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EX-32.1 - EXHIBIT 32.1 (SECTION 906 CERTIFICATION DAVID A. JACKSON) - KNIGHT TRANSPORTATION INCexhibit321.htm
EX-32.2 - EXHIBIT 32.2 (SECTION 906 CERTIFICATION ADAM W. MILLER) - KNIGHT TRANSPORTATION INCexhibit322.htm
EX-31.2 - EXHIBIT 31.2 (SECTION 302 CERTIFICATION ADAM W. MILLER) - KNIGHT TRANSPORTATION INCexhibit312.htm
EX-31.1 - EXHIBIT 31.1 (SECTION 302 CERTIFICATION DAVID A. JACKSON) - KNIGHT TRANSPORTATION INCexhibit311.htm
EX-10.2 - EXHIBIT 10.2 (FOURTH MODIFICATION AGREEMENT) - KNIGHT TRANSPORTATION INCexhibit102.htm
EX-10.1 - EXHIBIT 10.1 (THIRD MODIFICATION AGREEMENT) - KNIGHT TRANSPORTATION INCexhibit101.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
 
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: 001-32396

KNIGHT TRANSPORTATION, INC.
(Exact name of registrant as specified in its charter)

Arizona
86-0649974
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
   
20002 North 19th Avenue
Phoenix, Arizona
85027
(Address of Principal Executive Offices)
(Zip Code)
   
Registrant's telephone number, including area code:
602-269-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
☒  Yes ☐ No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
☒  Yes ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [X]
Accelerated filer [  ]
Non-accelerated filer [  ]
Smaller reporting company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
☐  Yes ☒ No

The number of shares outstanding of registrant's common stock, par value $0.01 per share, as of October 31, 2016, was 80,034,666 shares.
 

 
KNIGHT TRANSPORTATION, INC.

TABLE OF CONTENTS


 
Page Number
PART I – FINANCIAL INFORMATION
 
   
Item 1.
Financial Statements
 
     
 
1
     
 
3
     
 
4
     
 
5
     
 
7
     
Item 2.
18
     
Item 3.
35
     
Item 4.
35
     
Part II – OTHER INFORMATION
 
     
Item 1.
35
     
Item 1A.
36
     
Item 2.
36
     
Item 3.
36
     
Item 4.
36
     
Item 5.
36
     
Item 6.
37
     
 
38
 
PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES
Condensed Consolidated Unaudited Balance Sheets
(in thousands)
 
   
   
September 30,
2016
   
December 31,
2015
 
ASSETS
           
Current Assets:
           
Cash and cash equivalents
 
$
3,886
   
$
8,691
 
Trade receivables, net of allowance for doubtful accounts of $3,014 and $3,106, respectively
   
131,489
     
131,945
 
Notes receivable, net of allowance for doubtful notes receivable of $254 and $273, respectively
   
574
     
648
 
Prepaid expenses
   
16,671
     
17,320
 
Assets held for sale
   
18,347
     
29,327
 
Other current assets
   
8,507
     
14,215
 
Income tax receivable
   
8,845
     
41,967
 
Total current assets
   
188,319
     
244,113
 
                 
Property and Equipment:
               
Revenue equipment
   
905,195
     
866,252
 
Land and land improvements
   
53,492
     
52,951
 
Buildings and building improvements
   
143,734
     
139,102
 
Furniture and fixtures
   
20,494
     
18,363
 
Shop and service equipment
   
16,888
     
16,729
 
Leasehold improvements
   
4,834
     
3,061
 
Gross property and equipment
   
1,144,637
     
1,096,458
 
Less:  accumulated depreciation and amortization
   
(331,458
)
   
(292,815
)
Property and equipment, net
   
813,179
     
803,643
 
Notes receivable, long-term
   
3,198
     
3,419
 
Goodwill
   
47,035
     
47,050
 
Intangible assets, net
   
2,700
     
3,075
 
Other long-term assets, restricted cash and investments
   
32,783
     
18,932
 
Total long-term assets
   
898,895
     
876,119
 
Total assets
 
$
1,087,214
   
$
1,120,232
 

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
 


KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES
Condensed Consolidated Unaudited Balance Sheets (continued)
(in thousands, except par values)
 
             
   
September 30,
2016
   
December 31,
2015
 
LIABILITIES AND SHAREHOLDERS' EQUITY
           
Current Liabilities:
           
Accounts payable
 
$
18,904
   
$
14,818
 
Accrued payroll and purchased transportation
   
21,262
     
23,776
 
Accrued liabilities
   
16,539
     
21,609
 
Claims accrual – current portion
   
20,288
     
19,471
 
Dividend payable – current portion
   
298
     
349
 
Total current liabilities
   
77,291
     
80,023
 
                 
Long-term Liabilities:
               
Claims accrual – long-term portion
   
12,336
     
11,508
 
Long-term dividend payable and other liabilities
   
1,854
     
2,164
 
Deferred tax liabilities
   
177,201
     
174,165
 
Long-term debt
   
52,000
     
112,000
 
Total long-term liabilities
   
243,391
     
299,837
 
                 
Total liabilities
   
320,682
     
379,860
 
                 
Commitments and Contingencies (Note 6)
               
                 
Shareholders' Equity:
               
Preferred stock, $0.01 par value; 50,000 shares authorized; none issued and outstanding
   
-
     
-
 
Common stock, $0.01 par value; 300,000 shares authorized; 80,026 and 80,967 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
   
800
     
810
 
Additional paid-in capital
   
219,593
     
205,648
 
Accumulated other comprehensive income
   
-
     
2,573
 
Retained earnings
   
544,192
     
529,367
 
                 
Total Knight Transportation shareholders' equity
   
764,585
     
738,398
 
Noncontrolling interest
   
1,947
     
1,974
 
Total shareholders’ equity
   
766,532
     
740,372
 
                 
Total liabilities and shareholders' equity
 
$
1,087,214
   
$
1,120,232
 

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
 

KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES
Condensed Consolidated Unaudited Statements of Income
(in thousands, except per share data)
 
   
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
REVENUE:
                       
Revenue, before fuel surcharge
 
$
256,243
   
$
269,930
   
$
763,684
   
$
795,767
 
Fuel surcharge
   
24,287
     
30,192
     
65,252
     
96,458
 
Total revenue
   
280,530
     
300,122
     
828,936
     
892,225
 
OPERATING EXPENSES:
                               
Salaries, wages and benefits
   
82,688
     
85,514
     
250,732
     
249,921
 
Fuel
   
34,616
     
39,795
     
94,815
     
120,247
 
Operations and maintenance
   
19,781
     
20,390
     
56,886
     
62,065
 
Insurance and claims
   
9,251
     
8,149
     
26,330
     
25,076
 
Operating taxes and licenses
   
4,546
     
3,373
     
14,645
     
13,954
 
Communications
   
976
     
849
     
3,224
     
3,066
 
Depreciation and amortization
   
29,129
     
28,204
     
86,486
     
82,728
 
Purchased transportation
   
57,069
     
62,115
     
168,772
     
182,279
 
Miscellaneous operating expenses
   
5,540
     
5,307
     
13,304
     
18,541
 
Total operating expenses
   
243,596
     
253,696
     
715,194
     
757,877
 
                                 
Income from operations
   
36,934
     
46,426
     
113,742
     
134,348
 
                                 
Interest income
   
83
     
140
     
259
     
377
 
Interest expense
   
(182
)
   
(220
)
   
(742
)
   
(714
)
Other income
   
1,389
     
2,335
     
4,602
     
7,234
 
Income before income taxes
   
38,224
     
48,681
     
117,861
     
141,245
 
                                 
Income taxes
   
14,558
     
17,946
     
46,202
     
52,379
 
Net income
   
23,666
     
30,735
     
71,659
     
88,866
 
                                 
Net income attributable to noncontrolling interest
   
(316
)
   
(452
)
   
(1,064
)
   
(1,382
)
Net income attributable to Knight Transportation
 
$
23,350
   
$
30,283
   
$
70,595
   
$
87,484
 
                                 
Earnings per share:
                               
Basic
 
$
0.29
   
$
0.37
   
$
0.88
   
$
1.07
 
Diluted
 
$
0.29
   
$
0.37
   
$
0.87
   
$
1.06
 
                                 
Dividends declared per share
 
$
0.06
   
$
0.06
   
$
0.18
   
$
0.18
 
                                 
Weighted Average Shares Outstanding:
                               
Basic
   
80,040
     
81,127
     
80,284
     
81,678
 
Diluted
   
80,792
     
82,005
     
80,985
     
82,714
 

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
 

KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES
Condensed Consolidated Unaudited Statements of Comprehensive Income
(in thousands)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Net income
 
$
23,666
   
$
30,735
   
$
71,659
   
$
88,866
 
Other comprehensive income, net of tax:
                               
Realized gains from available-for-sale securities reclassified to net income(1)
   
(878
)
   
(1,307
)
   
(2,771
)
   
(4,093
)
Unrealized gain / (loss) from changes in fair value of available-for-sale securities(2)
   
145
     
(1,365
)
   
198
     
(4,632
)
Comprehensive income
   
22,933
   
$
28,063
     
69,086
   
$
80,141
 
Comprehensive income attributable to noncontrolling interest
   
(316
)
   
(452
)
   
(1,064
)
   
(1,382
)
Comprehensive income attributable to Knight Transportation
 
$
22,617
   
$
27,611
   
$
68,022
   
$
78,759
 

(1)
Net of current income tax expense of $546, $823, $1,723, and $2,576, respectively.
(2)
Net of deferred income tax expense / (benefit) of $85, $(875), $104, and $(3,024), respectively.

