals and purchased transportation increased $3.7 million,
or 25.3%, to $18.6 million in the 2004 period, from $14.8 million in the 2003
period. As a percentage of freight revenue, revenue equipment rentals and
purchased transportation expense increased to 14.2% in the 2004 period from
11.4% in the 2003 period. The increase is due principally to an increase in
revenue equipment rental payments and an increase in the number of independent
contractor fleet. Tractor and trailer equipment rental expense was $8.6 million
in the first quarter of 2004 compared with $5.0 million in the first quarter of
2003. The revenue equipment rental expense as a whole increased $2.9 million, or
56.5%, to $8.0 million in the 2004 period, from $5.1 million in the 2003 period.
As of March 31, 2004, we had financed approximately 966 tractors and 7,667
trailers under operating leases as compared to 916 tractors and 2,819 trailers
under operating leases as of March 31, 2003. Payments to independent contractors
increased $0.9 million to $10.6 million in the 2004 period from $9.7 million in
the 2003 period, mainly due to an increase in the independent contractor fleet
to an average of 396 during the 2004 period versus an average of 367 in the 2003
period.
Operating taxes and licenses remained essentially constant at $3.5 million in
the 2004 period and $3.4 million in the 2003 period. As a percentage of freight
revenue, operating taxes and licenses also remained essentially constant at 2.7%
in the 2004 period and 2.6% in the 2003 period.
Insurance and claims, consisting primarily of premiums and deductible amounts
for liability, physical damage, and cargo damage insurance and claims, increased
$0.2 million, or 2.8%, to $8.3 million in the 2004 period from $8.0 million in
the 2003 period. As a percentage of freight revenue, insurance and claims
remained relatively constant at 6.3% in the 2004 period and 6.2% in the 2003
period. 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. The
increase in self-insured retentions, effective March 1, 2004, may cause our
insurance and claims expense to be higher or more volatile in future periods
than in historical periods.
Page 14
Communications and utilities expense remained essentially constant at $1.8
million and $1.7 million in the 2004 and 2003 periods, respectively. As a
percentage of freight revenue, communications and utilities also remained
essentially constant at 1.4% and 1.3% in the 2004 and 2003 periods,
respectively.
General supplies and expenses, consisting primarily of headquarters and other
terminal facilities expenses increased $0.3 million, or 10.2%, to $3.5 million
in the 2004 period, from $3.2 million in the 2003 period. The increase is
primarily the result of increased professional fees in conjunction with our
Sarbanes Oxley compliance. As a percentage of freight revenue, general supplies
and expenses increased to 2.7% in the 2004 period from 2.4% in the 2003 period.
Depreciation and amortization, consisting primarily of depreciation of revenue
equipment, increased $1.2 million, or 11.3%, to $11.8 million in the 2004 period
from $10.6 million in the 2003 period. As a percentage of freight revenue,
depreciation and amortization increased to 9.0% in the 2004 period from 8.1% in
the 2003 period. The increase was primarily due to a loss on the disposal of
tractors and trailers of approximately $1.0 million in the 2004 period compared
to a gain of $0.2 million in the 2003 period. Depreciation and amortization
expense is net of any gain or loss on the disposal of tractors and trailers. The
loss on the disposal of tractors and trailers in the 2004 period included
approximately $2.0 million related to the trade-in costs and accelerated
depreciation partially offset by gains on the sale of equipment.
We expect our ownership/lease cost to decrease by the end of the year as the
majority of the trade-in and accelerated depreciation costs associated with the
fleet upgrade roll off. The portion of our ownership/lease cost that will not
decrease relates to the increased prices and decreased residual values of new
tractors and the cost relating to our decision to increase the size of our
trailer fleet in response to a shorter length of haul. As the rest of our
tractor fleet turns over in the remainder of 2004 and in 2005, we expect an
increase in our costs of about one-half cent per mile. 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,
we tested our goodwill ($11.5 million) for impairment and found no impairment.
Other expense, net, remained essentially constant at $0.6 million and 0.5% as a
percentage of freight revenue, in both the 2004 and 2003 periods. Included in
the other expense category are interest expense, interest income, and pre-tax
non-cash gains and losses related to the accounting for interest rate
derivatives under SFAS No. 133.
