ITEM
1.
FINANCIAL
STATEMENTS
COVENANT
TRANSPORT, INC. AND SUBSIDIARIES
CONSOLIDATED
CONDENSED BALANCE SHEETS
(In
thousands, except share data)
|
|
|
|
June
30, 2006
|
|
December
31, 2005
|
|
ASSETS
|
|
(unaudited)
|
|
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
2,583
|
|
$
|
3,618
|
|
Accounts
receivable, net of allowance of $1,938 in 2006 and
$2,200 in 2005
|
|
|
69,678
|
|
|
77,969
|
|
Drivers
advances and other receivables
|
|
|
6,693
|
|
|
3,932
|
|
Inventory
and supplies
|
|
|
4,656
|
|
|
4,661
|
|
Prepaid
expenses
|
|
|
12,585
|
|
|
16,199
|
|
Assets
held for sale
|
|
|
9,820
|
|
|
3,204
|
|
Deferred
income taxes
|
|
|
16,763
|
|
|
16,158
|
|
Income
taxes receivable
|
|
|
6,008
|
|
|
7,559
|
|
Total
current assets
|
|
|
128,786
|
|
|
133,300
|
|
|
|
|
|
|
|
|
|
Property
and equipment, at cost
|
|
|
278,029
|
|
|
295,433
|
|
Less
accumulated depreciation and amortization
|
|
|
(74,950
|
)
|
|
(84,275
|
)
|
Net
property and equipment
|
|
|
203,079
|
|
|
211,158
|
|
Other
assets
|
|
|
23,825
|
|
|
26,803
|
|
Total
assets
|
|
$
|
355,690
|
|
$
|
371,261
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Securitization
facility
|
|
$
|
47,781
|
|
$
|
47,281
|
|
Accounts
payable
|
|
|
7,217
|
|
|
8,457
|
|
Accrued
expenses
|
|
|
17,613
|
|
|
17,088
|
|
Current
portion of insurance and claims accrual
|
|
|
16,932
|
|
|
18,529
|
|
Total
current liabilities
|
|
|
89,543
|
|
|
91,355
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
24,000
|
|
|
33,000
|
|
Insurance
and claims accrual, net of current portion
|
|
|
19,941
|
|
|
23,272
|
|
Deferred
income taxes
|
|
|
33,494
|
|
|
33,910
|
|
Total
liabilities
|
|
|
166,978
|
|
|
181,537
|
|
|
|
|
|
|
|
|
|
Commitments
and contingent liabilities
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity:
|
|
|
|
|
|
|
|
Class
A common stock, $.01 par value; 20,000,000 shares authorized;
13,469,090 and 13,447,608 shares issued; 11,650,690 and
11,629,208
outstanding as of June 30, 2006 and December 31, 2005,
respectively
|
|
|
135
|
|
|
134
|
|
Class
B common stock, $.01 par value; 5,000,000 shares authorized;
2,350,000 shares issued and outstanding as of June 30, 2006 and
December 31, 2005
|
|
|
24
|
|
|
24
|
|
Additional
paid-in-capital
|
|
|
91,823
|
|
|
91,553
|
|
Treasury
stock at cost; 1,818,400 shares as of June 30, 2006 and December
31, 2005,
respectively
|
|
|
(21,582
|
)
|
|
(21,582
|
)
|
Retained
earnings
|
|
|
118,312
|
|
|
119,595
|
|
Total
stockholders' equity
|
|
|
188,712
|
|
|
189,724
|
|
Total
liabilities and stockholders' equity
|
|
$
|
355,690
|
|
$
|
371,261
|
|
The
accompanying notes are an integral part of these consolidated condensed
financial statements.
CONSOLIDATED
CONDENSED STATEMENTS OF OPERATIONS
FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In
thousands, except per share data)
|
|
Three
months ended
June
30,
(unaudited)
|
|
Six
months ended
June
30,
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
Freight
revenue
|
|
$
|
139,344
|
|
$
|
138,736
|
|
$
|
268,788
|
|
$
|
262,306
|
|
Fuel
surcharges
|
|
|
30,018
|
|
|
18,077
|
|
|
52,109
|
|
|
32,433
|
|
Total
revenue
|
|
$
|
169,362
|
|
$
|
156,813
|
|
$
|
320,887
|
|
$
|
294,739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries,
wages, and related expenses
|
|
|
64,421
|
|
|
60,967
|
|
|
123,063
|
|
|
114,913
|
|
Fuel
expense
|
|
|
50,301
|
|
|
39,905
|
|
|
92,217
|
|
|
73,395
|
|
Operations
and maintenance
|
|
|
8,774
|
|
|
8,444
|
|
|
17,271
|
|
|
15,672
|
|
Revenue
equipment rentals and purchased transportation
|
|
|
15,458
|
|
|
15,049
|
|
|
30,136
|
|
|
30,409
|
|
Operating
taxes and licenses
|
|
|
3,465
|
|
|
3,604
|
|
|
6,767
|
|
|
6,943
|
|
Insurance
and claims
|
|
|
8,187
|
|
|
9,603
|
|
|
16,414
|
|
|
18,437
|
|
Communications
and utilities
|
|
|
1,527
|
|
|
1,601
|
|
|
3,117
|
|
|
3,240
|
|
General
supplies and expenses
|
|
|
5,740
|
|
|
4,314
|
|
|
10,044
|
|
|
8,464
|
|
Depreciation
and amortization, including net gains on
disposition of equipment
|
|
|
8,536
|
|
|
10,284
|
|
|
18,555
|
|
|
19,948
|
|
Total
operating expenses
|
|
|
166,409
|
|
|
153,771
|
|
|
317,584
|
|
|
291,421
|
|
Operating
income
|
|
|
2,953
|
|
|
3,042
|
|
|
3,303
|
|
|
3,318
|
|
Other
(income) expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
1,075
|
|
|
1,038
|
|
|
2,199
|
|
|
1,652
|
|
Interest
income
|
|
|
(122
|
)
|
|
(57
|
)
|
|
(259
|
)
|
|
(101
|
)
|
Other
|
|
|
(22
|
)
|
|
(94
|
)
|
|
(75
|
)
|
|
(330
|
)
|
Other
expenses, net
|
|
|
931
|
|
|
887
|
|
|
1,865
|
|
|
1,221
|
|
Income
before income taxes
|
|
|
2,022
|
|
|
2,155
|
|
|
1,438
|
|
|
2,097
|
|
Income
tax expense
|
|
|
2,420
|
|
|
1,503
|
|
|
2,721
|
|
|
2,094
|
|
Net
income (loss)
|
|
$
|
(398
|
)
|
$
|
652
|
|
$
|
(1,283
|
)
|
$
|
3
|
|
Net
income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings (loss) per share:
|
|
$
|
(0.03
|
)
|
|
0.05
|
|
$
|
(0.09
|
)
|
|
0.00
|
|
Diluted
earnings (loss) per share:
|
|
$
|
(0.03
|
)
|
|
0.05
|
|
$
|
(0.09
|
)
|
|
0.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
weighted average shares outstanding
|
|
|
13,997
|
|
|
14,100
|
|
|
13,991
|
|
|
14,375
|
|
Diluted
weighted average shares outstanding
|
|
|
13,997
|
|
|
14,182
|
|
|
13,991
|
|
|
14,533
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these consolidated condensed
financial statements.
CONSOLIDATED
CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY
AND
COMPREHENSIVE LOSS
FOR
THE SIX MONTHS ENDED JUNE 30, 2006
(Unaudited
and in thousands)
|
|
Common
Stock
Class
Class
A
B
|
|
Additional
Paid-In
Capital
|
|
Treasury
Stock
|
|
Retained
Earnings
|
|
Total
Stockholders'
Equity
|
|
Comprehensive
Loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at December 31, 2005
|
|
$
|
134
|
|
$
|
24
|
|
$
|
91,553
|
|
$
|
(21,582
|
)
|
$
|
119,595
|
|
$
|
189,724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise
of employee stock
options
|
|
|
1
|
|
|
-
|
|
|
191
|
|
|
-
|
|
|
-
|
|
|
192
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit arising from
the
exercise of stock options
|
|
|
-
|
|
|
-
|
|
|
17
|
|
|
-
|
|
|
-
|
|
|
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SFAS
No. 123R stock-based
employee
compensation cost
|
|
|
|
|
|
|
|
|
62
|
|
|
|
|
|
|
|
|
62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(1,283
|
)
|
|
(1,283
|
)
|
|
(1,283
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
loss for six
months
ended June 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(1,283
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances
at June 30, 2006
|
|
$
|
135
|
|
$
|
24
|
|
$
|
91,823
|
|
$
|
(21,582
|
)
|
$
|
118,312
|
|
$
|
188,712
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
accompanying notes are an integral part of these consolidated condensed
financial statements.
CONSOLIDATED
CONDENSED STATEMENTS OF CASH FLOWS
FOR
THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(In
thousands)
|
|
Six
months ended June 30,
(unaudited)
|
|
|
|
|
|
|
|
|
|
2006
|
|
2005
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(1,283
|
)
|
$
|
3
|
|
Adjustments
to reconcile net income (loss) to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
Provision
for losses on accounts receivable
|
|
|
292
|
|
|
510
|
|
Depreciation
and amortization
|
|
|
20,214
|
|
|
20,067
|
|
Deferred
income taxes (benefit)
|
|
|
(1,021
|
)
|
|
(10,850
|
)
|
Income
tax benefit from exercise of stock options
|
|
|
0
|
|
|
50
|
|
Net
gain on disposition of property and equipment
|
|
|
(1,659
|
)
|
|
(119
|
)
|
Non-cash
stock compensation
|
|
|
62
|
|
|
0
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Receivables
and advances
|
|
|
8,107
|
|
|
8,592
|
|
Prepaid
expenses and other assets
|
|
|
3,614
|
|
|
(7,994
|
)
|
Inventory
and supplies
|
|
|
5
|
|
|
(559
|
)
|
Insurance
and claims accrual
|
|
|
(4,928
|
)
|
|
(148
|
)
|
Accounts
payable and accrued expenses
|
|
|
890
|
|
|
371
|
|
Net
cash flows provided by operating activities
|
|
|
24,293
|
|
|
9,924
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Acquisition
of property and equipment
|
|
|
(77,757
|
)
|
|
(66,975
|
)
|
Proceeds
from building sale leaseback
|
|
|
29,630
|
|
|
0
|
|
Proceeds
from disposition of property and equipment
|
|
|
31,090
|
|
|
28,230
|
|
Net
cash flows used in investing activities
|
|
|
(17,037
|
)
|
|
(38,745
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Exercise
of stock options
|
|
|
192
|
|
|
418
|
|
Excess
income tax benefit arising from the exercise of stock
options
|
|
|
17
|
|
|
0
|
|
Repurchase
of company stock
|
|
|
0
|
|
|
(11,657
|
)
|
Proceeds
from issuance of debt
|
|
|
36,500
|
|
|
78,000
|
|
Repayments
of debt
|
|
|
(45,000
|
)
|
|
(42,872
|
)
|
Deferred
costs
|
|
|
0
|
|
|
8
|
|
Net
cash provided by (used in) financing activities
|
|
|
(8,291
|
)
|
|
23,898
|
|
|
|
|
|
|
|
|
|
Net
change in cash and cash equivalents
|
|
|
(1,035
|
)
|
|
(4,923
|
)
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at beginning of period
|
|
|
3,618
|
|
|
5,066
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of period
|
|
$
|
2,583
|
|
$
|
143
|
|
The
accompanying notes are an integral part of these consolidated condensed
financial statements.
NOTES
TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note
1.
Basis
of Presentation
The
consolidated condensed financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly owned subsidiaries.