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

 
KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES
Condensed Consolidated Unaudited Statements of Cash Flows
(in thousands)
 
       
   
Nine Months Ended
September 30,
 
   
2016
   
2015
 
Cash Flows From Operating Activities:
           
Net income
 
$
71,659
   
$
88,866
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
86,486
     
82,728
 
Gain on sale of equipment
   
(7,451
)
   
(12,181
)
Gain from sale of available-for-sale securities
   
(4,494
)
   
(6,669
)
Gain from sale of Transportation Resource Partners I
   
-
     
(122
)
Transportaion Resource Partners I impairment
   
67
     
-
 
Income from investment in Transportation Resource Partners III
   
(177
)
   
(443
)
Non-cash compensation expense for issuance of common stock to certain members of the Board of Directors
   
398
     
354
 
Provision for doubtful accounts and notes receivable
   
594
     
1,216
 
Excess tax benefits related to stock-based compensation
   
(1,107
)
   
(3,064
)
Stock-based compensation expense, net
   
3,126
     
5,288
 
Deferred income taxes
   
4,655
     
(12,281
)
                 
Changes in operating assets and liabilities:
               
Trade receivables
   
(133
)
   
7,368
 
Other current assets
   
5,707
     
(906
)
Prepaid expenses
   
649
     
(6,049
)
Income tax receivable
   
33,122
     
9,719
 
Other long-term assets
   
547
     
(1,643
)
Accounts payable
   
1,869
     
(3,021
)
Accrued liabilities and claims accrual
   
(6,354
)
   
7,479
 
                 
Net cash provided by operating activities
   
189,163
     
156,639
 
                 
Cash Flows From Investing Activities:
               
Purchases of property and equipment
   
(126,028
)
   
(166,790
)
Proceeds from sale of equipment/assets held for sale
   
49,972
     
57,938
 
Proceeds from notes receivable
   
1,348
     
1,442
 
Change in restricted cash and investments
   
(19
)
   
(25
)
Proceeds from sale of available-for-sale securities
   
7,403
     
9,339
 
Cash payments to Transportation Resource Partners
   
(21,778
)
   
-
 
Cash proceeds from Transportation Resource Partners
   
423
     
191
 
                 
Net cash used in investing activities
   
(88,679
)
   
(97,905
)

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
 


KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES
Condensed Consolidated Unaudited Statements of Cash Flows (continued)
(in thousands)
 
   
   
Nine Months Ended
September 30,
 
   
2016
   
2015
 
Cash Flows From Financing Activities:
           
Dividends paid
 
$
(14,753
)
 
$
(15,003
)
Payments to repurchase company stock
   
(39,873
)
   
(45,345
)
Payments on line of credit borrowings, net
   
(60,000
)
   
(14,400
)
Excess tax benefits related to stock-based compensation
   
1,107
     
3,064
 
Cash distribution to noncontrolling interest holder
   
(1,091
)
   
(603
)
Proceeds from exercise of stock options
   
9,321
     
9,190
 
                 
Net cash used in financing activities
   
(105,289
)
   
(63,097
)
                 
Net decrease in Cash and Cash Equivalents
   
(4,805
)
   
(4,363
)
Cash and Cash Equivalents, beginning of period
   
8,691
     
17,066
 
                 
Cash and Cash Equivalents, end of period
 
$
3,886
   
$
12,703
 
                 
Supplemental Disclosures:
               
Non-cash investing and financing transactions:
               
Equipment acquired included in accounts payable
 
$
6,436
   
$
8,852
 
Transfer from property and equipment to assets held for sale
 
$
25,035
   
$
32,800
 
Financing provided to independent contractors for equipment sold
 
$
1,024
   
$
571
 
Net dividend accrued for restricted stock units
 
$
69
   
$
137
 
Cash flow information:
               
Income taxes paid
 
$
7,238
   
$
52,000
 
Interest expense paid
 
$
782
   
$
749
 

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.
 

 
KNIGHT TRANSPORTATION, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

Note 1. Financial Information

References in this Report on Form 10-Q to "we," "us," "our," "Knight," or the "Company" or similar terms refer to Knight Transportation, Inc. and its consolidated subsidiaries. All inter-company balances and transactions have been eliminated in consolidation.

The accompanying condensed consolidated unaudited financial statements of Knight Transportation, Inc. and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America and Regulation S-X, instructions to Form 10-Q, and other relevant rules and regulations of the Securities and Exchange Commission (the "SEC"), as applicable to the preparation and presentation of interim financial information. Certain information and footnote disclosures have been omitted or condensed pursuant to such rules and regulations.  We believe all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Results of operations in interim periods are not necessarily indicative of results for a full year.  These condensed consolidated unaudited financial statements and notes thereto should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015.

Note 2. Stock-Based Compensation

In May 2015, our shareholders approved the Amended and Restated 2015 Omnibus Incentive Plan (the “2015 Plan”). This plan combines into a single plan the Company’s 2005 Executive Cash Bonus Plan (the “2005 Plan”) and the 2012 Equity Compensation Plan (the “2012 Plan”) and allows for future grants under the 2015 Plan.  Grants outstanding under the 2005 Plan and 2012 Plan will continue in force and effect and continue to be governed solely by the terms and conditions of the instrument evidencing such grants, and will be interpreted under the terms of the 2005 Plan and the 2012 Plan, as applicable. Since approval of the 2015 Plan in May 2015, all grants of stock-based compensation are made under the 2015 Plan.  Stock-based compensation expense for the three months and nine months ended September 30, 2016, and 2015, are as follows (dollars in thousands):

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Stock compensation expense for options, net of forfeitures
 
$
434
   
$
307
   
$
1,318
   
$
754
 
Stock compensation expense for restricted stock units and performance restricted stock units, net of forfeitures
   
112
     
1,380
     
1,808
     
4,534
 
Total stock compensation expense
 
$
546
   
$
1,687
   
$
3,126
   
$
5,288
 

Our policy is to recognize compensation expense on a straight-line basis over the requisite service period for the entire award.

As of September 30, 2016, we have approximately $3.8 million of unrecognized compensation expense related to unvested options.  This cost is expected to be recognized over a weighted-average period of 1.8 years and a total period of 3.4 years.  We have approximately $8.8 million of unrecognized compensation expense related to restricted stock unit awards, which is anticipated to be recognized over a weighted-average period of 3.4 years and a total period of 6.3 years. We also have approximately $6.0 million of unrecognized compensation cost related to unvested performance awards.  That cost is expected to be recognized over a weighted-average period of 2.6 years and total period of 3.3 years.

 
A total of 569,480 and 590,141 stock options were granted during the first nine months of 2016 and 2015, respectively. We received approximately $9.3 million in cash from the exercise of stock options during the nine months ended September 30, 2016, compared to $9.2 million for the same period in 2015.

A summary of the option award activity under our equity compensation plans as of September 30, 2016, and changes during the nine months ended September 30, 2016, is presented below:

   
Option Totals
   
Weighted Average Exercise
Price Per Share
 
Outstanding as of December 31, 2015
   
2,008,872
   
$
21.41
 
Granted
   
569,480
     
24.23
 
Exercised
   
(522,613
)
   
17.87
 
Forfeited
   
(109,404
)
   
25.02
 
Outstanding as of September 30, 2016
   
1,946,335
   
$
23.46
 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model.  Listed below are the weighted-average assumptions used for the fair value computation:

 
Nine Months Ended
September 30,
 
2016
 
2015
Dividend yield (1)
0.99%
 
0.80%
Expected volatility (2)
27.91%
 
25.88%
Risk-free interest rate (3)
0.90%
 
0.98%
Expected term (4)
2.74 years
 
2.74 years
Weighted-average fair value of options granted
$4.28
 
$5.00

(1)
Dividend yield – the dividend yield is based on our historical experience and future expectation of dividend payouts.
(2)
Expected volatility – we analyzed the volatility of our stock using historical data.
(3)
Risk-free interest rate – the risk-free interest rate assumption is based on U.S. Treasury securities at a constant maturity with a maturity period that most closely resembles the expected term of the stock option award.
(4)
Expected term – the expected term of employee stock options represents the weighted-average period the stock options are expected to remain outstanding and has been determined based on an analysis of historical exercise behavior.

A total of 10,222 and 13,950 restricted stock unit awards were granted during the first nine months of 2016 and 2015, respectively. A summary of the restricted stock unit award activity under our equity compensation plans as of September 30, 2016, and changes during the nine months ended September 30, 2016, is presented below:

   
Number of Restricted Stock Unit Awards
   
Weighted Average Grant Date
Fair Value
 
Unvested as of December 31, 2015
   
879,173
   
$
16.45
 
Granted
   
10,222
     
27.37
 
Vested
   
(162,467
)
   
16.66
 
Forfeited
   
(24,860
)
   
16.24
 
Unvested as of September 30, 2016
   
702,068
   
$
16.57
 

The fair value of each restricted stock unit is based on the closing market price on the date of grant.
 