Our income tax expense was $1.7 million and $2.1 million in the 2004 and 2003
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem, our
tax rate will fluctuate in future periods as income fluctuates.
Primarily as a result of the factors described above, net income remained
essentially constant at $0.7 million and $0.8 million in the 2004 and 2003
periods. As a result of the foregoing, our net margin also remained essentially
constant at 0.6% in the 2004 and 2003 periods.
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 March 31, 2004, were funds provided by operations, proceeds under
the Securitization facility (as defined below), borrowings under our primary
credit agreement, which had maximum available borrowing of $100.0 million at
March 31, 2004 (the "Credit Agreement"), and operating leases of revenue
equipment. We expect capital expenditures, primarily for revenue equipment (net
of trade-ins), to be approximately $45.0 to $55.0 million in 2004, exclusive of
acquisitions of companies, and including assets financed with leases, as we
transition back to a three-
Page 15
year trade cycle for tractors and a seven year trade cycle on dry van trailers.
Historically, we have financed a large portion of our revenue equipment through
operating leases. Capital expenditures as reflected on our balance sheet and
statement of cash flows could be lower if we choose to finance some of our
revenue equipment through operating leases. We believe our sources of liquidity
are adequate to meet our current and projected needs for at least the next
twelve months. On a longer term basis, based on anticipated future cash flows,
current availability under our credit facility, and sources of equipment lease
financing that we expect will be available to us, we do not expect to experience
significant liquidity constraints in the foreseeable future.
Net cash provided by operating activities was $17.7 million in the 2004 period
and $11.7 million in the 2003 period. Our primary sources of cash flow from
operations in the 2004 period were net income, accounts receivable and
depreciation and amortization.
Net cash provided by investing activities was $2.3 million in the 2004 period
and $6.1 million in the 2003 period. The cash provided in the 2003 and 2004
periods related to the sale of tractors and trailers less the acquisition of new
revenue equipment.
Net cash used in financing activities was $21.2 million in the 2004 period, and
$16.3 million in the 2003 period. During the three month period ended March 31,
2004, we reduced outstanding balance sheet debt by $21.2 million. At March 31,
2004, we had outstanding debt of $40.5 million, consisting of $39.2 million in
the Securitization facility and a $1.3 million interest bearing note to the
former primary stockholder of SRT. Interest rates on this debt range from 1.1%
to 6.5%.
In December 2000, we entered into the Credit Agreement with a group of banks.
The facility matures in December 2005. Borrowings under the Credit Agreement are
based on the banks' base rate, which floats daily, or LIBOR, which accrues
interest based on one, two, three or six month LIBOR rates plus an applicable
margin that is adjusted quarterly between 0.75% and 1.25% based on a
Consolidated Leverage Ratio which is generally defined as the ratio of
borrowings, letters of credit, and the present value of operating lease
obligations to our earnings before interest, income taxes, depreciation,
amortization, and rental payments under operating leases. The applicable margin
was 1.125% at March 31, 2004. At March 31, 2004, we had no borrowings
outstanding under the Credit Agreement. The Credit Agreement is guaranteed by us
and all of our subsidiaries except CVTI Receivables Corp. ("CRC") and Volunteer
Insurance Limited.
The Credit Agreement has a maximum borrowing limit of $100.0 million, with a
feature which permits an increase up to a maximum borrowing limit of $140.0
million. Borrowings related to revenue equipment are limited to the lesser of
90% of net book value of revenue equipment or the maximum borrowing limit.
Letters of credit are limited to an aggregate commitment of $70.0 million. The
Credit Agreement includes a "security agreement" such that the Credit Agreement
may be collateralized by virtually all of our assets if a covenant violation
occurs. A commitment fee, that is adjusted quarterly between 0.15% and 0.25% per
annum based on the Consolidated Leverage Ratio, is due on the daily unused
portion of the Credit Agreement. At March 31, 2004 and December 31, 2003, we had
undrawn letters of credit outstanding of approximately $57.2 million and $51.2
million, respectively. As of March 31, 2004, we had approximately $42.8 million
of borrowing capacity under the Credit Agreement.