References in this report to "we," "us," "our," the "Company," and similar
expressions refer to Covenant Transport, Inc. and its wholly owned subsidiaries.
All significant intercompany balances and transactions have been eliminated
in
consolidation.
The
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America, pursuant to the rules and
regulations of the Securities and Exchange Commission. In the opinion of
management, the accompanying financial statements include all adjustments which
are necessary for a fair presentation of the results for the interim periods
presented, such adjustments being of a normal recurring nature. Certain
information and footnote disclosures have been condensed or omitted pursuant
to
such rules and regulations. The December 31, 2005 consolidated condensed balance
sheet was derived from our audited balance sheet for the year then ended. It
is
suggested that these consolidated condensed financial statements and notes
thereto be read in conjunction with the consolidated condensed financial
statements and notes thereto included in our Form 10-K for the year ended
December 31, 2005. Results of operations in interim periods are not necessarily
indicative of results to be expected for a full year.
Certain
prior period financial statement balances have been reclassified to conform
to
the current period's classification.
Note
2.
Comprehensive
Earnings
Comprehensive
earnings generally include all changes in equity during a period except those
resulting from investments by owners and distributions to owners. Comprehensive
earnings for the six month periods ended June 30, 2006 and 2005 equaled net
income (loss).
Note
3.
Segment
Information
We
have
one reportable segment under the provisions of Statement of Financial Accounting
Standards (“SFAS”) No.131,
Disclosures
about Segments of an Enterprise and Related Information
.
Each of
our four transportation service offerings that meet the quantitative threshold
requirements of SFAS No. 131 provides truckload transportation services that
have been aggregated since they have similar economic characteristics and meet
the other aggregation criteria of SFAS No. 131. Accordingly, we have not
presented separate financial information for each of our service offerings
as
our consolidated condensed financial statements present our one reportable
segment. Our four major transportation service offerings are: (a) expedited
long
haul service, (b) refrigerated service, (c) dedicated service, and (d) regional
solo-driver service. We generate other revenue through a subsidiary that
provides freight brokerage services. This operation does not meet the
quantitative threshold reporting requirements of SFAS No. 131.
Note
4.
Basic
and Diluted Earnings (Loss) per Share
We
apply
the provisions of SFAS No. 128
,
Earnings per Share
,
which
requires us to present basic EPS and diluted EPS. Basic EPS excludes dilution
and is computed by dividing earnings available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
EPS
reflects the dilution that could occur if securities or other contracts to
issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the Company.
The
calculation of diluted loss per share for the three months and six months ended
June 30, 2006, excludes all unexercised shares, since the effect of any assumed
exercise of the related options would be antidilutive. The calculation of
diluted earnings per share for the three months and six months ended June 30,
2005, excludes approximately 857,946 shares and 226,998 shares respectively,
since the effect of assumed exercise of the related options would be
antidilutive.
The
following table sets forth, for the periods indicated, the calculation of net
earnings (loss) per share included in our consolidated condensed statements
of
operations:
(in
thousands except per share data)
|
|
Three
months ended
June
30,
|
|
Six
months ended
June
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
earnings (loss)
|
|
$
|
(398
|
)
|
$
|
652
|
|
$
|
(1,283
|
)
|
$
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
for basic earnings per share
-
weighted-average shares
|
|
|
13,997
|
|
|
14,100
|
|
|
13,991
|
|
|
14,375
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
stock options
|
|
|
0
|
|
|
82
|
|
|
0
|
|
|
158
|
|
Denominator
for diluted earnings per share
-
adjusted weighted-average shares and
assumed
conversions
|
|
|
13,997
|
|
|
14,182
|
|
|
13,991
|
|
|
14,533
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings (loss) per share:
|
|
$
|
(0.03
|
)
|
$
|
0.05
|
|
$
|
(0.09
|
)
|
$
|
0.00
|
|
Diluted
earnings (loss) per share:
|
|
$
|
(0.03
|
)
|
$
|
0.05
|
|
$
|
(0.09
|
)
|
$
|
0.00
|
|
Note
5.
Share-Based
Compensation
Prior
to
May 23, 2006, we had four stock-based compensation plans. Prior to January
1,
2006, we accounted for those plans under the recognition and measurement
principles of Accounting Principles Board (“APB”) Opinion No. 25,
Accounting
for Stock Issued to Employees,
and
related Interpretations. No stock-based compensation cost was reflected in
net
income, as all options granted under those plans had an exercise price equal
to
the market value of the underlying common stock on the date of grant. On May
23,
2006, upon the recommendation of our Board of Directors, our stockholders
approved the Covenant Transport, Inc. 2006 Omnibus Incentive Plan. The Covenant
Transport, Inc. 2006 Omnibus Incentive Plan replaced the Covenant Transport,
Inc. 2003 Incentive Stock Plan, Amended and Restated Incentive Stock Plan,
Outside Director Stock Option Plan, and 1998 Non-Officer Incentive Stock
Plan.
Effective
January 1, 2006, we adopted SFAS No. 123R,
Share-Based
Payment
("SFAS
No. 123R") using a modified version of the prospective transition method. Under
this transition method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under SFAS No. 123R for either recognition or pro forma
disclosures. Stock-based employee compensation expense for the three months
and
six months ended June 30, 2006 was approximately $58,330 and $62,290,
respectively, and is included in salaries, wages, and related expenses within
the consolidated condensed statements of operations. There was no cumulative
effect of initially adopting SFAS No. 123R.
In
periods prior to January 1, 2006, we accounted for our stock-based compensation
plans under APB Opinion No. 25,
Accounting
for Stock Issued to Employees,
and
related Interpretations, under which no compensation expense has been recognized
because all employee and outside director stock options have been granted with
the exercise price equal to the fair value of the our Class A common stock
on
the date of grant. The fair value of options granted was estimated as of the
date of grant using the Black-Scholes option pricing model. The fair value
of
the employee and outside director stock options which would have been expensed
in the three months and six months ended June 30, 2005 would have been $1.3
million and $1.7 million, respectively.
Our
pro
forma net income (loss) and earnings (loss) per share would have been as
indicated below had the estimated fair value of all option grants on their
grant
date
been
charged to salaries, wages and related expense in accordance with SFAS No.
123R.
(in
thousands, except per share data)
|
|
Three
months ended June 30, 2005
|
|
Six
months ended June 30, 2005
|
|
|
|
|
|
|
|
Net
income, as reported:
|
|
$
|
652
|
|
$
|
3
|
|
Deduct:
Total stock-based employee compensation
expense
determined under fair value based method for
all
awards, net of related tax effects
|
|
|
(1,349
|
)
|
|
(1,744
|
)
|
Pro
forma net loss
|
|
$
|
(697
|
)
|
$
|
(1,741
|
)
|
|
|
|
|
|
|
|
|
Basic
and diluted earnings (loss) per share:
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
0.05
|
|
$
|
0.00
|
|
Pro
forma
|
|
$
|
(0.05
|
)
|
$
|
(0.12
|
)
|
|
|
|
|
|
|
|
|
On
August
31, 2005, the Compensation Committee of our Board of Directors approved the
acceleration of the vesting of all outstanding unvested stock options. As a
result, the vesting of approximately 170,000 previously unvested stock options
granted under our Amended and Restated Incentive Stock Plan and our 2003
Incentive Stock Plan was accelerated and all such options became fully
exercisable as of August 31, 2005. This acceleration of vesting did not result
in any compensation expense for us during 2005; however, without the
acceleration of vesting we would have been required to recognize compensation
expense beginning in 2006 in accordance with SFAS No. 123R. Under the fair
value
method of SFAS No. 123R, we would have recorded $2.2 million, net of
tax, for the 12 month period ended December 31, 2005, which represents the
pro
forma compensation expense as well as the effect of the acceleration of the
stock options that would be recorded as compensation expense.
The
following tables summarize our stock option activity for the six months ended
June 30, 2006:
|
Number
of
options
(in
thousands)
|
|
|
Weighted
average
exercise
price
|
|
Weighted
average
remaining
contractual
term
|
|
|
Aggregate
intrinsic
value
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at beginning of the
period
|
1,454
|
|
$
|
14.33
|
|
|
|
|
|
Options
granted
|
5
|
|
$
|
13.80
|
|
|
|
|
|
Options
exercised
|
(15)
|
|
$
|
12.38
|
|
|
|
|
|
Options
forfeited
|
(15)
|
|
$
|
15.25
|
|
|
|
|
|
Options
expired
|
(178)
|
|
$
|
15.50
|
|
|
|
|
|
Outstanding
at end of period
|
1,251
|
|
$
|
14.18
|
|
5.8
years
|
|
$
|
$2,312
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at end of period
|
1,236
|
|
$
|
14.21
|
|
5.8
years
|
|
$
|
$2,264
|
The
fair
value of each option award is estimated on the date of grant using the
Black-Scholes option-pricing model, which uses a number of assumptions to
determine the fair value of the options on the date of grant. The following
weighted-average assumptions were used to determine the fair value of the stock
options granted during the three and six months ended June 30, 2006 and
2005:
|
|
Three
months ended June 30,
|
|
Six
months ended June 30,
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
Expected
volatility
|
|
37.4%
- 39.5%
|
|
51.9%
|
|
37.4%
- 39.5%
|
|
50.6%
- 51.9%
|
Risk-free
interest rate
|
|
4.9%
- 5.0%
|
|
3.9%
|
|
4.9%
- 5.0%
|
|
3.8%
- 3.9%
|
Expected
lives (in years)
|
|
5.0
|
|
5.0
|
|
5.0
|
|
5.0
|
The
expected lives of the options are based on the historical and expected future
employee exercise behavior. Expected volatility is based upon the historical
volatility of our common stock. The risk-free interest rate is based upon the
U.S. Treasury yield curve at the date of grant with maturity dates
approximately equal to the expected life at the grant date.
The following tables summarize our restricted stock award activity for the
six
months ended June 30, 2006:
|
|
Number
of
stock
awards
|
|
Weighted
average
grant
date
fair value
|
|
Unvested
at January 1, 2006
|
|
0
|
|
$
|
0
|
|
Granted
|
|
|
371,985
|
|
$
|
12.79
|
|
Vested
|
|
|
0
|
|
|
-
|
|
Forfeited
|
|
|
0
|
|
|
-
|
|
Unvested
at June 30, 2006
|
|
|
371,985
|
|
$
|
12.79
|
|
Included
in the above table is 316,665 restricted stock awards that vest only if we
achieve an earnings-per-share target of $2.00 by 2010. The underlying
performance targets of earnings per share for these restricted stock awards
do
not begin until the 2007 fiscal year, therefore no compensation expense for
these restricted stock awards will be recorded until January 1,
2007.
As
of
June 30, 2006, we had $0.1 million and $0.7 million in unrecognized compensation
expense related to stock options and restricted stock awards, respectively,
which is expected to be recognized over a weighted average period of
approximately 3 years for stock options and 4 years for restricted stock
awards.
Note
6.
Income
Taxes
Income
tax expense varies from the amount computed by applying the federal corporate
income tax rate of 35% to income before income taxes primarily due to state
income taxes, net of federal income tax effect, adjusted for permanent
differences, the most significant of which is the effect of the per diem pay
structure for drivers.
On
April
20, 2006, we completed the appeals process with the IRS related to their 2001
and 2002 audits. Related to this settlement with the IRS, we recorded additional
income tax expense of approximately $0.5 million for the three months ended
June
30, 2006. We received a favorable resolution in the Closing Agreement received
from the IRS which stated that our wholly-owned captive insurance subsidiary
made a valid election under section 953(d) of the Internal Revenue Code and
is
to be respected as an insurance company.