 
Beginning in 2014, we issued performance restricted stock units (“PRSUs”) to selected key employees that may be earned based on revenue growth and return on assets, and may then be modified based on our total shareholder return, as defined in the instrument evidencing the grant, over a three-year period. The primary award adjustment may range from 0 percent to 150 percent of the initial grant, based upon performance achieved over the three-year period. The primary award modifier, which would multiply the adjusted primary award by 75 percent to 125 percent, is measured by determining the percentile rank of the total shareholder return, as defined in the instrument evidencing the grant, of Knight Transportation common stock in relation to the total shareholder return of a peer group for the three-year period. The final award will be based on performance achieved in accordance with the scale set forth in the plan agreement. PRSUs do not earn dividend equivalents.

A total of 177,741 and 165,720 PRSUs were granted in the first nine months of 2016 and 2015, respectively. A summary of the performance restricted stock unit award activity under our equity compensation plans for the nine months ended September 30, 2016 is presented below:

   
Number of Performance Restricted Stock Unit Awards
   
Weighted Average
Grant Date
Fair Value
 
Unvested as of December 31, 2015
   
341,782
   
$
26.46
 
Granted
   
177,741
     
23.89
 
Shares earned above target
   
2,516
     
23.85
 
Vested
   
(5,391
)
   
23.85
 
Cancelled
   
(8,170
)
   
25.21
 
Unvested as of September 30, 2016
   
508,478
   
$
25.60
 

The number of granted shares, cancelled shares, and unvested shares are included in the table above based on the performance target established at the initial grant date.

The performance measurement period for the awards granted in the nine months ended September 30, 2016, is January 1, 2016 to December 31, 2018. These awards will vest January 31, 2020, or thirteen months following the expiration of the performance period. The fair value of each PRSU grant is estimated on the date of grant using the Monte Carlo Simulation valuation model.  Listed below are the weighted-average assumptions used for the fair value computation:

   
Nine Months Ended
September 30,
 
   
2016
   
2015
 
Dividend yield (1)
   
0.99
%
   
0.80
%
Expected volatility (2)
   
27.95
%
   
23.18
%
Average peer volatility (2)
   
34.37
%
   
30.70
%
Average peer correlation coefficient (3)
   
0.60
     
0.49
 
Risk-free interest rate (4)
   
0.89
%
   
0.78
%
Expected term (5)
   
2.84
     
2.63
 
Weighted-average fair value of PRSUs granted
 
$
23.89
   
$
29.30
 

(1)
The dividend yield, used to project stock price to the end of the performance period, is based on our historical experience and future expectation of dividend payouts. Total shareholder return is determined assuming that dividends are reinvested in the issuing entity over the performance period, which is mathematically equivalent to utilizing a 0% dividend yield.
(2)
We (or peer company) estimated volatility using our (or their) historical share price performance over the remaining performance period as of the grant date.
(3)
The correlation coefficients are used to model the way in which each entity tends to move in relation to each other; the correlation assumptions were developed using the same stock price data as the volatility assumptions.
(4)
The risk-free interest rate assumption is based on U.S. Treasury securities at a constant maturity with a maturity period that most closely resembles the expected term of the performance award.
(5)
Since the Monte Carlo simulation valuation is an open form model that uses an expected life commensurate with the performance period, the expected life of the PRSUs was assumed to be the period from the grant date to the end of the performance period.
 
 
Note 3. Earnings Per Share

A reconciliation of the basic and diluted earnings per share computations for the three months and nine months ended  September 30, 2016 and 2015, respectively, is as follows (dollars in thousands except per share data):

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2016
   
2015
   
2016
   
2015
 
Weighted-average common shares outstanding – basic
   
80,040
     
81,127
     
80,284
     
81,678
 
Dilutive effect of stock options and unvested restricted stock units
   
752
     
878
     
701
     
1,036
 
Weighted-average common shares outstanding – diluted
   
80,792
     
82,005
     
80,985
     
82,714
 
                                 
Net income attributable to Knight Transportation
 
$
23,350
   
$
30,283
   
$
70,595
   
$
87,484
 
                                 
Basic earnings per share
 
$
0.29
   
$
0.37
   
$
0.88
   
$
1.07
 
Diluted earnings per share
 
$
0.29
   
$
0.37
   
$
0.87
   
$
1.06
 

Certain shares of options, restricted stock units, and PRSUs (collectively, “equity awards”) were excluded from the computation of diluted earnings per share because the equity award’s exercise prices were greater than the average market price of the common shares and the sum total of assumed proceeds resulted in fewer shares repurchased than the weighted equity awards outstanding hypothetically exercised per the treasury method.

The number of anti-dilutive shares are:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Number of anti-dilutive shares
937,040
 
597,076
 
1,071,800
 
322,036

Note 4. Segment Information

We have two operating and reportable segments:  (i) the Trucking segment comprised of three operating units (Dry Van, Refrigerated, and Drayage), and (ii) the Logistics segment comprised of two operating units (Brokerage and Intermodal). We also provide logistics, freight management and other non-trucking services through our Logistics businesses. Through our Trucking and Logistics segment capabilities, we are able to transport, or can arrange for the transportation of, general commodities for customers throughout the United States and parts of Canada and Mexico.

In determining our reportable segments, we focus on financial information such as operating revenues and expenses, operating income, operating ratios, and other key operating statistics common in the industry.  The chief operating decision maker also uses this information to evaluate segment performance and allocate resources to our operations.

 
Our segments provide transportation and related services for one another. Such services are billed at cost, and no profit is earned. Such intersegment revenues and expenses are eliminated in our consolidated results.

The following table sets forth revenue and operating income between the Trucking and Logistics segments for the three months and nine months ended September 30, 2016 and 2015 (dollars in thousands).

   
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Revenues:
  $    
 
%
    $    
 
%
    $    
 
%
    $    
 
%
 
Trucking Segment
 
$
228,590
     
81.5
   
$
242,046
     
80.6
   
$
672,969
     
81.2
   
$
722,963
     
81.0
 
Logistics Segment
   
53,643
     
19.1
     
62,773
     
20.9
     
163,955
     
19.8
     
181,339
     
20.3
 
Subtotal
   
282,233
             
304,819
             
836,924
             
904,302
         
Intersegment Eliminations Trucking
   
(34
)
   
0.0
     
(38
)
   
0.0
     
(106
)
   
0.0
     
(116
)
   
0.0
 
Intersegment Eliminations Logistics
   
(1,669
)
   
(0.6
)
   
(4,659
)
   
(1.5
)
   
(7,882
)
   
(1.0
)
   
(11,961
)
   
(1.3
)
Total
 
$
280,530
     
100
%
 
$
300,122
     
100
%
 
$
828,936
     
100
%
 
$
892,225
     
100
%
                                                                 
Operating Income:
                                                               
Trucking Segment
 
$
34,439
     
93.2
   
$
42,710
     
92.0
   
$
105,647
     
92.9
   
$
122,800
     
91.4
 
Logistics Segment
   
2,495
     
6.8
     
3,716
     
8.0
     
8,095
     
7.1
     
11,548
     
8.6
 
Total
 
$
36,934
     
100
%
 
$
46,426
     
100
%
 
$
113,742
     
100
%
 
$
134,348
     
100
%

No segmental asset or liability information is provided as we do not prepare balance sheets by segment, and the chief operating decision maker does not review segment assets or liabilities to make operating decisions.

Note 5. Joint Ventures

In 2014, we formed an Arizona limited liability company, Kool Trans, LLC, for the purpose of expanding our refrigerated trucking business. In 2015, we changed the company name to Kold Trans, LLC. We are entitled to 80% of the profits of the entity and have effective control over the management of the entity. In accordance with ASC 810-10-15-8, Consolidation, we consolidate the financial activities of this entity into these condensed consolidated financial statements. The noncontrolling interest for this entity is presented as a separate component of the condensed consolidated financial statements.

In 2010, we partnered with a non-related investor to form an Arizona limited liability company for the purpose of sourcing commercial vehicle parts. We contributed $26,000 to acquire 52% ownership of this entity. In accordance with ASC 810-10-15-8, Consolidation, we consolidate the financial activities of this entity into the condensed consolidated financial statements. The noncontrolling interest for this entity is presented as a separate component of the condensed consolidated financial statements.

Note 6. Commitments and Contingencies

We are a party to certain claims and pending litigation arising in the normal course of business.  These proceedings primarily involve claims for personal injury, property damage, physical damage, and cargo loss incurred in the transportation of freight or for personnel matters, as well as certain class action litigation in which plaintiffs allege failure to provide meal and rest breaks, unpaid wages, unauthorized deductions, and other items.

We are insured against auto liability (“AL”) claims under a primary self-insured retention ("SIR") policy with retention ranging from $1.0 million to $3.0 million per occurrence and in some years, depending on the applicable policy year, we have been responsible for aggregate losses up to $1.5 million within the primary AL layer.  For the policy periods March 1, 2016 to March 1, 2017, and March 1, 2015 to March 1, 2016, the SIR is $2.5 million with no additional aggregate limits or deductibles within the primary AL policy.  We have secured excess liability coverage up to $130.0 million per occurrence for the policy period March 1, 2016 to March 1, 2017. For policy period March 1, 2015 to March 1, 2016, our excess liability coverage limit was $105.0 million per occurrence. We also carry a $2.5 million aggregate deductible for any loss or losses within the excess coverage layer.
 