In December 2000, we entered into an accounts receivable securitization facility
(the "Securitization facility"). On a revolving basis, we sell our interests in
our accounts receivable to CRC, a wholly-owned bankruptcy-remote special purpose
subsidiary incorporated in Nevada. CRC sells a percentage ownership in such
receivables to an unrelated financial entity. We can receive up to $62.0 million
of proceeds, subject to eligible receivables and will pay a service fee recorded
as interest expense, based on commercial paper interest rates plus an applicable
margin of 0.41% per annum and a commitment fee of 0.10% per annum on the daily
unused portion of the facility. The net proceeds under the Securitization
facility are required to be shown as a current liability because the term,
subject to annual renewals, is 364 days. As of March 31, 2004 and December 31,
2003, the Company had received $39.2 million and $48.4 million, respectively, in
proceeds, with a weighted average interest rate of 1.1% and 1.0%, respectively.
The transaction 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,
Consolidated Leverage Ratio, acquisitions and dispositions, and total
Page 16
indebtedness. All of these agreements are cross-defaulted. We are in compliance
with these agreements as of March 31, 2004.
Contractual Obligations and Commitments - In April 2003, we engaged in a
sale-leaseback transaction involving approximately 1,266 dry van trailers. We
sold the trailers to a finance company for approximately $15.6 million in cash
and leased the trailers back under three year walk away leases. The resulting
gain was approximately $0.3 million and is being amortized over the life of the
lease. The monthly cost of the lease payments will be higher than the cost of
the depreciation and interest expense; however, there will be no residual risk
of loss at disposition.
In April 2003, we also entered into an agreement with a finance company to sell
approximately 2,585 dry van trailers and to lease an additional 3,600 model year
2004 dry van trailers over the next 12 months. We sold the trailers, which
consist of model year 1991 to model year 1997 dry van trailers, to the finance
company for approximately $20.5 million in cash and leased the 3,600 dry van
trailers back under seven year walk away leases. The monthly cost of the lease
payments will be higher than the cost of the depreciation and interest expense;
however there will be no residual risk of loss at disposition.
Contractual Obligations and Commitments - We had commitments outstanding related
to equipment, debt obligations, and diesel fuel purchases as of January 1, 2004.
The following table sets forth our contractual cash obligations and commitments
as of January 1, 2004.
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) Approximately $48.4 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 or operating leases, proceeds from sales of
existing equipment, and cash flows from operations. We have the option to
cancel commitments relating to equipment with 60 days notice.
Page 17
OFF BALANCE SHEET ARRANGEMENTS
Operating leases have been an important source of financing for our revenue
equipment, computer equipment and company airplane. We lease a significant
portion of our tractor and trailer fleet using operating leases. At March 31,
2004, we had financed approximately 966 tractors and 7,667 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 $8.0 million in the
2004 period, compared to $5.1 million in the 2003 period. The total amount of
remaining payments under operating leases as of March 31, 2004, was
approximately $151.2 million. In connection with the leases of a majority of the
value of the equipment we finance with operating leases, we issued residual
value guarantees, which provide that if we do not purchase the leased equipment
from the lessor at the end of the lease term, then we are liable to the lessor
for an amount equal to the shortage (if any) between the proceeds from the sale
of the equipment and an agreed value. As of March 31, 2004, the maximum amount
of the residual value guarantees was approximately $51.5 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 tractors. As of March 31, 2004, we
have accrued $1.5 million to reflect the shortfall we expect on the 2001 model
year tractors.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make decisions
based upon estimates, assumptions, and factors we consider as relevant to the
circumstances. Such decisions include the selection of applicable accounting
principles and the use of judgment in their application, the results of which
impact reported amounts and disclosures. Changes in future economic conditions
or other business circumstances may affect the outcomes of our estimates and
assumptions. Accordingly, actual results could differ from those anticipated. A
summary of the significant accounting policies followed in preparation of the
financial statements is contained in Note 1 of the financial statements
contained in the Company's annual report on Form 10-K for the fiscal year ended
December 31, 2003. The following discussion addresses our most critical
accounting policies, which are those that are both important to the portrayal of
our financial condition and results of operations and that require significant
judgment or use of complex estimates.