Subsequent
to June 30, 2006, the IRS, completed their audit fieldwork of our 2003 and
2004
tax returns and has proposed the disallowance, with which we have agreed, of
approximately $350,000 of costs related to the November 2003 stock offering.
During the three months ended June 30, 2006, we recorded $0.1 million of income
tax expense related to this proposed disallowance of tax benefits. Additionally,
the IRS has proposed to disallow the tax benefits associated with insurance
premium payments made to our wholly-owned captive insurance subsidiary for
the
2003 and 2004 years. Due to the favorable resolution of the 2001 and 2002 IRS
audit on this issue, we are vigorously defending our position related to this
proposed disallowance of tax benefits using all administrative and legal
processes available. For the three and six months ended June 30, 2006, income
tax expense of $0.1 million and $0.2 million, respectively, was recorded in
our
consolidated condensed statements of operations related to this uncertain tax
position. If we are unsuccessful in defending our position on this deduction,
we
could owe additional taxes totaling $1.6 million on this matter. We believe
that
we have properly accrued for this matter on our consolidated condensed balance
sheet at June 30, 2006.
Note
7.
Derivative
Instruments and Other Comprehensive Income
We
account for derivative instruments in accordance with SFAS No. 133,
Accounting
for Derivative Instruments and Hedging Activities
(as
amended, "SFAS No. 133"). SFAS No. 133 requires that all derivative instruments
be recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or in other
comprehensive income, depending on whether a derivative is designated as part
of
a hedging relationship and, if it is, depending on the type of hedging
relationship.
In
2001,
we entered into two $10.0 million notional amount cancelable interest rate
swap
agreements to manage the risk of variability in cash flows associated with
floating-rate debt. Due to the counter-parties' imbedded options to cancel,
these derivatives did not qualify, and are not designated as hedging instruments
under SFAS No. 133. Consequently, these derivatives are marked to fair value
through earnings, in other expense in the accompanying statements of operations.
At June 30, 2006, the swap agreements had expired and there was no liability
thereunder; however, at June 30, 2005 the fair value of these interest-rate
swap
agreements was a liability of $0.2 million, which is included in accrued
expenses on the consolidated
condensed
balance
sheets.
The
derivative activity, as reported in the consolidated condensed financial
statements for the six months ended June 30, 2006 and 2005 is summarized in
the
following table:
(in
thousands)
|
|
Six
months ended
June
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Net
liability for derivatives at January 1
|
|
$
|
(13
|
)
|
$
|
(439
|
)
|
|
|
|
|
|
|
|
|
Gain
in value of derivative instruments that do not qualify as
hedging
Instruments
|
|
|
13
|
|
|
273
|
|
|
|
|
|
|
|
|
|
Net
liability for derivatives at June 30
|
|
$
|
-
|
|
$
|
(166
|
)
|
From
time
to time,
we
enter
into fuel purchase commitments for a notional amount of diesel fuel at prices
which are determined when fuel purchases occur.
Note
8. Property and Equipment
Depreciation
is calculated using the straight-line method over the estimated useful lives
of
the assets. Revenue equipment is generally depreciated over five to ten years
with salvage values ranging from 4% to 39%. The salvage value, useful life,
and
annual depreciation of tractors and trailers are evaluated annually based on
the
current market environment and on the Company's recent experience with
disposition values. Any change could result in greater or lesser annual expense
in the future. Included in depreciation in the consolidated condensed statements
of operations are net gains on disposal of revenue equipment of $1.5 million
and
$0.3 million for the three months ended June 30, 2006 and 2005, respectively,
and of $1.7 million and $0.1 million for the six months ended June 30, 2006
and
2005, respectively. We also evaluate the carrying value of long-lived assets
for
impairment by analyzing the operating performance and future cash flows for
those assets, whenever events or changes in circumstances indicate that the
carrying amounts of such assets may not be recoverable. We evaluate the need
to
adjust the carrying value of the underlying assets if the sum of the expected
cash flows is less than the carrying value. Impairment can be impacted by our
projection of the actual level of future cash flows, the level of actual cash
flows and salvage values, the methods of estimation used for determining fair
values, and the impact of guaranteed residuals. Any changes in management's
judgments could result in greater or lesser annual depreciation expense or
additional impairment charges in the future.
In
April
2006, we entered into a sale leaseback transaction involving our corporate
headquarters, a maintenance facility, a body shop, and approximately forty-six
acres of surrounding property in Chattanooga, Tennessee. We received proceeds
of
approximately $29.6 million from the sale of the property, which we used to
pay
down borrowings under our Credit Agreement and to purchase revenue equipment.
In
the transaction, we entered into a twenty-year lease agreement, whereby we
will
lease back the property at an annual rental rate of approximately $2.5 million,
subject to annual rent increases of 1.0%, resulting in annual straight-line
rental expense of approximately $2.7 million. The transaction resulted in a
gain
of approximately $2.1 million, which will be amortized ratably over the life
of
the lease and recorded as depreciation expense on our consolidated condensed
statements of operations.
Note
9.
Securitization
Facility and Long-Term Debt
Our
securitization facility and long-term debt consisted of the following at June
30, 2006 and December 31, 2005:
(in
thousands)
|
|
June
30, 2006
|
|
December
31, 2005
|
|
|
|
|
|
|
|
Securitization
Facility
|
|
$
|
47,781
|
|
$
|
47,281
|
|
|
|
|
|
|
|
|
|
Borrowings
under Credit Agreement
|
|
$
|
24,000
|
|
$
|
33,000
|
|
Less
current maturities
|
|
|
-
|
|
|
-
|
|
Long-term
debt, less current portion
|
|
$
|
24,000
|
|
$
|
33,000
|
|
In
December 2004, we entered into a Credit Agreement with a group of banks (the
“Credit Agreement”). The facility matures in December 2009. Borrowings under the
Credit Agreement are based on the banks' base rate, which floats daily, or
LIBOR, which accrues interest based on one, two, three, or six month LIBOR
rates
plus an applicable margin that is adjusted quarterly between 0.75% and 1.25%
based on cash flow coverage (the applicable margin was 1.0% at June 30, 2006).
At June 30, 2006, we had $24.0 million of borrowings outstanding under the
Credit Agreement.
The
Credit Agreement has a maximum borrowing limit of $150.0 million with an
accordion feature which permits an increase up to a maximum borrowing limit
of
$200.0 million. Borrowings related to revenue equipment are limited to the
lesser of 90% of net book value of revenue equipment or the maximum borrowing
limit. Letters of credit are limited to an aggregate commitment of
$85.0 million. The Credit Agreement is secured by a pledge of the stock of
most of the Company's subsidiaries. A commitment fee, that is adjusted quarterly
between 0.15% and 0.25% per annum based on cash flow coverage, is due on the
daily unused portion of the Credit Agreement. As of June 30, 2006, we had
approximately $55.5 million of available borrowing capacity. At June 30, 2006
and December 31, 2005, we had undrawn letters of credit outstanding of
approximately $70.5 million and $73.9
million,
respectively.
In
December 2000, we entered into an accounts receivable securitization facility
(the "Securitization Facility"). On a revolving basis, we sell our interests
in
our accounts receivable to CVTI Receivables Corp. (“CRC”), a wholly-owned
bankruptcy-remote special purpose subsidiary incorporated in Nevada. CRC sells
a
percentage ownership in such receivables to an unrelated financial entity.
We
can receive up to $62.0 million of proceeds, subject to eligible receivables,
and pay a service fee recorded as interest expense, based on commercial paper
interest rates plus an applicable margin of 0.44% per annum and a commitment
fee
of 0.10% per annum on the daily unused portion of the Securitization Facility.
The net proceeds under the Securitization Facility are required to be shown
as a
current liability because the term, subject to annual renewals, is 364 days.
As
of June 30, 2006 and December 31, 2005, we had $47.8 million and
$47.3 million outstanding, respectively, with weighted average interest
rates of 5.4% and 4.4%, respectively. CRC does not meet the requirements for
off-balance sheet accounting; therefore, it is reflected in our consolidated
condensed financial statements.
The
Credit Agreement and Securitization Facility contain certain restrictions and
covenants relating to, among other things, dividends, tangible net worth, cash
flow coverage, acquisitions and dispositions, and total indebtedness. These
agreements are cross-defaulted. We were in compliance with the covenants as
of
June 30, 2006.
Note
10.
Recent
Accounting Pronouncements
In
June
2006, the FASB published Interpretation No. 48,
Accounting
for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
(“FIN
48”). FIN 48 prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken
or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. The effective date of this interpretation
is
January 1, 2007, the first fiscal year beginning after December 15, 2006. We
are
continuing to evaluate the impact of the adoption of FIN 48 on our consolidated
financial statements.
In
April
2006, the FASB issued FASB Staff Position (“FSP”) FIN 46(R)-6,
Determining
the Variability to be Considered in Applying FASB Interpretation No.
46(R)
,
that
will become effective beginning third quarter of 2006. FSP FIN No. 46(R)-6
clarifies that the variability to be considered in applying FASB Interpretation
46(R) shall be based on an analysis of the design of the variable interest
entity. We do not believe the adoption of FSP FIN No. 46(R)-6 will have a
material impact on our consolidated financial statements.
In
March
2006, the FASB issued SFAS No. 156,
Accounting
for Servicing of Financial Assets - an amendment of SFAS No.
140
,
that
provides guidance on accounting for separately recognized servicing assets
and
servicing liabilities. In accordance with SFAS No. 156, separately recognized
servicing assets and servicing liabilities must be initially recognized at
fair
value, if practicable. Subsequent to initial recognition, companies may use
either the amortization method or the fair value measurement method to account
for servicing assets and servicing liabilities within the scope of this
Statement. The provisions of SFAS No. 156 are effective as of the beginning
of
the first fiscal year that begins after September 15, 2006. We do not believe
the adoption of SFAS No. 156 will have a material impact on our consolidated
financial statements.
In
February 2006, the FASB issued SFAS No. 155,
Accounting
for Certain Hybrid Financial Instruments - an amendment of FASB Statements
No.
133 and 140
,
to
permit fair value remeasurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation in
accordance with the provisions of SFAS No. 133. The provisions of SFAS No.
155
are effective for all financial instruments acquired or issued after the
beginning of the first fiscal year that begins after September 15, 2006. We
do
not believe the adoption of SFAS No. 155 will have a material impact on our
consolidated financial statements.
Effective
December 31, 2005, we adopted FASB Interpretation No. 47,
Accounting
for Conditional Asset Retirement Obligations
(“
FIN
47
”)
,
which
clarifies that the term conditional asset retirement obligation as used in
SFAS
No. 143,
Accounting
for Asset Retirement Obligations
,
refers
to a legal obligation to perform an asset retirement activity in which the
timing and/or method of settlement are conditioned on a future event that may
or
may not be within the control of the entity. The obligation to perform the
asset
retirement activity is unconditional even though uncertainty exists about the
timing and/or method of settlement. Accordingly, an entity is required to
recognize a liability for the fair value of a conditional asset retirement
obligation if the fair value of the liability can be reasonably estimated.
Uncertainty about the timing and/or method of settlement of a conditional asset
retirement obligation should be factored into the measurement of the liability
when sufficient information exists. FIN 47 also clarifies when an entity would
have sufficient information to reasonably estimate the fair value of an asset
retirement obligation. The adoption of FIN 47 impacted our accounting for the
conditional obligation to remove Company decals and other identifying markings
from certain tractors and trailers under operating leases at the end of the
lease terms. In the three and six months ended June 30, 2006, the impact of
the
adoption of FIN 47 was approximately $0.1 million and $0.2 million,
respectively, of additional expense in our revenue equipment rentals and
purchased transportation expenses.
In
May
2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections
.