 
We are self-insured for workers' compensation coverage. On March 31, 2016, the self-retention level was increased from a maximum $500,000 per occurrence to a maximum $1.0 million per occurrence. We also maintain primary and excess coverage for employee medical expenses and hospitalization, with self-insured retention of $240,000 per claimant in 2016, and $225,000 per claimant in 2015.

Based on our present knowledge of the facts, and in certain cases, advice of outside counsel, management believes the resolution of open claims and pending litigation, taking into account existing reserves, and accrued liabilities recorded is not likely to have a materially adverse effect on our consolidated financial statements.

Note 7. Property and Equipment

To ensure that our facilities remain modern and efficient, we periodically have facility upgrades, or new construction, in process at our various service center or corporate headquarters locations. Until these projects are completed, we consider these to be assets not yet placed in service and they are not depreciated.  Once they are placed into service, we depreciate them according to our depreciation policy. At September 30, 2016 and December 31, 2015, we had approximately $10.4 million and $17.5 million, respectively, of facility construction in process assets included under "Buildings and building improvements” on the accompanying condensed consolidated balance sheets.

Note 8. Goodwill and Intangibles, net

Goodwill represents the excess of the purchase price of our acquisitions over the fair value of the net assets acquired. The tax benefit from the recognition on the tax return of the amortization of the excess tax goodwill over book goodwill is treated as a reduction in the book basis of goodwill.

The changes in the carrying amounts of goodwill were as follows (dollars in thousands):

   
Nine Months Ended September 30, 2016
 
Goodwill at beginning of period
 
$
47,050
 
Amortization relating to deferred tax assets
   
(15
)
Goodwill at end of period
 
$
47,035
 

In conjunction with our acquisitions, identifiable intangible assets subject to amortization have been recorded at fair value and are being amortized over a weighted-average amortization period of 7.6 years.

Intangible asset balances were as follows (dollars in thousands):

   
September 30,
2016
   
December 31,
2015
 
Gross carrying amount
 
$
3,700
   
$
3,700
 
Accumulated amortization
   
(1,000
)
   
(625
)
Intangible assets, net
 
$
2,700
   
$
3,075
 
 
 
Amortization expense associated with these intangible assets was $0.1 million and $0.4 million for the three and nine months ended September 30, 2016, and 2015, respectively, and is included in Depreciation and amortization” on the accompanying condensed consolidated statements of income. Future amortization expense for intangible assets is estimated at $0.1 million for the remainder of 2016, $0.5 million for each of the years 2017 through 2019, and $0.4 million in 2020 and 2021.

Note 9. Investments and Related Commitments

In 2003, we signed a partnership agreement with Transportation Resource Partners ("TRP"), a company that makes privately negotiated equity investments. Per the original partnership agreement, we committed to invest $5.0 million in TRP. In 2006, we increased the commitment amount to $5.5 million. Although no gain or loss was recognized from TRP investment activity in the three or nine month periods in 2016, we recorded impairment of $67,000 for an other-than-temporary loss on the investment in the three months ended September 30, 2016. No impairment was recorded in the three or nine month periods in 2015, but we recognized a net gain of $122,000 from TRP investment activity in the nine months ended September 30, 2015. The carrying value of our investment in TRP was $233,400 at September 30, 2016 and $300,000 at December 31, 2015. Our investment in TRP is accounted for using the cost method, and the balance is included within "Other long-term assets, restricted cash and investments" on our accompanying condensed consolidated balance sheets.

In 2008, we formed Knight Capital Growth, LLC and committed $15.0 million to invest in another partnership managed and operated by the managers and principals of TRP. This partnership, Transportation Resource Partners III, LP ("TRP III"), is focused on investment opportunities similar to TRP. In 2015, TRP III released us from $2.1 million of our outstanding commitment. As of September 30, 2016, we have contributed approximately $11.1 million to TRP III, leaving an outstanding commitment of $1.8 million. Our investment in TRP III is accounted for using the equity method. For the three months ended September 30, 2016, we recorded income of approximately $32,100, for our investment in TRP III, and $204,000 for the three months ended September 30, 2015. For the nine months ended September 30, 2016 and 2015, we recognized income of $177,000, and $443,000, respectively, for TRP III. The carrying value of our investment in TRP III was $5.6 million and $5.8 million as of September 30, 2016 and December 31, 2015, respectively, and is included within "Other long-term assets, restricted cash and investments" on our accompanying condensed consolidated balance sheets.

In 2015, we committed to invest in another TRP partnership, TRP Capital Partners, LP (“TRP IV”). TRP IV is managed and operated by the managers and principals of TRP and TRP III, and is focused on similar investment opportunities. We committed to contribute a total of $4.9 million to TRP IV, and have contributed approximately $2.1 million, leaving an outstanding commitment of approximately $2.8 million as of September 30, 2016. Our investment in TRP IV is accounted for using the cost method, and the balance is included within "Other long-term assets, restricted cash and investments" on our accompanying condensed consolidated balance sheets.

In the first quarter of 2016, we committed to invest in another TRP partnership, TRP CoInvest Partners, (NTI) I, LP (“TRP Coinvestment”). The new partnership is managed and operated by the managers and principals of the other TRP partnerships, and is focused on similar investment opportunities. We committed to contribute, and have paid a total of, $10.0 million to the new partnership, leaving no outstanding commitment as of September 30, 2016. Our investment in TRP Coinvestment is accounted for using the equity method, and the carrying value at September 30, 2016 was $10.0 million and is included within "Other long-term assets, restricted cash and investments" on our accompanying condensed consolidated balance sheets.

In the third quarter of 2016, we committed to invest in another TRP partnership, TRP CoInvest Partners, (QLS) I, LP (“TRP Coinvestment QLS”). The new partnership is managed and operated by the managers and principals of the other TRP partnerships, and is focused on similar investment opportunities. We committed to contribute, and have paid a total of, $9.7 million to the new partnership, leaving no outstanding commitment as of September 30, 2016. Our investment in TRP Coinvestment is accounted for using the equity method, and the carrying value at September 30, 2016 was $9.7 million and is included within "Other long-term assets, restricted cash and investments" on our accompanying condensed consolidated balance sheets.

 
Note 10. Marketable Equity Securities

We have certain marketable equity securities classified as available-for-sale securities, which are recorded at fair value with unrealized gains and losses, net of tax, as a component of "Accumulated other comprehensive income" in shareholders' equity on the accompanying condensed consolidated balance sheets. Realized gains and losses on available-for-sale securities are included in the determination of net income. We use specific identification to determine the cost of securities sold, or amounts reclassified out of accumulated other comprehensive income into earnings and included in “Other income” on the accompanying condensed consolidated statements of income.

The following table shows the Company’s realized gains during the three and nine month periods ended September 30, 2016 and 2015, on certain securities that were classified as available-for-sale (dollars in thousands).

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2016
 
2015
 
2016
 
2015
 
Realized gains
               
Sales proceeds
 
$
2,220
   
$
3,151
   
$
7,403
   
$
9,339
 
Cost of securities sold
   
796
     
1,021
     
2,909
     
2,670
 
Realized gain
 
$
1,424
   
$
2,130
   
$
4,494
   
$
6,669
 
                                 
Realized gains, net of taxes
 
$
878
   
$
1,307
   
$
2,771
   
$
4,093
 

During the third quarter, we disposed of our holdings in available-for-sale equity investments leaving no balance on the accompanying condensed consolidated balance sheet as of September 30, 2016. As of December 31, 2015, our available-for-sale investment balance was approximately $7.1 million, including gross unrealized gains of approximately $4.2 million, or $2.6 million (net of tax), and was included in "Other long-term assets, restricted cash and investments" on the accompanying condensed consolidated balance sheet.

Note 11. Assets Held for Sale

Revenue equipment that is not utilized in continuing operations and is held for sale is classified as "Assets held for sale" on the accompanying condensed consolidated balance sheets.  Assets held for sale at September 30, 2016 and December 31, 2015, totaled $18.3 million and $29.3 million, respectively. Assets held for sale are no longer subject to depreciation, and are recorded at the lower of depreciated carrying value or fair market value less selling costs. We expect to sell these assets and replace them with new assets within twelve months of being classified as "Assets held for sale."

Note 12. Income Taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. For interim reporting purposes, our income tax provisions are recorded based on the estimated annual effective tax rate. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
 

 
We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial operations.  A valuation allowance for deferred tax assets has not been deemed necessary due to our profitable operations.

We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits.  We file federal and state income tax returns with varying statutes of limitations. The 2012 through 2015 tax years remain subject to examination by federal and state tax authorities.  As of  September 30, 2016, cumulative gross unrecognized tax benefits were $0.7 million.  We had no unrecognized tax benefits as of December 31, 2015.  All unrecognized tax benefits, if recognized, would affect the effective tax rate.