Our critical accounting policies include the following:
Property and Equipment - Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. We depreciate revenue
equipment excluding day cabs over five to ten years with salvage values ranging
from 9% to 33%. We evaluate the salvage value, useful life, and annual
depreciation of tractors and trailers annually based on the current market
environment and our recent experience with disposition values. Any change could
result in greater or lesser annual expense in the future. Gains or losses on
disposal of revenue equipment are included in depreciation in the statements of
operations. We also evaluate the carrying value of long-lived assets for
impairment by analyzing the operating performance and future cash flows for
those assets, whenever events or changes in circumstances indicate that the
carrying amounts of such assets may not be recoverable. We evaluate the need to
adjust the carrying value of the underlying assets if the sum of the expected
cash flows is less than the carrying value. Impairment can be impacted by our
projection of future cash flows, the level of actual cash flows and salvage
values, the methods of estimation used for determining fair values and the
impact of guaranteed residuals. Any changes in management's judgments could
result in greater or lesser annual depreciation expense or additional impairment
charges in the future.
Insurance and Other Claims - Our insurance program for liability, property
damage, and cargo loss and damage, involves self-insurance with high risk
retention levels. We accrue the estimated cost of the uninsured portion of
pending claims. These accruals are based on our evaluation of the nature and
severity of the claim and estimates of future claims development based on
historical trends, as well as the legal and other costs to settle or defend the
claims. Because of our significant self-insured retention amounts, we have
significant exposure to fluctuations in the number and severity of claims. If
there is an increase in the frequency and severity of claims, or we are required
to accrue or pay additional amounts if the claims prove to be more severe than
originally assessed, our profitability
Page 18
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, computer equipment
and company airplane. We lease a significant portion of our tractor and trailer
fleet using operating leases. In connection with the leases of a majority of the
value of the equipment we finance with operating leases, we issued residual
value guarantees, which provide that if we do not purchase the leased equipment
from the lessor at the end of the lease term, then we are liable to the lessor
for an amount equal to the shortage (if any) between the proceeds from the sale
of the equipment and an agreed value. As of March 31, 2004, the maximum amount
of the residual value guarantees was approximately $51.5 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 tractors. As of March 31, 2004, we
have accrued $1.5 million to reflect the shortfall we expect on the 2001 model
year tractors. 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, and are contesting the disallowances. We have accrued amounts that
we believe are appropriate given our expectations concerning the ultimate
resolution of the strategies. Significant management judgments are involved in
assessing the likelihood of sustaining the strategies and in determining the
likely range of defense and settlement costs.
Deferred income taxes represent a substantial liability on our consolidated
balance sheet. 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
carry forwards. We evaluate our tax assets and liabilities on a periodic basis
and adjust these balances as appropriate. We believe that we have adequately
provided for our future tax consequences based upon current facts and
circumstances and current tax law. During the three months ended March 31, 2004,
we made no material changes in our assumptions regarding the determination of
deferred income taxes. However, should these tax positions be challenged and not
prevail, different outcomes could result and have a significant impact on the
amounts reported through our Consolidated Statement of Operations.
The carrying value of our deferred tax assets (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.
Page 19
INFLATION, NEW EMISSIONS CONTROL REGULATIONS AND FUEL COSTS
Most of our operating expenses are inflation-sensitive, with inflation generally
producing increased costs of operations. During the past three years, the most
significant effects of inflation have been on revenue equipment prices and the
compensation paid to the drivers. New emissions control regulations have
resulted in higher tractor prices, and there has been an industry-wide increase
in wages paid to attract and retain qualified drivers. We attempt to limit 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 the trucking industry's seasonal shortage of
equipment on traffic originating in California and our ability to satisfy some
of that requirement. The seasonal shortage typically occurs between May and
August because California produce carriers' equipment is fully utilized for
produce during those months and does not compete for shipments hauled by our dry
van operation. During September and October, business increases as a result of
increased retail merchandise shipped in anticipation of the holidays.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks from changes in (i) certain commodity
prices and (ii) certain interest rates on its debt.
COMMODITY PRICE RISK
Prices and availability of all petroleum products are subject to political,
economic, and market factors that are generally outside our control. Because our
operations are dependent upon diesel fuel, significant increases in diesel
Page 20
fuel costs could materially and adversely affect our results of operations and
financial condition. Historically, we have been able to recover a portion of
long-term fuel price increases from customers in the form of fuel surcharges.