SFAS No. 154 replaces APB Opionion No. 20,
Accounting Changes
,
and
SFAS Statement No. 3,
Reporting Changes in Interim Financial Statements
.
SFAS No. 154 changes the accounting for, and reporting of, a change in
accounting principle. SFAS No. 154 requires retrospective application to
prior periods’ financial statements of voluntary changes in accounting principle
and changes required by new accounting standards when the standard does not
include specific transition provisions, unless it is impracticable to do
so. SFAS No. 154 is effective for accounting changes and corrections
of errors in fiscal years beginning after December 15, 2005.
We
adopted
this statement effective January 2006.
In
December 2004, the FASB issued SFAS No. 123R,
Share-Based
Payments
,
revising SFAS No. 123,
Accounting
for Stock Based Compensation
;
superseding APB Opinion No. 25,
Accounting
for Stock Issued to Employees
and
its
related implementation guidance; and amending SFAS No. 95,
Statement
of Cash Flows
.
SFAS
No. 123R requires companies to recognize the grant date fair value of stock
options and other equity-based compensation issued to employees in its income
statement, generally over the remaining vesting period. In 2005, we accelerated
the vesting of substantially all of our outstanding stock options. This allowed
us to recognize an expense in 2005 which was significantly less than the
compensation expense that would have been recognized beginning in 2006 in
accordance with SFAS No. 123R. SFAS No. 123R was effective January 1, 2006.
Our
adoption of SFAS No. 123R had minimal impact for the three and six month periods
ended June 30, 2006 (See Note 5).
Note
11.
Commitments
and Contingencies
In
the
normal course of business, we are party to ordinary, routine litigation, most
of
which involves claims for personal injury and property damage incurred in
connection with the transportation of freight. We maintain insurance to cover
liabilities arising from the transportation of freight for amounts in excess
of
certain self-insured retentions. In the opinion of management, our potential
exposure under pending legal proceedings is adequately provided for in the
accompanying consolidated condensed financial statements. Currently, we are
involved in the significant personal injury claim described below.
On
March
7, 2003, an accident occurred in Wisconsin involving a vehicle and one of our
tractors. Two adult occupants of the vehicle were killed in the accident. The
only other occupant of the vehicle was a child, who survived with little
apparent injury. Suit was filed in the United States District Court in Minnesota
by heirs of one of the decedents against us and our driver under the style:
Bill
Kayachitch and Susan Kayachitch as co-trustees for the heirs and next of kin
of
Souvorachak Kayachitch, deceased, vs. Julie Robinson and Covenant Transport,
Inc
.
The
case was settled on October 10, 2005 at a level below the aggregate coverage
limits of our insurance policies and was formally dismissed in February 2006.
Representatives of the child may file an additional suit against the Company.
Financial
risks which potentially subject us to concentrations of credit risk consist
of
deposits in banks in excess of the Federal Deposit Insurance Corporation limits.
Our sales are generally made on account without collateral. Repayment terms
vary
based on certain conditions. We maintain reserves that management believes
are
adequate to provide for potential credit losses. The majority of our customer
base spans the United States. We monitor these risks and believe the risk of
incurring material losses is remote.
We
use
purchase commitments through suppliers to reduce a portion of our cash flow
exposure to fuel price fluctuations.
MANAGEMENT'S
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The
consolidated condensed financial statements include the accounts of Covenant
Transport, Inc., a Nevada holding company, and its wholly-owned subsidiaries.
References in this report to "we," "us," "our," the "Company," and similar
expressions refer to Covenant Transport, Inc. and its wholly-owned subsidiaries.
All significant intercompany balances and transactions have been eliminated
in
consolidation.
This
quarterly report contains
certain
statements that may be considered forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such
statements may be identified by their use of terms or phrases such as "expects,"
"estimates," "projects," "believes," "anticipates," "plans," "intends," and
similar terms and phrases. Forward-looking statements
are
based
upon the current beliefs and expectations of our management and
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.
Actual
results may differ from those set forth in 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 below. We do not assume, and specifically disclaim, any obligation to
update any forward-looking statements contained in this report.
Executive
Overview
We
are
one of the ten largest truckload carriers in the United States measured by
revenue according to
Transport
Topics,
a
publication of the American Trucking Associations. We focus on targeted markets
where we believe our service standards can provide a competitive advantage.
Currently, we categorize our business with four major transportation service
offerings: Expedited long haul service, Refrigerated service, Dedicated service,
and Regional solo-driver service. We are a major carrier for transportation
companies such as freight forwarders, less-than-truckload carriers, and
third-party logistics providers that require a high level of service to support
their businesses, as well as for traditional truckload customers such as
manufacturers and retailers. We generate other revenue through a subsidiary
that
provides freight brokerage services.
For
the
six months ended June 30, 2006, total revenue increased $26.2 million, or 8.9%,
to $320.9 million from $294.7 million in the 2005 period. Freight revenue,
which excludes revenue from fuel surcharges, increased $6.5 million, or 2.5%,
to
$268.8 million in the 2006 period from $262.3 million in the 2005
period. We experienced a net loss of $1.3 million, or $0.09 per share, for
the
first six months of 2006, compared with a slight profit of $3 thousand, or
$0.00
per share, for the first six months of 2005.
For
the
six months ended June 30, 2006, our average freight revenue per tractor per
week, our main measure of asset productivity, increased 5.6%, to $3,025 in
the
first six months of 2006 compared to $2,865 in the same period of 2005. The
increase was primarily generated by a 1.0% increase in average freight revenue
per loaded mile and a 3.8% increase in average miles per tractor equipment
utilization. Weighted average tractors decreased 3.0% to 3,434 in the 2006
period from 3,541 in the 2005 period.
Our
after-tax costs remained essentially constant on a per-mile basis with the
level
in the first quarter of 2006, and increased only 2.2%, or $.03 per mile,
compared with the first six months of 2005. The main factors were a $.023 per
mile increase in compensation expense, driven primarily by increases in driver
pay and office salaries related to the business realignment, and a $.013 per
mile increase in our health insurance claim costs, partially offset by a $.011
per mile decrease in our insurance and claims expense.
During
2005, we began the formal realignment of our business into four distinct service
offerings: Expedited long haul, Refrigerated, Dedicated, and Regional
solo-driver. We manage and operate each service offering separately, each under
the authority of a general manager. We have now hired the general managers
for
each of the service offerings. In addition, within the Regional solo-driver
service offering, we have divided the business into several service centers,
each under separate management as well. Our freight brokerage operation is
also
managed and operated as a separate subsidiary.
The
realignment has involved significant changes, including selecting and installing
new leadership over each service offering, reassigning personnel, allocating
tractors and trailers to each service offering, migrating operations to
preferred traffic lanes for each service offering, acquainting drivers and
customers to new lanes, contacts, and procedures, developing and approving
business plans, developing systems to support, measure, and hold accountable
each service offering, including budgets, incentive targets, and individual
income statements. We also have been addressing driver retention by focusing
on
driver development and satisfaction as key components of every aspect of our
business. Although we have continued to make significant progress, this process
will continue at least into 2007.
For
the
three months ended June 30, 2006, results of the business realignment on each
service offering include the following, as compared to the results we had
achieved for the three months ended June 30, 2005:
•
|
Expedited
long haul service. Increased the fleet by approximately 10%, expanded
the
length of haul to reflect a renewed focus on transcontinental loads,
and
increased miles per truck. The team operation is also the main training
ground for new drivers, and improvements in our training have allowed
us
to lower turnover in a difficult driver market. Average freight revenue
per total mile has remained basically flat with last year, although
the
length of haul has expanded about 15%.
|
|
|
•
|
Refrigerated
service. Increased our combined Southern Refrigerated Transport (“SRT”)
and Covenant Refrigerated fleet by approximately 22%, expanded the
length
of haul, and increased miles per truck slightly. Average freight
revenue
per total mile increased 2.4%, while average length of haul has increased
about 7%. Within this service offering, SRT continues to generate
the best
performance of any part of our company, and Covenant Refrigerated
should
be complimented for taking on more trucks than its business plan
called
for to cover additional trucks coming out of the regional service
offering.
|
|
|
•
|
Dedicated
service. Increased the fleet by approximately 39% and expanded the
length
of haul, while miles per truck decreased about 15%. Average freight
revenue per total mile increased 15.7% even with the longer length
of
haul. While we believe the reallocation of trucks from the regional
business to new dedicated business was prudent, the margins on the
new
dedicated business have not reached our long-term targets due to
the quick
expansion of this service offering.
|
|
|
•
|
Regional
solo-driver service. Decreased the fleet by approximately 38%, decreased
the length of haul, and increased miles per truck slightly. Average
freight revenue per total mile decreased 5.1%. The freight mix within
our
regional service offering changed substantially. The average truck
count
for the quarter decreased by almost 600 trucks versus the second
quarter
of last year, and we expect the truck count to continue to decrease
over
the remainder of the year, as additional trucks are allocated elsewhere
and the overall size of the company’s fleet is reduced. Within the
regional service offering, average length of haul decreased about
25% to
552 miles in the second quarter of 2006, as we continue to pursue
shorter,
more consistent lanes within defined regions. The process of repositioning
several hundred tractors around freight centers and driver domiciles
has
caused an increase in brokered freight and some lane and customer
turnover
that has temporarily affected the rate structure of this service
offering.
We understand the reasons for the rate decrease and will be working
diligently to correct them within the context of building a successful
regional offering.
|
We
also
initiated a freight brokerage operation in the first quarter of 2006 and hired
a
Vice President and General Manager of Brokerage Operations. Freight brokerage
is
operated as a separate subsidiary, Covenant Transport Solutions, Inc. We expect
the brokerage operation to help us continue to serve customers when we lack
capacity in a given area or the load does not meet our operating profile. We
expect this service to be especially helpful as we continue to realign trucks
between service offerings and manage our freight mix toward preferred
lanes.
Our
business realignment presents numerous challenges and may result in volatile
financial performance or periods of unprofitable results. We believe our results
were most volatile during the first half of 2006. However, fluctuations in
results may be ongoing as major activities within the realignment will continue
at least into 2007.
At
June
30, 2006, we had $188.7 million in stockholders' equity and $71.8 million in
balance sheet debt for a total debt-to-capitalization ratio of 27.6% and a
book
value of $13.48 per share.
Revenue
We
generate substantially all of our revenue by transporting freight for our
customers. Generally, we are paid by the mile or by the load for our services.
The main factors that affect our revenue are the revenue per mile we receive
from our customers, the percentage of miles for which we are compensated, the
number of tractors operating, and the number of miles we generate with our
equipment. These factors relate to, among other things, the U.S. economy,
inventory levels, the level of truck capacity in our markets, specific customer
demand, the percentage of team-driven tractors in our fleet, driver
availability, and our average length of haul.
We
also
derive revenue from fuel surcharges, loading and unloading activities, equipment
detention, and other accessorial services. Prior to 2004, we measured freight
revenue, before fuel and accessorial surcharges, in addition to total revenue.
In 2004, we reclassified accessorial revenue, other than fuel surcharges, into
freight revenue, and our historical financial statements have been conformed
to
this presentation. We continue to measure revenue before fuel surcharges, or
“freight revenue,” because we believe that fuel surcharges tend to be a volatile
source of revenue. We believe the exclusion of fuel surcharges affords a more
consistent basis for comparing the results of operations from period to period.
We
operate tractors driven by a single driver and also tractors assigned to
two-person driver teams. Over time the percentage of our revenue generated
by
driver teams has trended down, although the mix depends on a variety of factors
over time. Our single driver tractors generally operate in shorter lengths
of
haul, generate fewer miles per tractor, and experience more non-revenue miles,
but the lower productive miles are expected to be offset by generally higher
revenue per loaded mile and the reduced employee expense of compensating only
one driver. We expect operating statistics and expenses to shift with the mix
of
single and team operations.