With the exception of the unrecognized tax benefits discussed above, we believe that our income tax filing positions and deductions will be sustained upon audit and do not anticipate any adjustments that will result in a material change to our consolidated financial position, results of operations and cash flows.  Our policy is to recognize interest and penalties related to unrecognized tax benefits as income tax expense.  No interest or penalties related to unrecognized tax benefits has been recognized as of September 30, 2016 or December 31, 2015, because the Company has not yet received the refunds related to the uncertain tax benefits.  None of the unrecognized tax benefits are expected to reverse in the next 12 months.

Note 13. Company Share Repurchase Programs

In 2011, our Board of Directors unanimously authorized the repurchase of 10.0 million shares of our common stock. The repurchase authorization is intended to afford flexibility to acquire shares opportunistically in future periods and does not indicate an intention to repurchase any particular number of shares within a definite timeframe.  Any repurchases would be effected based upon share price and market conditions. The Company’s share repurchase program does not obligate it to acquire any specific number of shares. Under the program, shares may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Exchange Act.

Under the share repurchase program, we repurchased 0.1 million shares for $3.3 million in the three months ended September 30, 2016, and 1.6 million shares for $39.9 million in the nine months ended September 30, 2016. We repurchased 0.6 million shares for $15.0 million in the three months ended September 30, 2015, and 1.6 million shares for $45.3 million in the nine months ended September 30, 2015. As of September 30, 2016, there were 4.3 million shares remaining for future purchases under our repurchase program. The repurchase authorization will remain in effect until the share limit is reached or the program is terminated.

Note 14. Fair Value Measurements

Our assets and liabilities measured at fair value are based on principles set forth in ASC 820-10, Fair Value Measurements and Disclosure, for recurring and non-recurring fair value measurements of financial and non-financial assets and liabilities. This standard defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles in the United States, and expands disclosures about fair value measurements. This standard establishes a three-level hierarchy for fair value measurements based upon the significant inputs used to determine fair value.  Observable inputs are those which are obtained from market participants external to us while unobservable inputs are generally developed internally, utilizing management's estimates, assumptions, and specific knowledge of the nature of the assets or liabilities and related markets.  The three levels are defined as follows:

Level 1 – Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
 
 
Level 2 – Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).

Level 3 – Unobservable inputs, only used to the extent that observable inputs are not available, reflect our assumptions about the pricing of an asset or liability.

In accordance with the fair value hierarchy described above, the following table shows the fair value of our financial assets and liabilities that are required to be measured at fair value as of September 30, 2016 and December 31, 2015 (dollars in thousands). 

   
Total
   
Total
   
Level One
   
Level Two
   
Level Three
 
   
Balance at
September 30, 2016
   
Balance at
December 31, 2015
   
Balance at
September 30, 2016
   
Balance at
December 31, 2015
   
Balance at
September 30, 2016
   
Balance at
December 31, 2015
   
Balance at
September 30, 2016
   
Balance at
December 31, 2015
 
Assets:
                                               
Available-for-sale securities:
                                               
Equity securities - common shares
   
-
   
$
7,101
     
-
   
$
7,101
     
-
     
-
     
-
     
-
 
Restricted cash and investments:
                                                         
Money market funds
 
$
1,261
   
$
1,003
   
$
1,261
   
$
1,003
     
-
     
-
     
-
     
-
 
Trading securities:
                                                               
Debt securities - municipal securities
 
$
2,040
   
$
2,279
     
-
     
-
   
$
2,040
   
$
2,279
     
-
     
-
 
 
Note 15. Notes Receivable

We provide financing to independent contractors and third parties on equipment sold or leased under our equipment sale program. Most of the notes are collateralized and are due in weekly installments, comprised of principal and interest payments. Interest rates are set forth in the contracts and generally range from 2.0% to 20%.

The notes receivable balances are classified separately between current and long-term on the accompanying condensed consolidated balance sheets.  The current and long-term balance of our notes receivable at September 30, 2016 and December 31, 2015, are as follows (dollars in thousands):

   
September 30,
2016
   
December 31,
2015
 
Notes receivable from independent contractors
 
$
1,093
   
$
794
 
Notes receivable from third parties
   
2,933
     
3,546
 
Gross notes receivable
   
4,026
     
4,340
 
Allowance for doubtful notes receivable
   
(254
)
   
(273
)
Total notes receivable, net of allowance
   
3,772
     
4,067
 
                 
Current portion, net of allowance
   
574
     
648
 
Long-term portion
 
$
3,198
   
$
3,419
 
 
 
Note 16. Line of Credit

We maintain a revolving line of credit which permits revolving borrowings and letters of credit.  The line of credit is maintained at $300.0 million and matures December 1, 2017. Effective August 8, 2016, we entered into a modification to our line of credit agreement that extends the maturity date to August 1, 2019, and amends our minimum tangible net worth covenant to $500.0 million from $400.0 million. We incur interest on borrowings under the line of credit at the prime rate or LIBOR plus 0.625%, determined by us at the time of borrowing. We had $52.0 million outstanding under the line of credit as of September 30, 2016, compared to $112.0 million as of December 31, 2015.  The weighted average variable annual percentage rate ("APR") for amounts borrowed during the nine months ended September 30, 2016 was 1.07%.  Borrowings under the line of credit are recorded in the "Long-term debt" line of the accompanying condensed consolidated balance sheets.  As of September 30, 2016, we also utilized $31.1 million of the line of credit for letters of credit issued to various regulatory authorities and insurance carriers in connection with our self-insurance programs.  With the outstanding letters of credit and debt borrowed, we have $216.9 million available for future borrowings as of September 30, 2016.  After consideration of fees incurred for the unused portion of our line of credit, our weighted average variable APR for the nine months ended September 30, 2016 was 1.27%. We are obligated to comply with certain financial and other covenants under the line of credit agreement and were in compliance with such covenants at and for the three and nine months ended September 30, 2016 and for the year ended December 31, 2015.

Note 17. Recent Accounting Pronouncements

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 203): Classification of Certain Cash receipts and Cash Payments. This update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU is effective for reporting periods beginning after December 15, 2017. We are currently evaluating the new guidance to determine the impact it may have on our condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvement to Employee Share-based Payment Accounting. The objective of this update is to simplify several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This ASU is effective for reporting periods beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the new guidance to determine the impact it may have on our condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net).  This update clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The amendments in this update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which requires revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. The guidance in this update supersedes virtually all present U.S. GAAP guidance on revenue recognition. The amendments to the standard require the use of more estimates and judgments than the present standards and require additional disclosures. The amendments in these updates will be effective for reporting periods beginning after December 15, 2017. We are currently evaluating the effect that this guidance will have on our condensed consolidated financial statements and related disclosures and have not yet selected a transition method.
 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This update seeks to increase the transparency and comparability among entities by requiring public entities to recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. To satisfy the standard’s objective, a lessee will recognize a right-of-use asset representing its right to use the underlying asset for the lease term and a lease liability for the obligation to make lease payments. Both the right-of-use asset and lease liability will initially be measured at the present value of the lease payments, with subsequent measurement dependent on the classification of the lease as either a finance or an operating lease. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. Accounting by lessors will remain mostly unchanged from current U.S. GAAP.

In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that companies may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. The transition guidance also provides specific guidance for sale and leaseback transactions, build-to-suit leases, leveraged leases, and amounts previously recognized in accordance with the business combinations guidance for leases. The new standard is effective for public companies for annual periods beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. We are currently evaluating the effect that adopting this standard will have on our condensed consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall (Subtopic 825-10). This update was issued to enhance the reporting model for financial instruments regarding certain aspects of recognition, measurement, presentation, and disclosure. The update (i) requires equity investments (except those accounted for under the equity method or that are consolidated) to be measured at fair value with changes in fair value recognized in net income; (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (iii) eliminates the requirement for an entity to disclose the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost; (iv) requires an entity to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and (v) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements. These provisions are effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. The standard is to be applied using a cumulative-effect adjustment to the balance sheet as of the beginning of the year of adoption. We are currently evaluating the effect that adopting this standard will have on our condensed consolidated financial statements.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report contains certain statements that may be considered "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended, and such statements are subject to the safe harbor created by those sections and the Private Securities Litigation Reform Act of 1995, as amended.  All statements, other than statements of historical or current fact, are statements that could be deemed forward-looking statements, including without limitation: any projections of earnings, revenues, cash flows, dividends, capital expenditures, or other financial items; any statement of plans, strategies, and objectives of management for future operations; any statements concerning proposed acquisition plans, new services or developments; any statements regarding future economic conditions or performance; and any statements of belief and any statement of assumptions underlying any of the foregoing.  In this Item 2, statements relating to the ability of our infrastructure to support future growth, the flexibility of our model to adapt to market conditions, our ability to recruit and retain qualified drivers, our ability to react to
 
 
market conditions, our ability to gain market share, future tractor prices, potential acquisitions, our equipment purchasing plans and equipment turnover, the expected freight environment and economic trends, whether we grow organically, our ability to obtain favorable pricing terms from vendors and suppliers, expected liquidity and methods for achieving sufficient liquidity, future fuel prices, future third-party service provider relationships and availability, future compensation arrangements with independent contractors and drivers, our expected need or desire to incur indebtedness, expected sources of liquidity for capital expenditures and allocation of capital, expected tractor trade-ins, expected sources of working capital and funds for acquiring revenue equipment, expected capital expenditures, future asset utilization, future capital requirements, future trucking capacity, future consumer spending, expected freight demand and volumes, future rates, future depreciation and amortization, expected tractor and trailer fleet age, regulatory changes and the impact thereof, and future purchased transportation expense, among others, are forward-looking statements. Such statements may be identified by their use of terms or phrases such as "believe," "may," "could," "expects," "estimates," "projects," "anticipates," "plans," "intends," "hope," and similar terms and phrases.  Forward-looking statements are based on currently available operating, financial, and competitive information.  Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, which could cause future events and actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled "Item 1A. Risk Factors," set forth in our Form 10-K for the year ended December 31, 2015, along with any supplements in Part II below, and various disclosures in our press releases, stockholder reports, and other filings with the Securities and Exchange Commission.