The price and availability of diesel fuel can be unpredictable as well as the
extent to which fuel surcharges could be collected to offset such increases. For
the three months ended March 31, 2004, diesel fuel expenses net of fuel
surcharge represented 15.2% of our total operating expenses and 15.7% of freight
revenue. At March 31, 2004, we had no derivative financial instruments to reduce
our exposure to fuel price fluctuations.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
INTEREST RATE RISK
Our market risk is also affected by changes in interest rates. Historically, we
have used a combination of fixed rate and variable rate obligations to manage
our interest rate exposure. Fixed rate obligations expose us to the risk that
interest rates might fall. Variable rate obligations expose us to the risk that
interest rates might rise.
Our variable rate obligations consist of our Credit Agreement and our 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 1.125% at
March 31, 2004). During the first quarter of 2001, we entered into two $10
million notional amount interest rate swap agreements to manage the risk of
variability in cash flows associated with floating-rate debt. The swaps expire
January 2006 and March 2006. These derivatives are not designated as hedging
instruments under SFAS No. 133 and consequently are marked to fair value through
earnings, in other expense in the accompanying statement of operations. At March
31, 2004, the fair value of these interest rate swap agreements was a liability
of $1.2 million. At March 31, 2004, we did not have any borrowings 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 March 31, 2004, borrowings of $39.2 million had been drawn on the
Securitization facility. Assuming variable rate borrowings under the Credit
Agreement and Securitization facility at March 31, 2004 levels, a one percentage
point increase in interest rates would increase our annual interest expense by
$192,000.
We do not trade in derivatives with the objective of earning financial gains on
price fluctuations, on a speculative basis, nor do we trade in these instruments
when there are no underlying related exposures.
ITEM 4. CONTROLS AND PROCEDURES
As required by Rule 13a-15 under the Exchange Act, the Company has carried out
an evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures as of the end of the period covered by this
report. This evaluation was carried out under the supervision and with the
participation of the Company's management, including its Chief Executive Officer
and its Chief Financial Officer. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our controls and procedures
were effective as of the end of the period covered by this report. There were no
changes in our internal control over financial reporting that occurred during
the period covered by this report that have materially affected or that are
reasonably likely to materially affect the Company's internal control over
financial reporting.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in the Company's
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include controls and procedures designed to ensure that information required to
be disclosed in Company reports filed under the Exchange Act is accumulated and
communicated to management, including the Company's Chief Executive Officer as
appropriate, to allow timely decisions regarding disclosures.
Page 21
The Company has confidence in its internal controls and procedures.
Nevertheless, the Company's management, including the Chief Executive Officer
and Chief Financial Officer, does not expect that our disclosure procedures and
controls or our internal controls will prevent all errors or intentional fraud.
An internal control system, no matter how well-conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of such
internal controls are met. Further, the design of an internal control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all internal control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected.
Page 22
PART II
OTHER INFORMATION
Item 1. 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. During the
quarter ended March 31, 2004, there were no material
developments.
Items 2, 3, 4, Not applicable
and 5.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Reference Description
3.1 (1) Restated Articles of Incorporation
3.2 (1) Amended Bylaws dated September 27, 1994.
4.1 (1) Restated Articles of Incorporation
4.2 (1) Amended Bylaws dated September 27, 1994.
31.1 # Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, by David R. Parker, the Company's
Chief Executive Officer.
31.2 # Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, by Joey B. Hogan, the Company's Chief
Financial Officer.
32 # Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, by David R. Parker, the Company's Chief Executive
Officer, and Joey B. Hogan, the Company's Chief Financial Officer.
- -----------------------------------------------------------------------------------------------------------------
References:
(1) Incorporated by reference from Form S-1, Registration No. 33-82978, effective October 28, 1994.
# Filed herewith.
(b) A Form 8-K was filed on January 28, 2004 to report information regarding the Company's press
release announcing its financial and operating results for the quarter and twelve months ending
December 31, 2003. A Form 8-K was filed on February 3, 2004 to provide the transcript of the
Company's January 28, 2004 conference call relating to the financial and operating results for the
quarter and twelve months ending December 31, 2003.
Page 23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVENANT TRANSPORT, INC.
Date: May 5, 2004 /s/ Joey B. Hogan
-----------------
Joey B. Hogan
Executive Vice President and Chief Financial Officer, in his capacity as such and on
behalf of the issuer.