Expenses
and Profitability
The
main
factors that impact our profitability on the expense side are the variable
costs
of transporting freight for our customers. These costs include fuel expense,
driver-related expenses, such as wages, benefits, training, and recruitment,
and
independent contractor costs, which we record as purchased transportation.
Expenses that have both fixed and variable components include maintenance and
tire expense 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. Our main fixed cost
is the acquisition and financing of long-term assets, primarily revenue
equipment and operating terminals. In addition, we have other mostly fixed
costs, such as our non-driver personnel.
Looking
forward, our profitability goal is to return to an operating ratio of
approximately 90%. We expect this to require successful execution of our
business realignment around service offerings, in particular an improvement
in
our Regional solo-driver service offering, as well as additional improvements
in
revenue per tractor per week, for all of our service offerings, to overcome
expected additional cost increases and to expand our margins. In addition,
we
expect driver availability to be a pressing issue facing us and the industry
for
the foreseeable future. We expect competition for quality drivers to remain
intense and that driver numbers will be the most substantial limiting factor
on
capacity growth. We expect many carriers to use future rate increases to
increase driver compensation. Because a large percentage of our costs are
variable, changes in revenue per mile affect our profitability to a greater
extent than changes in miles per tractor. For the foreseeable future, we expect
to decrease the size of our revenue equipment fleet of our existing regional
service offering, with at least a portion of the equipment being allocated
to
other service offerings.
Revenue
Equipment
We
operate approximately 3,509 tractors and 8,453 trailers. Of our tractors, at
June 30, 2006, approximately 1,949 were owned, 1,412 were financed under
operating leases, and 148 were provided by independent contractors, who own
and
drive their own tractors. Of our trailers, at June 30, 2006, approximately
1,432
were owned and approximately 7,021 were financed under operating leases. We
finance a portion of our tractor fleet and most of our trailer fleet with
off-balance sheet operating leases. These leases generally run for a period
of
three years for tractors and five to seven years for trailers.
In
September 2005, we entered into an agreement with a finance company to lease
approximately 1,800 model-year 2006 and 2007 dry van trailers under seven-year
walk away leases. These trailers will replace approximately 1,200 model-year
1998 and 1999 dry van trailers and approximately 600 model-year 2000 dry van
trailers. At June 30, 2006, we had taken delivery and replaced approximately
1,500 of these trailers. We should complete the remainder of these replacements
by the end of the year. After the completion of this transaction, our oldest
trailers in operation will be 2001 model-year trailers.
For
2006,
in line with our overall fleet reduction initiative, our plan to replace
approximately 2,100 tractors was reduced to a plan to replace approximately
1,960 tractors, or approximately 56% of our Company-owned tractor fleet. This
is
still approximately twice the number of tractors we would normally replace
and
will result in a substantial increase over normal replacement capital
expenditures. We are increasing our purchases in 2006 to afford us flexibility
to evaluate the cost and performance of tractors equipped with engines that
meet
2007 emissions requirements.
Independent
contractors (owner-operators) provide a tractor and a driver and are responsible
for all operating expenses in exchange for a fixed payment per mile. We do
not
have the capital outlay of purchasing the tractor. The payments to independent
contractors and the financing of equipment under operating leases are recorded
in revenue equipment rentals and purchased transportation. Expenses associated
with owned equipment, such as interest and depreciation, are not incurred,
and
for independent contractor-tractors, driver compensation, fuel, and other
expenses are not incurred. Because obtaining equipment from independent
contractors and under operating leases effectively shifts financing expenses
from interest to "above the line" operating expenses, we evaluate our efficiency
using net margin as well as operating ratio.
RESULTS
OF OPERATIONS
The
following table sets forth the percentage relationship of certain items to
total
revenue and freight revenue:
|
|
Three
Months Ended
June
30,
|
|
|
|
Three
Months Ended
June
30,
|
|
|
2006
|
|
2005
|
|
|
|
2006
|
|
2005
|
Total
revenue
|
|
100.0%
|
|
100.0%
|
|
Freight
revenue (1)
|
|
100.0%
|
|
100.0%
|
Operating
expenses:
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
Salaries,
wages, and related
expenses
|
|
38.0
|
|
38.9
|
|
Salaries,
wages, and related
expenses
|
|
46.2
|
|
43.9
|
Fuel
expense
|
|
29.7
|
|
25.4
|
|
Fuel
expense (1)
|
|
14.6
|
|
15.7
|
Operations
and maintenance
|
|
5.2
|
|
5.4
|
|
Operations
and maintenance
|
|
6.3
|
|
6.1
|
Revenue
equipment rentals and
purchased
transportation
|
|
9.1
|
|
9.6
|
|
Revenue
equipment rentals and
purchased
transportation
|
|
11.1
|
|
10.8
|
Operating
taxes and licenses
|
|
2.1
|
|
2.3
|
|
Operating
taxes and licenses
|
|
2.5
|
|
2.6
|
Insurance
and claims
|
|
4.8
|
|
6.1
|
|
Insurance
and claims
|
|
5.9
|
|
6.9
|
Communications
and utilities
|
|
1.0
|
|
1.0
|
|
Communications
and utilities
|
|
1.1
|
|
1.2
|
General
supplies and expenses
|
|
3.4
|
|
2.8
|
|
General
supplies and expenses
|
|
4.1
|
|
3.1
|
Depreciation
and amortization
|
|
5.0
|
|
6.6
|
|
Depreciation
and amortization
|
|
6.1
|
|
7.4
|
Total
operating expenses
|
|
98.3
|
|
98.1
|
|
Total
operating expenses
|
|
97.9
|
|
97.8
|
Operating
income
|
|
1.8
|
|
1.9
|
|
Operating
income
|
|
2.1
|
|
2.2
|
Other
expense, net
|
|
0.6
|
|
0.6
|
|
Other
expense, net
|
|
.7
|
|
0.6
|
Income
before income taxes
|
|
1.2
|
|
1.4
|
|
Income
before income taxes
|
|
1.4
|
|
1.6
|
Income
tax expense
|
|
1.4
|
|
1.0
|
|
Income
tax expense
|
|
1.7
|
|
1.1
|
Net
income (loss)
|
|
(0.2%)
|
|
0.4%
|
|
Net
income (loss)
|
|
(0.3%)
|
|
0.5%
|
(1)
|
Freight
revenue is total revenue less fuel surcharge revenue. Fuel surcharge
revenue is shown netted against the fuel expense category ($30.0
million
and $18.1 million in the three months ended June 30, 2006 and 2005,
respectively).
|
|
|
Six
Months Ended
June
30,
|
|
|
|
Six
Months Ended
June
30,
|
|
|
2006
|
|
2005
|
|
|
|
2006
|
|
2005
|
Total
revenue
|
|
100.0%
|
|
100.0%
|
|
Freight
revenue (2)
|
|
100.0%
|
|
100.0%
|
Operating
expenses:
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
Salaries,
wages, and related
expenses
|
|
38.4
|
|
39.0
|
|
Salaries,
wages, and related
expenses
|
|
45.8
|
|
43.8
|
Fuel
expense
|
|
28.7
|
|
24.9
|
|
Fuel
expense (2)
|
|
14.9
|
|
15.6
|
Operations
and maintenance
|
|
5.4
|
|
5.3
|
|
Operations
and maintenance
|
|
6.4
|
|
6.0
|
Revenue
equipment rentals and purchased transportation
|
|
9.4
|
|
10.3
|
|
Revenue
equipment rentals and purchased transportation
|
|
11.2
|
|
11.6
|
Operating
taxes and licenses
|
|
2.1
|
|
2.4
|
|
Operating
taxes and licenses
|
|
2.5
|
|
2.6
|
Insurance
and claims
|
|
5.1
|
|
6.3
|
|
Insurance
and claims
|
|
6.1
|
|
7.0
|
Communications
and utilities
|
|
1.0
|
|
1.1
|
|
Communications
and utilities
|
|
1.2
|
|
1.2
|
General
supplies and expenses
|
|
3.1
|
|
2.9
|
|
General
supplies and expenses
|
|
3.7
|
|
3.2
|
Depreciation
and amortization
|
|
5.8
|
|
6.8
|
|
Depreciation
and amortization
|
|
6.9
|
|
7.6
|
Total
operating expenses
|
|
99.0
|
|
98.9
|
|
Total
operating expenses
|
|
98.8
|
|
98.7
|
Operating
income
|
|
1.0
|
|
1.1
|
|
Operating
income
|
|
1.2
|
|
1.3
|
Other
expense, net
|
|
0.6
|
|
0.4
|
|
Other
expense, net
|
|
0.7
|
|
0.5
|
Income
before income taxes
|
|
0.4
|
|
0.7
|
|
Income
before income taxes
|
|
0.5
|
|
0.8
|
Income
tax expense
|
|
0.8
|
|
0.7
|
|
Income
tax expense
|
|
1.0
|
|
0.8
|
Net
income (loss)
|
|
(0.4%)
|
|
0.0%
|
|
Net
income (loss)
|
|
(0.5%)
|
|
0.0%
|
(2)
|
Freight
revenue is total revenue less fuel surcharge revenue. Fuel surcharge
revenue is shown netted against the fuel expense category ($52.1
million
and $32.4 million in the six months ended June 30, 2006 and 2005,
respectively).
|
COMPARISON
OF THREE MONTHS ENDED JUNE 30, 2006 TO THREE MONTHS ENDED JUNE 30,
2005
For
the
quarter ended June 30, 2006, total revenue increased $12.6 million, or 8.0%,
to
$169.4 million from $156.8 million in the 2005 period. Total revenue
includes $30.1 million and $18.1 million of fuel surcharge revenue in the 2006
and 2005 periods, respectively. For comparison purposes in the discussion below,
we use freight revenue (total revenue less fuel surcharge revenue) when
discussing changes as a percentage of revenue. We believe removing this
sometimes volatile source of revenue affords a more consistent basis for
comparing the results of operations from period to period.
Freight
revenue remained relatively constant at $139.3 million in the three months
ended
June 30, 2006, and $138.7 million in the same period of 2005. Average freight
revenue per tractor per week, our primary measure of productivity, increased
5.0% to $3,109 in the 2006 period from $2,961 in the 2005 period. The increase
was primarily generated by a 4.3% increase in average miles per tractor, a
reduction in non-revenue miles percentage and a 0.7% increase in our average
freight revenue per total mile. We are continuing to constrain the size of
our
tractor fleet to achieve greater fleet utilization and improved profitability.
In general, the changes in freight mix as a result of the realignment expanded
the portions of our business with longer lengths of haul, more miles per
tractor, and generally lower rate structures, while shrinking the regional
service offering, which had the highest rate structure but significantly lower
miles per tractor.
Salaries,
wages, and related expenses increased $3.4 million, or 5.7%, to $64.4 million
in
the 2006 period, from $61.0 million in the 2005 period. As a percentage of
freight revenue, salaries, wages, and related expenses increased to 46.2% in
the
2006 period from 43.9% in the 2005 period. The increase was largely attributable
to driver pay per mile increases and driver retention bonus programs instituted
in the second half of 2005, an increase in the percentage of our fleet comprised
of company drivers versus owner-operators, higher health claim costs and
additional office salaries related to our business realignment. Driver pay
increased $1.1 million to $44.1 million in the 2006 period from $43.0 million
in
the 2005 period. Our payroll expense for employees, other than over-the-road
drivers, as well as our employee benefits, increased $2.3 million to $20.3
million in the 2006 period from $18.0 million in the 2005 period, including
a
$1.2 million increase in our health insurance claim costs.