All such forward-looking statements speak only as of the date of this Form 10-Q.  You are cautioned not to place undue reliance on such forward-looking statements.  We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in the events, conditions, or circumstances on which any such statement is based.

Introduction

Business Overview

We offer a broad range of full truckload transportation and logistics services with one of North America's largest tractor fleets, operated through a nationwide network of service centers, and contractual access to thousands of third-party capacity providers.  We have grown substantially by increasing the geographic reach of our service center network and by expanding the breadth of our services for customers.  Our Trucking segment provides truckload transportation, including dedicated services, of various products, goods, and materials for our diverse customer base through our Dry Van, Refrigerated, and Drayage operating units.  The Brokerage and Intermodal operating units of our Logistics segment provide a multitude of shipment solutions, including additional sources of truckload capacity and alternative transportation modes, by utilizing our vast network of third-party capacity providers and rail providers, as well as certain logistics, freight management, and other non-trucking services.  Our objective is to operate our Trucking and Logistics business with industry-leading margins and growth while providing safe, high-quality, cost-effective solutions for our customers.

Factors that affect our results of operations are industry-wide economic factors, such as freight demand, truckload and rail intermodal capacity, fuel prices, inventory levels, industrial production, government regulation, and unemployment rates, as well as our capital allocation, sales and marketing, operating, and spending decisions. We measure our results through key metrics, such as the number of tractors we operate, our revenue per tractor (which includes primarily our revenue per total mile and our number of miles per tractor), freight volumes brokered to third-party capacity providers (including our rail partners), driver and independent contractor recruitment and retention, and our ability to control costs on a company-wide basis, as measured by cost per mile in our Trucking segment and non-GAAP operating ratio in both segments.  Our success depends on our ability to efficiently and effectively manage our resources in providing transportation and logistics solutions to our customers in light of such factors.  We evaluate the growth opportunities for each of our Trucking and Logistics businesses based on customer demand and supply chain trends, availability of drivers and third-party capacity providers, expected returns on invested capital, expected net cash flows, and our company-specific capabilities.
 
 
Recent Consolidated Results of Operations and Quarter-End Financial Condition

Our consolidated results of operations for the three months ended September 30, 2016, compared to the three months ended September 30, 2015, were as follows:

Total revenue decreased 6.5%, to $280.5 million from $300.1 million;
   
Revenue, before fuel surcharge, decreased 5.1%, to $256.2 million from $269.9 million;
   
Net income attributable to Knight Transportation decreased 22.9%, to $23.4 million from $30.3 million; and
   
Net earnings attributable to Knight Transportation per diluted share decreased to $0.29 per share from $0.37 per share.

The freight environment remained modest in the third quarter of 2016 compared to the same quarter in the prior year. We continued to experience excess trucking capacity with fewer non-contract opportunities that pressured our revenue per loaded mile as compared to last year. However, we sustained improvement in our asset utilization and experienced more favorable freight conditions as the quarter progressed. Although an environment of surplus trucking capacity continues, we are encouraged by current freight volumes and asset utilization and expect capacity to continue to tighten in the next few quarters as signaled by significantly declining new truck orders, the weak used equipment market, increased bankruptcies, reduction in the driver workforce, broker margin compression, inflationary driver pay and additional regulatory burdens expected to phase in over the coming quarters.

During the third quarter of 2016, our Trucking segment produced a non-GAAP operating ratio of 83.1% compared to 79.8% in the same quarter of 2015, while trucking revenue, excluding trucking fuel surcharge, decreased 3.6% in the quarter year over year.  Please see the reconciliation table below for a reconciliation of GAAP operating ratio to non-GAAP operating ratio. Productivity, as measured by average revenue per tractor, before fuel surcharge, decreased 0.8% in the third quarter of 2016 compared to the same quarter of 2015, attributable to a 2.1% decrease in average revenue per loaded mile, and an increase in non-paid empty mile percentage of 30 basis points, partially offset by a 1.6% increase in average miles per tractor.

Our Logistics segment produced an operating ratio of 95.2% in the third quarter of 2016 compared to 93.6% for the same quarter in 2015, with revenue declining 10.6%.  The decrease in revenue is attributable primarily to a decline in non-trucking service revenue in the third quarter of 2016 from the same quarter of 2015, as we exited our agricultural sourcing business in the first quarter of 2016. Revenue from our Brokerage business, the largest component of our Logistics segment, also decreased in the third quarter of 2016 compared to the same quarter of 2015 by 4.5%.  Despite Brokerage revenue decreasing, Brokerage load volume increased 7.0%. The decrease in Brokerage revenue was a result of lower fuel surcharge, a shorter length of haul, and lower non-contract pricing. Brokerage gross margins contracted 140 basis points in the quarter as capacity began to tighten.

In the third quarter of 2016, we returned $8.1 million to our shareholders in the form of quarterly cash dividends and stock repurchases and ended the quarter with $764.6 million of shareholders' equity. In the third quarter of 2016, we generated $55.6 million in cash flow from operations and used $40.7 million for capital expenditures net of equipment sales.
 
 
Our liquidity is not materially affected by off-balance sheet transactions.  See the discussion under "Off-Balance Sheet Transactions" and "Liquidity and Capital Resources" for a description of our off-balance sheet transactions.

Consolidated Revenue and Expenses

We primarily generate revenue by transporting freight for our customers in our Trucking segment or arranging for the transportation of customer freight in our Logistics segment.  Our total revenue is reported under "Results of Operations" and categorized as (i) Trucking revenue, before fuel surcharge, (ii) Trucking fuel surcharge revenue, and (iii) Logistics revenue.  Trucking revenue, before fuel surcharge, and Trucking fuel surcharge revenue is largely generated by the trucking services provided by our three Trucking operating units (Dry Van, Refrigerated, and Drayage) whereas Logistics revenue is mostly generated by the logistics services provided by our two Logistics operating units (Brokerage and Intermodal). We also provide logistics, freight management, sourcing, and other non-trucking services, such as used equipment sales and leasing to independent contractors and third-parties, through our Logistics business.

The total revenue and operating expenses of our Trucking and Logistics segments are similarly affected by certain factors that generally relate to, among other things, overall economic and weather conditions in the United States, customer inventory levels, specific customer demand, the levels of truckload and rail intermodal capacity, and availability of qualified drivers, independent contractors, and third-party capacity providers. See the section entitled "Item 1A. Risk Factors," set forth in our Form 10-K for the year ended December 31, 2015, along with various disclosures in our press releases, shareholder reports, and other filings with the Securities and Exchange Commission.

To reduce our risk to fuel price fluctuations in our Trucking segment, we have a fuel surcharge program under which we obtain additional fuel surcharges from our customers that generally recover a majority, but not all, of the increased fuel costs; however, we cannot ensure that current recovery levels will continue in the future.  In discussing our overall and segment-based results of operations, because changes in fuel costs typically cause fuel surcharge revenue to fluctuate, we identify Trucking fuel surcharge revenue separately and omit fuel surcharge revenue from our statistical calculations.  We believe that omitting this potentially volatile source of revenue provides a more meaningful comparison of our operating results from period to period.

A primary measure we use to evaluate the profitability of our overall and segment based operations is operating ratio, measured both on a GAAP basis (operating expenses expressed as a percentage of revenue) and on a non-GAAP basis (“non-GAAP operating ratio”) that many in our industry use (operating expenses, net of Trucking fuel surcharge revenue, expressed as a percentage of Trucking revenue, excluding Trucking fuel surcharge revenue).  We believe the second method allows us to more effectively compare periods while excluding the potentially volatile effect of changes in fuel prices.  Non-GAAP operating ratio is not a substitute for or superior to, and should be considered in addition to, GAAP operating ratio. Pursuant to the requirements of Regulation G, the tables below compare our operating ratio using both methods on a consolidated basis.

The following table reconciles consolidated GAAP operating ratio to consolidated non-GAAP operating ratio (dollars in thousands):

   
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
GAAP Presentation:
  $    
 
%
       
 
%
    $    
 
%
       
 
%
 
Total revenue
 
$
280,530
           
$
300,122
           
$
828,936
           
$
892,225
         
Total operating expenses
   
243,596
     
86.8
     
253,696
     
84.5
     
715,194
     
86.3
     
757,877
     
84.9
 
Income from operations
   
36,934
           
$
46,426
             
113,742
           
$
134,348
         
 
   
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Non-GAAP Presentation(1):
   $    
 
%
       
 
%
       
 
%
    $    
 
%
 
Total revenue
 
$
280,530
           
$
300,122
           
$
828,936
           
$
892,225
         
Less fuel surcharge
   
(24,287
)
           
(30,192
)
           
(65,252
)
           
(96,458
)
       
Revenue, before fuel surcharge
   
256,243
             
269,930
             
763,684
             
795,767
         
                                                                 
Total operating expenses
   
243,596
             
253,696
             
715,194
             
757,877
         
Less fuel surcharge
   
(24,287
)
           
(30,192
)
           
(65,252
)
           
(96,458
)
       
Total operating expenses, net of fuel surcharge
   
219,309
     
85.6
     
223,504
     
82.8
     
649,942
     
85.1
     
661,419
     
83.1
 
Income from operations
   
36,934
             
46,426
             
113,742
             
134,348
         

 (1)
These items represent non-GAAP financial measures and are not substitutes for or superior to, and should be considered in addition to, the GAAP financial measures presented in the previous table.

The following table sets forth revenue and operating income between the Trucking and Logistics segments for the three months and nine months ended September 30, 2016 and 2015 (dollars in thousands).

   
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Revenues:
     
 
%
    $    
 
%
    $    
 
%
    $    
 
%
 
Trucking Segment
 
$
228,590
     
81.5
   
$
242,046
     
80.6
   
$
672,969
     
81.2
   
$
722,963
     
81.0
 
Logistics Segment
   
53,643
     
19.1
     
62,773
     
20.9
     
163,955
     
19.8
     
181,339
     
20.3
 
Subtotal
   
282,233
             
304,819
             
836,924
             
904,302
         
Intersegment Eliminations Trucking
   
(34
)
   
0.0
     
(38
)
   
0.0
     
(106
)
   
0.0
     
(116
)
   
0.0
 
Intersegment Eliminations Logistics
   
(1,669
)
   
(0.6
)
   
(4,659
)
   
(1.5
)
   
(7,882
)
   
(1.0
)
   
(11,961
)
   
(1.3
)
Total
 
$
280,530
     
100
%
 
$
300,122
     
100
%
 
$
828,936
     
100
%
 
$
892,225
     
100
%
                                                                 
Operating Income:
                                                               
Trucking Segment
 
$
34,439
     
93.2
   
$
42,710
     
92.0
   
$
105,647
     
92.9
   
$
122,800
     
91.4
 
Logistics Segment
   
2,495
     
6.8
     
3,716
     
8.0
     
8,095
     
7.1
     
11,548
     
8.6
 
Total
 
$
36,934
     
100
%
 
$
46,426
     
100
%
 
$
113,742
     
100
%
 
$
134,348
     
100
%

Trucking Strategy and Segment Information

Our Trucking operating strategy is to achieve a high level of asset utilization within a highly disciplined operating system while maintaining strict controls over our cost structure.  To achieve these goals, we operate primarily in high-density, predictable freight lanes in select geographic regions and attempt to develop and expand our customer base around each of our service centers by providing multiple truckload services for each customer.  This operating strategy allows us to take advantage of the large amount of freight transported in regional markets.  Our service centers enable us to better serve our customers and work more closely with our driving associates.  We operate a premium, modern fleet to appeal to drivers and customers, reduce maintenance expenses and driver and equipment downtime, and enhance our fuel and other operating efficiencies.  We employ technology in a cost-effective manner to assist us in controlling operating costs and in enhancing revenue.
 
 
Trucking revenue is generated by our Dry Van, Refrigerated, and Drayage operating units.  Generally, we are paid a predetermined rate per mile or per load for our Trucking services.  Additional revenues are generated by charging for tractor and trailer detention, loading and unloading activities, dedicated services, and other specialized services, as well as through the collection of fuel surcharges to mitigate the impact of increases in the cost of fuel.  The main factors that affect our Trucking revenue are the revenue per mile we receive from our customers, the percentage of miles for which we are compensated, and the number of loaded miles we generate with our equipment.

Effectively controlling our expenses is an important element of maximizing our profitability.  The most significant expenses of our Trucking segment are primarily variable and include fuel and fuel taxes, driver-related expenses (such as wages, benefits, training, and recruitment) and costs associated with independent contractors (which are primarily included in purchased transportation expense recorded on the "Purchased transportation" line in the accompanying condensed consolidated statements of income).  Expenses that have both fixed and variable components include maintenance expense (which includes costs for replacement tires for our revenue equipment) and our total cost of insurance and claims.  These expenses generally vary with the miles we travel but also have a controllable component based on safety, fleet age, efficiency, and other factors.  The main fixed costs for our Trucking segment are the acquisition and depreciation of long-term assets (such as revenue equipment and service centers) and the compensation of non-driver personnel.

The primary measure we use to evaluate the profitability of our Trucking segment is operating ratio, measured both on a GAAP basis (operating expenses expressed as a percentage of revenue) and on a non-GAAP basis that many in our industry use (operating expenses, net of Trucking fuel surcharge revenue, expressed as a percentage of Trucking revenue, excluding Trucking fuel surcharge revenue).  We believe the second method allows us to more effectively compare periods while excluding the potentially volatile effect of changes in fuel prices.  Non-GAAP operating ratio is not a substitute for or superior to, and should be considered in addition to, GAAP operating ratio. Pursuant to the requirements of Regulation G, the tables below compare our operating ratio using both methods.

The following table sets forth the Trucking segment operating ratio on a GAAP basis (dollars in thousands).

 
GAAP Presentation:
 
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Trucking Segment
  $    
 
%
    $    
 
%
    $    
 
%
    $    
 
%
 
Revenue
 
$
228,590
           
$
242,046
           
$
672,969
           
$
722,963
         
Operating expenses
   
194,151
     
84.9
     
199,336
     
82.4
     
567,322
     
84.3
     
600,163
     
83.0
 
Operating income
 
$
34,439
           
$
42,710
           
$
105,647
           
$
122,800
         
 
 
The following table sets forth the non-GAAP operating ratio for our Trucking segment as if fuel surcharges are excluded from total revenue and instead reported as a reduction of operation expenses, excluding intersegment activity (dollars in thousands).

 
Non-GAAP Presentation(1):
 
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Trucking Segment
  $    
 
%
    $    
 
%
    $    
 
%
    $    
 
%
 
Revenue
 
$
228,590
           
$
242,046
           
$
672,969
           
$
722,963
         
Less: Trucking fuel surcharge revenue
   
(24,287
)
           
(30,192
)
           
(65,252
)
           
(96,458
)
       
Less: Intersegment transactions
   
(34
)
           
(38
)
           
(106
)
           
(116
)
       
Revenue, net of fuel surcharge and intersegment transactions
   
204,269
             
211,816
             
607,711
             
626,389
         
Operating expenses
   
194,151
             
199,336
             
567,322
             
600,163
         
Less: Trucking fuel surcharge revenue
   
(24,287
)
           
(30,192
)
           
(65,252
)
           
(96,458
)
       
Less: Intersegment transactions
   
(34
)
           
(38
)
           
(106
)
           
(116
)
       
Operating expenses, net of fuel surcharge and intersegment transactions
   
169,830
     
83.1
     
169,106
     
79.8
     
501,964
     
82.6
     
503,589
     
80.4
 
Operating income
 
$
34,439
           
$
42,710
           
$
105,647
           
$
122,800
         
 
(1)
These items represent non-GAAP financial measures and are not substitutes for or superior to, and should be considered in addition to, the GAAP financial measures presented in the previous table.
 
When evaluating Trucking revenue, we consider the following key operating statistics for each period:  (i) average revenue per tractor; (ii) average length of haul (miles with loaded trailer cargo); (iii) non-paid empty miles percent (miles without trailer cargo); and (iv) average number of tractors and trailers in operation.  The following table sets forth key operating statistics of the Trucking segment for the indicated periods.

   
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Average revenue per tractor(1)
 
$
43,501
   
$
43,863
   
$
129,444
   
$
130,398
 
Average length of haul (miles)
   
500
     
505
     
500
     
505
 
Non-paid empty mile percent
   
12.4
%
   
12.1
%
   
12.4
%
   
11.7
%
Average tractors in operation during period
   
4,696
     
4,829
     
4,694
     
4,804
 
Average trailers in operation during period
   
12,325
     
12,021
     
12,194
     
11,668
 

(1)
Average revenue per tractor is based on trucking revenue, net of intersegment elimination, and does not include fuel surcharge revenue.
 
 
Our Trucking segment requires substantial capital expenditures for purchases of new revenue equipment.  We fund these purchases with cash flows from operations and financing available under our existing line of credit.  We operated an average of 4,696 tractors in the third quarter of 2016, of which 4,282 were company-owned tractors as of September 30, 2016. The average age of our company-owned tractor fleet was 2.0 years in the quarter ended September 30, 2016.  We also operated an average of 12,325 trailers in the third quarter of 2016, with an average age of 3.9 years.  Our net property, plant, and equipment at September 30, 2016, was $813.2 million, most of which relates to our Trucking segment. 