We
maintain a workers' compensation plan and group medical plan for our employees
with a deductible amount of $1.0 million for each workers' compensation claim
and a stop loss amount of $275,000 for each medical claim.
Fuel
expense, net of fuel surcharge revenue of $30.0 million in the 2006 period
and
$18.1 million in the 2005 period, decreased $1.5 million, or 7.1%, to $20.3
million in the 2006 period, from $21.8 million in the 2005 period. As a
percentage of freight revenue, net fuel expense decreased to 14.6% in the 2006
period from 15.7% in the 2005 period. Although fuel prices increased sharply
during 2006 from already high levels during 2005, our improved fuel surcharge
program, better fuel economy due to lower idle times and a lower percentage
of
non-revenue miles allowed us to improve our net fuel expense. Fuel surcharges
amounted to $.29 per total mile in the 2006 period and $0.18 per total mile
in
the 2005 period. Fuel costs may be affected in the future by price fluctuations,
volume purchase commitments, the terms and collectibility of fuel surcharges,
the percentage of miles driven by independent contractors, and lower fuel
mileage due to government mandated emissions standards that have resulted in
less fuel efficient engines.
Operations
and maintenance, consisting primarily of vehicle maintenance, repairs, and
driver recruitment expenses, increased $.3 million to $8.7 million in the 2006
period from $8.4 million in the 2005 period. As a percentage of freight revenue,
operations and maintenance increased to 6.3% in the 2006 period from 6.1% in
the
2005 period. The increase resulted primarily from higher unloading costs and
increased driver recruiting expense due to increased competition for a limited
number of qualified drivers.
Revenue
equipment rentals and purchased transportation increased $.5 million, or 2.7%,
to $15.5 million in the 2006 period, from $15.0 million in the 2005 period.
As a
percentage of freight revenue, revenue equipment rentals and purchased
transportation expense increased to 11.1% in the 2006 period from 10.8% in
the
2005 period. Tractor and trailer equipment rental and other related expenses
increased $0.7 million, to $10.5 million compared with $9.8 million in the
same
period of 2005. We had financed approximately 1,412 tractors and 7,021 trailers
under operating leases at June 30, 2006, compared with 1,088 tractors and 7,925
trailers under operating leases at June 30, 2005. Payments to independent
contractors decreased slightly to $5.0 million in the 2006 period from $5.3
million in the 2005 period, mainly due to a decrease in the independent
contractor fleet to an average of 148 during the 2006 period versus an average
of 197 in the 2005 period.
Operating
taxes and licenses decreased $0.1 million to $3.5 million in the 2006 period
from $3.6 million in the 2005 periods. As a percentage of freight revenue,
operating taxes and licenses remained essentially constant at 2.5% in the 2006
period versus 2.6% in the 2005 period.
Insurance
and claims, consisting primarily of premiums and deductible amounts for
liability, physical damage, and cargo damage insurance and claims, decreased
$1.4 million, or 14.7%, to approximately $8.2 million in the 2006 period from
approximately $9.6 million in the 2005 period. As a percentage of freight
revenue, insurance and claims decreased to 5.9% in the 2005 period from 6.9%
in
the 2005 period. During the quarter, we reduced our accrual for casualty claims
to 8.0 cents per mile from 9.3 cents per mile for the same quarter in 2005
as a
result of several quarters of improved safety results that have changed our
actuarial estimate.
Our
current casualty program expires in February 2007. In general, for casualty
claims, we have insurance coverage up to $50.0 million per claim. We are
self-insured for personal injury and property damage claims for amounts up
to
$2.0 million per occurrence, subject to an additional $2.0 million
self-insured aggregate amount, which results in total self-insured retention
of
up to $4.0 million until the $2.0 million aggregate threshold is
reached. We are self-insured for cargo loss and damage claims for amounts up
to
$1.0 million per occurrence. Insurance and claims expense varies based on
the frequency and severity of claims, the premium expense, and the level of
self-insured retention, the development of claims over time, and other factors.
With our significant self-insured retention, insurance and claims expense may
fluctuate significantly from period to period.
Communications
and utilities expense remained essentially constant at $1.5 million and $1.6
million in the 2006 and 2005 periods, respectively. As a percentage of freight
revenue, communications and utilities also remained essentially constant at
1.1%
in the 2006 period and 1.2% in the 2005 period.
General
supplies and expenses, consisting primarily of headquarters and other terminal
facilities expenses, increased $1.4 million to $5.7 million in the 2006 period
from $4.3 million in the 2005 period. As a percentage of freight revenue,
general supplies and expenses increased to 4.1% in the 2006 period from 3.1%
in
the 2005 period. Of this increase, $0.7 million was for additional building
rent
paid on our headquarters building and surrounding property in Chattanooga,
Tennessee for which we completed a sale leaseback transaction effective April
2006 as described more fully in the following paragraph. The additional increase
is partially due to our paying for contract labor related to the business
realignment and an increase in our travel expenses related to customer
visits.
In
April
2006, we entered into a sale leaseback transaction involving our corporate
headquarters, a maintenance facility, a body shop, and approximately forty-six
acres of surrounding property in Chattanooga, Tennessee. We received proceeds
of
approximately $29.6 million from the sale of the property, which we used to
pay
down borrowings under our Credit Agreement and to purchase revenue equipment.
In
the transaction, we entered into a twenty-year lease agreement, whereby we
will
lease back the property at an annual rental rate of approximately $2.5 million,
subject to annual rent increases of 1.0%, resulting in annual straight-line
rental expense of approximately $2.7 million. The transaction resulted in a
gain
of approximately $2.1 million, which will be amortized ratably over the life
of
the lease and recorded as depreciation expense on our consolidated condensed
statements of operations.
Depreciation
and amortization, consisting primarily of depreciation of revenue equipment,
decreased $1.8 million, or 17% to $8.5 million in the 2006 period from $10.3
million in the 2005 period. As a percentage of freight revenue, depreciation
and
amortization decreased to 6.1% in the 2006 period from 7.4% in the 2005 period.
The decrease primarily related to a net gain on the disposal of tractors and
trailers of approximately $1.5 million in the 2006 period compared to a net
gain
of $0.3 million in the 2005 period. Additionally, a decrease of $0.2 million
in
depreciation expense for the 2006 period resulted from the April 2006 sale
leaseback transaction involving our Chattanooga facility as compared to the
2005
period. Depreciation and amortization expense is net of any gain or loss on
the
disposal of tractors and trailers.
Amortization
expense relates to deferred debt costs incurred and covenants not to compete
from five acquisitions. Goodwill amortization ceased beginning January 1, 2002,
in accordance with SFAS No. 142,
Goodwill
and Other Intangible Assets.
We
evaluate goodwill and certain intangibles for impairment, annually. During
the
second quarter of 2006, we tested our goodwill totaling $11.5 million for
impairment and found no impairment.
The
other
expense category includes interest expense, interest income, and pre-tax
non-cash gains or losses related to the accounting for interest rate derivatives
under SFAS No. 133. Other expense, net, remained constant at $0.9 million in
the
2006 and the 2005 periods, respectively. In the 2006 period, we did not
recognize a pre-tax, non-cash gain compared to a $0.1 million gain in the 2005
period related to the accounting for interest rate derivatives under SFAS No.
133.
Our
income tax expense was $2.4 million and $1.5 million in the 2006 and 2005
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem,
our
tax rate will fluctuate in future periods as income fluctuates. On April 20,
2006, we completed the appeals process with the IRS related to their 2001 and
2002 audits. Related to this settlement with the IRS, we recorded additional
income tax expense of approximately $0.5 million for the three months ended
June
30, 2006. We received a favorable resolution in the Closing Agreement received
from the IRS which stated that our wholly-owned captive insurance subsidiary
made a valid election under section 953(d) of the Internal Revenue Code and
is
to be respected as an insurance company.
Subsequent
to June 30, 2006, the IRS, completed their audit fieldwork of our 2003 and
2004
tax returns and has proposed the disallowance, with which we have agreed, of
approximately $350,000 of costs related to the November 2003 stock offering.
During the three months ended June 30, 2006, we recorded $0.1 million of income
tax expense related to this proposed disallowance of tax benefits. Additionally,
the IRS has proposed to disallow the tax benefits associated with insurance
premium payments made to our wholly-owned captive insurance subsidiary for
the
2003 and 2004 years. Due to the favorable resolution of the 2001 and 2002 IRS
audit on this issue, we are vigorously defending our position related to this
proposed disallowance of tax benefits using all administrative and legal
processes available. For the three months ended June 30, 2006, income tax
expense of $0.1 million was recorded in our consolidated condensed statements
of
operations. If we are unsuccessful in defending our position on this deduction,
we could owe additional taxes totaling $1.6 million on this matter. We believe
that we have properly accrued for this matter on our consolidated condensed
balance sheet at June 30, 2006.
Primarily
as a result of the factors described above, net income decreased approximately
$1.1 million to a net loss of $0.4 million in the 2006 period from net income
of
$0.7 million in the 2005 period. As a result of the foregoing, our net margin
decreased to (0.3%) in the 2006 period from 0.5% in the 2005
period.
COMPARISON
OF SIX MONTHS ENDED JUNE 30, 2006 TO SIX MONTHS ENDED JUNE 30,
2005
For
the
six months ended June 30, 2006, total revenue increased $26.2 million, or 8.9%,
to $320.9 million from $294.7 million in the 2005 period. Total revenue
includes $52.1 million and $32.4 million of fuel surcharge revenue in the 2006
and 2005 periods, respectively. For comparison purposes in the discussion below,
we use freight revenue (total revenue less fuel surcharge revenue) when
discussing changes as a percentage of revenue. We believe removing this
sometimes volatile source of revenue affords a more consistent basis for
comparing the results of operations from period to period.
Freight
revenue increased $6.5 million or 2.5% to $268.8 million in the six months
ended
June 30, 2006 from $262.3 million in the same period of 2005. Average freight
revenue per tractor per week, our primary measure of asset productivity,
increased 5.6% to $3,025 in the 2006 period from $2,865 in the 2005 period.
The
increase was primarily generated by a 3.8% increase in average miles per
tractor, an improvement in non-revenue miles percentage and a 1.7% increase
in
our average freight revenue per total mile. We are continuing to constrain
the
size of our tractor fleet to achieve greater fleet utilization and improved
profitability. In general, the changes in freight mix as a result of the
realignment expanded the portions of our business with longer lengths of haul,
more miles per tractor, and generally lower rate structures, while shrinking
the
regional service offering, which had the highest rate structure but
significantly lower miles per tractor.
Salaries,
wages, and related expenses increased $8.2 million, or 7.1%, to $123.1 million
in the 2006 period, from $114.9 million in the 2005 period. As a percentage
of
freight revenue, salaries, wages, and related expenses increased to 45.8% in
the
2006 period, from 43.8% in the 2005 period. The increase was largely
attributable to driver pay per mile increases and driver retention bonus
programs instituted in the second half of 2005, an increase in the percentage
of
our fleet comprised of company drivers versus owner-operators, higher health
claim costs and additional office salaries related to our business realignment.
Driver pay increased $4.3 million to $84.4 million in the 2006 period from
$80.1
million in the 2005 period. Our payroll expense for employees, other than
over-the-road drivers, as well as our employee benefits, increased $3.8 million
to $38.7 million in the 2006 period from $34.9 million in the 2005 period,
including a $2.5 million increase in our health insurance claim
costs.
We
maintain a workers' compensation plan and group medical plan for our employees
with a deductible amount of $1.0 million for each workers' compensation claim
and a stop loss amount of $275,000 for each medical claim.