Our capital expenditures can also affect depreciation expense.  Trucking depreciation relates primarily to our owned tractors, trailers, electronic logging devices and other communication units, and other similar assets.  Changes to this fixed cost are generally attributed to increases or decreases to company-owned equipment and fluctuations in new equipment purchase prices, which have historically been precipitated in part by new or proposed federal and state regulations (such as the EPA engine emissions requirements relating to post-2014 model tractors and the California trailer efficiency requirements).  Depreciation can also be affected by the cost of used equipment that we sell or trade and the replacement of older used equipment.  Our management periodically reviews the condition, average age, and reasonableness of estimated useful lives and salvage values of our equipment and considers such factors in light of our experience with similar assets, used equipment market conditions, and prevailing industry practice.  Total Trucking segment depreciation and amortization expense was approximately $28.0 million in the third quarter of 2016, and approximately $83.4 million in the first nine months of 2016.

Logistics Strategy and Segment Information

Logistics revenue is generated primarily by our Brokerage and Intermodal operating units.  We also provide logistics, freight management and other non-trucking services to our customers through our Logistics business.  We are generally paid a predetermined rate per mile or per load for arranging freight transportation for our customers and providing other Logistics services.  Additional revenue is generated by offering specialized logistics solutions (including, but not limited to, origin management, surge volumes, disaster relief, special projects, and other logistics needs).  Our Logistics revenue is mainly affected by the rates we obtain from customers, the freight volumes we ship through our third-party capacity providers, and our ability to secure qualified third-party capacity providers to transport customer freight.

Our Logistics segment is less asset-intensive and is instead dependent upon capable non-driver personnel, modern and effective information technology, and qualified third-party capacity providers.  The most significant expense of our Logistics segment, which is primarily variable, is the cost of purchased transportation that we pay to third-party capacity providers (including our rail providers), which is included in the "Purchased transportation" line in the accompanying condensed consolidated statements of income.  This expense generally varies depending upon truckload and rail capacity, availability of third-party capacity providers, rates charged to customers, and current freight demand and customer shipping needs.  Other Logistics operating expenses are generally fixed and primarily include the compensation and benefits of non-driver personnel (included in salaries, wages and benefits expense recorded on the "Salaries, wages and benefits" line in the accompanying condensed consolidated statements of income) and depreciation and amortization expense.
 
 
The following table sets forth the Logistics segment revenue, operating expenses, and operating income (dollars in thousands).
 
 
 
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Logistics Segment
  $    
 
%
    $    
 
%
    $    
 
%
    $    
 
%
 
Revenue
 
$
53,643
           
$
62,773
           
$
163,955
           
$
181,339
         
Operating expenses
   
51,148
     
95.3
     
59,057
     
94.1
     
155,860
     
95.1
     
169,791
     
93.6
 
Operating income
 
$
2,495
           
$
3,716
           
$
8,095
           
$
11,548
         

The following table sets forth the Logistics segment revenue, operating expenses, and operating income, excluding intersegment transactions (dollars in thousands).

   
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
 
Logistics Segment
  $    
 
%
    $    
 
%
    $    
 
%
    $    
 
%
 
Revenue
 
$
53,643
           
$
62,773
           
$
163,955
           
$
181,339
         
Less: Intersegment transactions
   
(1,669
)
           
(4,659
)
           
(7,882
)
           
(11,961
)
       
Revenue excluding intersegment transactions
   
51,974
             
58,114
             
156,073
             
169,378
         
Operating expenses
   
51,148
             
59,057
             
155,860
             
169,791
         
Less: Intersegment transactions
   
(1,669
)
           
(4,659
)
           
(7,882
)
           
(11,961
)
       
Operating expenses excluding intersegment transactions
   
49,479
     
95.2
     
54,398
     
93.6
     
147,978
     
94.8
     
157,830
     
93.2
 
Operating income
 
$
2,495
           
$
3,716
           
$
8,095
           
$
11,548
         

We primarily measure the Logistics segment's profitability by reviewing the gross margin percentage (revenue net of intersegment elimination, less purchased transportation expense, expressed as a percentage of revenue, net of intersegment elimination) and the operating ratio.  The gross margin percentage can be affected by customer rates and the costs of securing third-party capacity providers.  Our third-party capacity providers generally are not subject to long-term or predetermined contracted rates, and our operating results could be affected if the availability of third-party capacity providers or the rates for such providers change in the future. The following table lists the gross margin percentage for our Brokerage and Intermodal businesses combined.

 
Three Months Ended
September 30, 2016
 
Three Months Ended
September 30, 2015
 
Nine Months Ended
September 30, 2016
 
Nine Months Ended
September 30, 2015
Combined Brokerage and Intermodal gross margin percent(1)
14.4%
 
16.0%
 
16.5%
 
16.1%

(1)
Gross margin percentage is based on revenue net of intersegment elimination.
 
 
Our Logistics segment does not require significant capital expenditures and is not asset-intensive like our Trucking segment.  Rather, our Logistics segment depends on effective usage of information systems and technology that enable us to efficiently arrange for the transportation of our customers' freight and remain resourceful and responsive in meeting customer shipping needs.  As our Logistics services evolve, we may incur costs to upgrade, integrate, or expand our information systems and technology.  Total Logistics segment depreciation and amortization expense was approximately $1.1 million in the third quarter of 2016, and $3.1 million in the first nine months of 2016, which is primarily attributed to equipment leased to third parties.

Trends and Outlook

We are encouraged by the freight volumes and asset utilization we have seen at the end of the third quarter and early part of  the fourth quarter of 2016. Several positive market indicators suggest we can expect a more favorable freight environment and normal seasonal trends through the end of the year. We believe excess capacity will continue to exit the market, as indicated by significantly declining new truck orders, the weak used equipment market, increased bankruptcies, reduction in driver workforce, broker margin compression, inflationary driver pay, and additional regulatory burdens expected to phase in over the coming quarters. Market factors including higher driver wages, lower gain on sale of revenue equipment, less other income, and fewer non-contract opportunities may continue to negatively affect our margins in our Trucking and Logistics segments if capacity is slow to exit the market.  We plan to limit organic fleet expansion until we see meaningful rate improvement and increased customer demand, while focusing on cost control, and allocating expansion capital toward Logistics.

Our driver development program remains a primary focus for our management team.  We believe carriers that are well-positioned to develop and retain drivers, withstand supply and demand fluctuations, and provide safe, dependable, and high-quality service to customers will have opportunities to increase freight rates and market share.  We believe domestic and global economic and political conditions present the most direct challenges to improved freight demand.  These threats include the possibility that rising energy prices, an inability of the United States government to timely and adequately address fiscal issues, currency fluctuations, or other factors outside our control could reduce consumer spending or industrial investment, thus negatively affecting freight volumes.

Several issues impacting the trucking industry could also cause our costs to increase for the remainder of 2016. These issues include driver and independent contractor availability, fuel price fluctuations, increases to new tractor and trailer purchase prices, and compliance with new and proposed federal and state regulations.  From a cost perspective, recruiting and retaining sufficient numbers of qualified drivers, independent contractors, and third-party capacity providers may become increasingly costly, equipment prices may continue to rise, and potentially higher fuel prices may not be fully offset by fuel surcharges. In the current economic and regulatory environments, it will be important to allocate equipment to more compensatory shipments, use technology to generate efficiencies, continue to grow our Logistics segment, and effectively manage fuel and other costs.  We believe we have the service center network, modern tractor fleet, comprehensive truckload and logistics services, management team and qualified personnel, technology, intense focus on cost control, and capital resources to successfully overcome these challenges and capitalize on future opportunities.

We expect to utilize the flexibility of our model to react and adapt to market conditions.  We believe we can optimize our model and refine our execution in reaction to, or in anticipation of, transportation market dynamics, particularly the markets for truckload and logistics services that we offer. We plan to continue to evaluate acquisition candidates and other opportunities that create value for our shareholders and further advance our long-term strategy.
 
 
Results of Operations

The following table sets forth the consolidated statements of income in dollars and as a percentage of total revenue and the percentage increase or decrease in the dollar amounts of those items compared to the prior year (dollars in thousands).

   
Three Months Ended
September 30, 2016
   
Three Months Ended
September 30, 2015
   
%
Change
   
Nine Months Ended
September 30, 2016
   
Nine Months Ended
September 30, 2015
   
%
Change
 
    $    
 
%
    $    
 
%
   
%
    $    
 
%
    $    
 
%
   
%
 
Trucking revenue
 
$
204,269
     
72.8
%
 
$
211,816
     
70.6
%
   
(3.6
%)
 
$
607,611
     
73.3
%
 
$
626,389
     
70.2
%
   
(3.0
%)
Trucking fuel  surcharge revenue
   
24,287
     
8.7
     
30,192
     
10.1
     
(19.6
)
   
65,252
     
7.9
     
96,458
     
10.8
     
(32.4
)
Logistics revenue
   
51,974
     
18.5
     
58,114
     
19.3
     
(10.6
)
   
156,073
     
18.8
     
169,378
     
19.0
     
(7.9
)
Total revenue
   
280,530
     
100.0
     
300,122
     
100.0
     
(6.5
)
   
828,936
     
100
     
892,225
     
100.0
     
(7.1
)