Fuel
expense, net of fuel surcharge revenue of $52.1 million in the 2006 period
and
$32.4 million in the 2005 period, decreased $.9 million to $40.1 million in
the
2006 period from $41.0 million in the 2005 period. As a percentage of freight
revenue, net fuel expense decreased to 14.9% in the 2006 period from 15.6%
in
the 2005 period. Although fuel prices increased sharply during 2006 from already
high levels during 2005, our improved fuel surcharge program, better fuel
economy due to lower idle times and a lower percentage of non-revenue miles
allowed us to improve our net fuel expense. Our fuel surcharge program was
able
to offset all of the higher fuel prices and allowed us better overall recovery
of excess fuel costs. Fuel surcharges amounted to $.26 per total mile in the
2006 period and $0.16 per total mile in the 2005 period. Fuel costs may be
affected in the future by price fluctuations, volume purchase commitments,
the
terms and collectibility of fuel surcharges, the percentage of miles driven
by
independent contractors, and lower fuel mileage due to government mandated
emissions standards that have resulted in less fuel efficient engines.
Operations
and maintenance, consisting primarily of vehicle maintenance, repairs, and
driver recruitment expenses, increased $1.6 million to $17.3 million in the
2006
period from $15.7 million in the 2005 period. As a percentage of freight
revenue, operations and maintenance increased to 6.4% in the 2006 period from
6.0% in the 2005 period. The increase resulted in part from higher unloading
costs, tractor maintenance costs and increased driver recruiting expense due
to
a tighter supply of drivers in the early part of 2006.
Revenue
equipment rentals and purchased transportation decreased $0.3 million, or 1.0%,
to $30.1 million in the 2006 period, from $30.4 million in the 2005 period.
As a
percentage of freight revenue, revenue equipment rentals and purchased
transportation expense decreased to 11.2% in the 2006 period from 11.6% in
the
2005 period. The decrease is due principally to a decrease in the percentage
of
our total miles that were driven by independent contractors, offset by an
increase in revenue equipment rental payments. Payments to independent
contractors decreased $1.1 million to $9.7 million in the 2006 period from
$10.8
million in the 2005 period, mainly due to a decrease in the independent
contractor fleet to an average of 147 during the 2006 period versus an average
of 198 in the 2005 period. Tractor and trailer equipment rental and other
related expenses increased $0.8 million, to $20.4 million in the 2006 period
compared with $19.6 million in the same period of 2005. We had financed
approximately 1,412 tractors and 7,021 trailers under operating leases at June
30, 2006, compared with 1,088 tractors and 7,925 trailers under operating leases
at June 30, 2005. During the second quarter of 2006, we purchased approximately
75 tractors that were previously leased
.
Operating
taxes and licenses remained essentially constant at $6.8 million and $6.9
million in the 2006 and 2005 periods, respectively. As a percentage of freight
revenue, operating taxes and licenses also remained essentially constant at
2.5%
and 2.6% in the 2006 and 2005 periods, respectively.
Insurance
and claims, consisting primarily of premiums and deductible amounts for
liability, physical damage, and cargo damage insurance and claims, decreased
$2.0 million, or 11.0%, to approximately $16.4 million in the 2006 period from
approximately $18.4 million in the 2005 period. As a percentage of freight
revenue, insurance and claims decreased to 6.1% in the 2006 period from 7.0%
in
the 2005 period. During the second quarter, we reduced our accrual for casualty
claims to 8.0 cents per mile from 9.3 cents per mile last year as a result
of
several quarters of improved safety results that have changed our actuarial
estimate. We also recorded and received an insurance rebate of approximately
$1.0 million during the first six months of 2006 resulting from achieving
monetary claim targets for our casualty policy in the year ending February
28,
2006.
Our
current casualty program expires in February 2007. In general, for casualty
claims, we have insurance coverage up to $50.0 million per claim. We are
self-insured for personal injury and property damage claims for amounts up
to
$2.0 million per occurrence, subject to an additional $2.0 million
self-insured aggregate amount, which results in total self-insured retention
of
up to $4.0 million until the $2.0 million aggregate threshold is
reached. We are self-insured for cargo loss and damage claims for amounts up
to
$1.0 million per occurrence. Insurance and claims expense varies based on
the frequency and severity of claims, the premium expense, and the level of
self-insured retention, the development of claims over time, and other factors.
With our significant self-insured retention, insurance and claims expense may
fluctuate significantly from period to period.
Communications
and utilities expense remained essentially constant at $3.1 million and $3.2
million in the 2006 and 2005 periods, respectively. As a percentage of freight
revenue, communications and utilities also remained essentially constant at
1.2%
in the 2006 and 2005 periods.
General
supplies and expenses, consisting primarily of headquarters and other terminal
facilities expenses, increased $1.5 million to $10.0 million in the 2006 period
from $8.5 million in the 2005 period. As a percentage of freight revenue,
general supplies and expenses increased to 3.7% in the 2006 period from 3.2%
in
the 2005 period. Of this increase, $0.7 million was for additional building
rent
paid on our headquarters building and surrounding property in Chattanooga,
Tennessee for which we completed a sale leaseback transaction effective April
2006 as described more fully in the following paragraph. The additional increase
is partially due to our paying for contract labor related to the business
realignment, an increase in our travel expenses related to customer visits
and
increased outside professional fees.
In
April
2006, we entered into a sale leaseback transaction involving our corporate
headquarters, a maintenance facility, a body shop, and approximately forty-six
acres of surrounding property in Chattanooga, Tennessee. We received proceeds
of
approximately $29.6 million from the sale of the property, which we used to
pay
down borrowings under our Credit Agreement and to purchase revenue equipment.
In
the transaction, we entered into a twenty-year lease agreement, whereby we
will
lease back the property at an annual rental rate of approximately $2.5 million,
subject to annual rent increases of 1.0%, resulting in annual straight-line
rental expense of approximately $2.7 million. The transaction resulted in a
gain
of approximately $2.1 million, which will be amortized ratably over the life
of
the lease and recorded as depreciation expense on our consolidated condensed
statements of operations.
Depreciation
and amortization, consisting primarily of depreciation of revenue equipment,
decreased $1.3 million, or 7.0%, to $18.6 million in the 2006 period from $19.9
million in the 2005 period. As a percentage of freight revenue, depreciation
and
amortization decreased to 6.9% in the 2005 period from 7.6% in the 2005 period.
The decrease primarily related to a net gain on the disposal of tractors and
trailers of $1.7 million in the 2006 period compared to a net gain of only
$0.1
million in the 2005 period. Additionally, a decrease of $0.2 million in
depreciation expense for the 2006 period resulted from the April 2006 sale
leaseback transaction involving our Chattanooga facility as compared to the
2005
period. Depreciation and amortization expense is net of any gain or loss on
the
disposal of tractors and trailers.
The
other
expense category includes interest expense, interest income, and pre-tax
non-cash gains or losses related to the accounting for interest rate derivatives
under SFAS No. 133. Other expense, net, increased $.7 million, to $1.9 million
in the 2006 period from $1.2 million in the 2005 period, primarily due to higher
variable interest rates.
Our
income tax expense was $2.7 million and $2.1 million in the 2006 and 2005
periods, respectively. The effective tax rate is different from the expected
combined tax rate due to permanent differences related to a per diem pay
structure implemented in 2001. Due to the nondeductible effect of per diem,
our
tax rate will fluctuate in future periods as income fluctuates. On April 20,
2006, we completed the appeals process with the IRS related to their 2001 and
2002 audits. Related to this settlement with the IRS, we recorded additional
income tax expense of approximately $0.5 million for the three months ended
June
30, 2006. We received a favorable resolution in the Closing Agreement received
from the IRS which stated that our wholly-owned captive insurance subsidiary
made a valid election under section 953(d) of the Internal Revenue Code and
is
to be respected as an insurance company.
Subsequent
to June 30, 2006, the IRS, completed their audit fieldwork of our 2003 and
2004
tax returns and has proposed the disallowance, with which we have agreed, of
approximately $350,000 of costs related to the November 2003 stock offering.
During the three months ended June 30, 2006, we recorded $0.1 million of income
tax expense related to this proposed disallowance of tax benefits. Additionally,
the IRS has proposed to disallow the tax benefits associated with insurance
premium payments made to our wholly-owned captive insurance subsidiary for
the
2003 and 2004 years. Due to the favorable resolution of the 2001 and 2002 IRS
audit on this issue, we are vigorously defending our position related to this
proposed disallowance of tax benefits using all administrative and legal
processes available. For the six months ended June 30, 2006, income tax expense
of $0.2 million was recorded in our consolidated condensed statements of
operations. If we are unsuccessful in defending our position on this deduction,
we could owe additional taxes totaling $1.6 million on this matter. We believe
that we have properly accrued for this matter on our consolidated condensed
balance sheet at June 30, 2006.
Primarily
as a result of the factors described above, net income decreased approximately
$1.3 million to a net loss of $1.3 million in the 2006 period from breakeven
profitability in the 2005 period.
LIQUIDITY
AND CAPITAL RESOURCES
Our
business requires significant capital investments. In recent years, we have
financed our capital requirements with borrowings under our Securitization
Facility and a line of credit, cash flows from operations, and long-term
operating leases. Our primary sources of liquidity at June 30, 2006, were funds
provided by operations, proceeds under the Securitization Facility, borrowings
under our Credit Agreement, and operating leases of revenue equipment.
Over
the
past several years, we have financed a large and increasing percentage of our
revenue equipment through operating leases. This has reduced the net value
of
revenue equipment reflected on our balance sheet, reduced our borrowings and
increased our net cash flows compared to purchasing all of our revenue
equipment. Certain items could fluctuate depending on whether we finance our
revenue equipment through borrowings or through operating leases. We expect
capital expenditures, primarily for revenue equipment (net of proceeds from
revenue equipment disposals and the April 2006 sale leaseback transaction),
to
be approximately $55.0 to $60.0 million in 2006, exclusive of acquisitions
of
companies, assuming all revenue equipment is purchased. We believe our sources
of liquidity are adequate to meet our current and projected needs for at least
the next twelve months. On a longer term basis, based on anticipated future
cash
flows, current availability under our Credit Agreement and Securitization
Facility, and sources of financing that we expect will be available to us,
we do
not expect to experience significant liquidity constraints in the foreseeable
future.
Cash
Flows
Net
cash
provided by operating activities was $24.3 million in the 2006 period and $9.9
million in the 2005 period. In the 2006 period, our primary source of cash
flow
from operating activities was from receivables. Our cash from operating
activities was lower in the 2005 period due to $10.0 million in tax payments
and
a $10.0 million payment for two years of prepaid insurance
premiums.
Net
cash
used in investing activities was $17.0 million in the 2006 period and $38.7
million in the 2005 period related to the purchase of tractors and trailers,
offset in 2006 by the $29.6 million of proceeds from the April 2006 sale
leaseback transaction of our Chattanooga facility, which was used for purchasing
additional revenue equipment and paying down our outstanding debt on the Credit
Facility.
Net
cash
used in financing activities was $8.3 million in the 2006 period, as we were
able to pay down the Credit Facility with the cash generated from the April
2006
sale leaseback transaction of our Chattanooga facility. Net cash provided by
financing activities was $23.9 million in the 2005 period. At June 30, 2006,
the
Company had outstanding debt of $71.8 million, primarily consisting of
approximately $24.0 million drawn under the Credit Agreement and $47.8 million
from the Securitization Facility. Interest rates on this debt range from 5.4%
to
6.2%.
In
May
2006, the Board of Directors approved an extension of our previously approved
stock repurchase plan for up to 1.3 million Company shares to be purchased
in
the open market or through negotiated transactions subject to criteria
established by the Board. No shares have been purchased under this plan during
2006. At June 30, 2006, there were 1,154,100 shares still available to purchase
under the guidance of this plan.
Material
Debt Agreements
In
December 2004, we entered into a Credit Agreement with a group of banks. The
facility matures in December 2009. Borrowings under the Credit Agreement are
based on the banks' base rate, which floats daily, or LIBOR, which accrues
interest based on one, two, three, or six month LIBOR rates plus an applicable
margin that is adjusted quarterly between 0.75% and 1.25% based on cash flow
coverage (the applicable margin was 1.0% at June 30, 2006). At June 30, 2006,
we
had $24.0 million outstanding under the Credit Agreement.
The
Credit Agreement has a maximum borrowing limit of $150.0 million with an
accordion feature, which permits an increase up to a maximum borrowing limit
of
$200.0 million. Borrowings related to revenue equipment are limited to the
lesser of 90% of net book value of revenue equipment or the maximum borrowing
limit. Letters of credit are limited to an aggregate commitment of
$85.0 million. The Credit Agreement is secured by a pledge of the stock of
most of our subsidiaries. A commitment fee that is adjusted quarterly between
0.15% and 0.25% per annum based on cash flow coverage, is due on the daily
unused portion of the Credit Agreement. As of June 30, 2006, we had
approximately $55.5 million of available borrowing capacity under the Credit
Agreement. At June 30, 2006 and December 31, 2005, we had undrawn letters
of credit outstanding of approximately $70.5
million
and $73.9
million,
respectively.
In
December 2000, we entered into the Securitization Facility. On a revolving
basis, we sell our interests in our accounts receivable to CVTI Receivables
Corp. ("CRC"), a wholly-owned bankruptcy-remote special purpose subsidiary
incorporated in Nevada. CRC sells a percentage ownership in such receivables
to
an unrelated financial entity. We can receive up to $62.0 million of proceeds,
subject to eligible receivables, and pay a service fee recorded as interest
expense, based on commercial paper interest rates plus an applicable margin
of
0.44% per annum and a commitment fee of 0.10% per annum on the daily unused
portion of the Securitization Facility. The net proceeds under the
Securitization Facility are required to be shown as a current liability because
the term, subject to annual renewals, is 364 days. As of June 30, 2006 and
December 31, 2005, we had $47.8 million and $47.3 million, respectively
outstanding, with weighted average interest rates of 5.4% and 4.4%,
respectively. CRC does not meet the requirements for off-balance sheet
accounting; therefore, it is reflected in our consolidated condensed financial
statements.
The
Credit Agreement and Securitization Facility contain certain restrictions and
covenants relating to, among other things, dividends, tangible net worth, cash
flow coverage, acquisitions and dispositions, and total indebtedness. These
agreements are cross-defaulted. We were in compliance with these agreements
as
of June 30, 2006.
OFF-BALANCE
SHEET ARRANGEMENTS
Operating
leases have been an important source of financing for our revenue equipment,
computer equipment, the Company airplane and certain real estate. At June 30,
2006, we had financed approximately 1,412 tractors and 7,021 trailers under
operating leases. Vehicles held under operating leases are not carried on our
balance sheet, and lease payments in respect of such vehicles are reflected
in
our income statements in the line item "Revenue equipment rentals and purchased
transportation." Our revenue equipment rental expense was $20.9 million in
the
2006 period, compared to $20.2 million in the 2005 period. The total amount
of
remaining payments under operating leases as of June 30, 2006, was approximately
$177.9 million. In connection with various operating leases, we issued residual
value guarantees, which provide that if we do not purchase the leased equipment
from the lessor at the end of the lease term, we are liable to the lessor for
an
amount equal to the shortage (if any) between the proceeds from the sale of
the
equipment and an agreed value. As of June 30, 2006, the maximum amount of the
residual value guarantees was approximately $45.6 million. To the extent the
expected value at the lease termination date is lower than the residual value
guarantee, we would accrue for the difference over the remaining lease term.
We
believe that proceeds from the sale of equipment under operating leases would
exceed the payment obligation on all operating leases.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make decisions
based upon estimates, assumptions, and factors we consider relevant to the
circumstances. Such decisions include the selection of applicable accounting
principles and the use of judgment in their application, the results of which
impact reported amounts and disclosures. Changes in future economic conditions
or other business circumstances may affect the outcomes of our estimates and
assumptions. Accordingly, actual results could differ from those anticipated.
A
summary of the significant accounting policies followed in preparation of the
financial statements is contained in Note 1 of the financial statements
contained in our annual report on Form 10-K for the fiscal year ended December
31, 2005. The following discussion addresses our most critical accounting
policies, which are those that are both important to the portrayal of our
financial condition and results of operations and that require significant
judgment or use of complex estimates.
Our
critical accounting policies include the following:
Depreciation
of Revenue Equipment - Depreciation is calculated using the straight-line method
over the estimated useful lives of the assets and was approximately $18.5
million on tractors and trailers in the first six months of 2006. Depreciation
of revenue equipment is our largest item of depreciation. We generally
depreciate new tractors (excluding day cabs) over five years to salvage values
of 4% to 33% and new trailers over seven years to salvage values of 17% to
39%.
Gains and losses on the disposal of revenue equipment are included in
depreciation expense in our statements of operations.
We
annually review the reasonableness of our estimates regarding useful lives
and
salvage values of our revenue equipment and other long-lived assets based upon,
among other things, our experience with similar assets, conditions in the used
revenue equipment market, and prevailing industry practice. Changes in our
useful life or salvage value estimates, or fluctuations in market values that
are not reflected in our estimates, could have a material effect on our results
of operations.
Revenue
equipment and other long-lived assets are tested for impairment whenever an
event occurs that indicates an impairment may exist. Expected future cash flows
are used to analyze whether an impairment has occurred. If the sum of expected
undiscounted cash flows is less than the carrying value of the long-lived asset,
than an impairment loss is recognized. We measure the impairment loss by
comparing the fair value of the asset to its carrying value. Fair value is
determined based on a discounted cash flow analysis or the appraised value
of
the assets, as appropriate. We have not recognized any impairments of long-lived
assets to date.
Accounting
for Investments - Effective July 1, 2000, we combined our logistics business
with the logistics businesses of five other transportation companies into a
company called Transplace, Inc (“Transplace”). Transplace operates a global
transportation logistics service. In the transaction, we contributed our
logistics customer list, logistics business software and software licenses,
certain intellectual property, intangible assets totaling approximately
$5.1 million, and $5.0 million in cash for the initial funding of the
venture, in exchange for 12.4% ownership. We account for our investment using
the cost method of accounting, with the investment included in other assets.
We
continue to evaluate our cost method investment in Transplace for impairment
due
to declines considered to be other than temporary. This impairment evaluation
includes general economic and company-specific evaluations. If we determine
that
a decline in the cost value of this investment is other than temporary, then
a
charge to earnings will be recorded to other (income) expenses in our
consolidated condensed statements of operations for all or a portion of the
unrealized loss, and a new cost basis in the investment will be established.
As
of June 30, 2006, no such charge had been recorded. However, we are closely
evaluating this investment for impairment as our evaluation of the value of
this
investment has been steadily declining over the last few fiscal quarters, and
based on the projected cash flows of Transplace, such a charge could be
forthcoming in upcoming quarterly results. Also, during the first quarter of
2005, the Company loaned Transplace approximately $2.7 million. The 6%
interest-bearing note receivable matures January 2007. Based on the borrowing
availability of Transplace, we do not believe there is any impairment of this
note receivable.
Insurance
and Other Claims - The primary claims arising against us consist of cargo
liability, personal injury, property damage, workers' compensation, and employee
medical expenses. Our insurance program involves self-insurance with high-risk
retention levels. Because of our significant self-insured retention amounts,
we
have significant exposure to fluctuations in the number and severity of claims
and to variations between our estimated and actual ultimate payouts. We accrue
the estimated cost of the uninsured portion of pending claims. Our estimates
require judgments concerning the nature and severity of the claim, historical
trends, advice from third-party administrators and insurers, the size of any
potential damage award based on factors such as the specific facts of individual
cases, the jurisdictions involved, the prospect of punitive damages, future
medical costs, and inflation estimates of future claims development, and the
legal and other costs to settle or defend the claims. We have significant
exposure to fluctuations in the number and severity of claims. If there is
an
increase in the frequency and severity of claims, or we are required to accrue
or pay additional amounts if the claims prove to be more severe than originally
assessed, or any of the claims would exceed the limits of our insurance
coverage, our profitability would be adversely affected.
In
addition to estimates within our self-insured retention layers, we also must
make judgments concerning our aggregate coverage limits. If any claim occurrence
were to exceed our aggregate coverage limits, we would have to accrue for the
excess amount. Our critical estimates include evaluating whether a claim may
exceed such limits and, if so, by how much. Currently, we are not aware of
any
such claims. If one or more claims were to exceed our then effective coverage
limits, our financial condition and results of operations could be materially
and adversely affected.
Lease
Accounting and Off-Balance Sheet Transactions - Operating leases have been
an
important source of financing for our revenue equipment, computer equipment,
and
Company airplane. In connection with the leases of a majority of the value
of
the equipment we finance with operating leases, we issued residual value
guarantees, which provide that if we do not purchase the leased equipment from
the lessor at the end of the lease term, then we are liable to the lessor for
an
amount equal to the shortage (if any) between the proceeds from the sale of
the
equipment and an agreed value. As of June 30, 2006, the maximum amount of the
residual value guarantees was approximately $45.6 million. To the extent the
expected value at the lease termination date is lower than the residual value
guarantee, we would accrue for the difference over the remaining lease term.
We
believe that proceeds from the sale of equipment under operating leases would
exceed the payment obligation on all operating leases. The estimated values
at
lease termination involve management judgments. As leases are entered into,
determination as to the classification as an operating or capital lease involves
management judgments on residual values and useful lives.
Accounting
for Income Taxes - We make important judgments concerning a variety of factors,
including the appropriateness of tax strategies, expected future tax
consequences based on future Company performance, and to the extent tax
strategies are challenged by taxing authorities, our likelihood of success.
We
utilize certain income tax planning strategies to reduce our overall cost of
income taxes. It is possible that certain strategies might be disallowed,
resulting in an increased liability for income taxes. Significant management
judgments are involved in assessing the likelihood of sustaining the strategies
and in determining the likely range of defense and settlement costs, and an
ultimate result worse than our expectations could adversely affect our results
of operations.
On
April
20, 2006, we completed the appeals process with the IRS related to their 2001
and 2002 audits. Related to this settlement with the IRS, we recorded additional
income tax expense of approximately $0.5 million for the three months ended
June
30, 2006. We received a favorable resolution in the Closing Agreement received
from the IRS which stated that our wholly-owned captive insurance subsidiary
made a valid election under section 953(d) of the Internal Revenue Code and
is
to be respected as an insurance company.
Subsequent
to June 30, 2006, the IRS, completed their audit fieldwork of our 2003 and
2004
tax returns and has proposed the disallowance, with which we have agreed, of
approximately $350,000 of costs related to the November 2003 stock offering.
During the three months ended June 30, 2006, we recorded $0.1 million of income
tax expense related to this proposed disallowance of tax benefits. Additionally,
the IRS has proposed to disallow the tax benefits associated with insurance
premium payments made to our wholly-owned captive insurance subsidiary for
the
2003 and 2004 years. Due to the favorable resolution of the 2001 and 2002 IRS
audit on this issue, we are vigorously defending our position related to this
proposed disallowance of tax benefits using all administrative and legal
processes available. For the three and six months ended June 30, 2006, income
tax expense of $0.1 million and $0.2 million, respectively, was recorded in
our
consolidated condensed statements of operations related to this uncertain tax
position. If we are unsuccessful in defending our position on this deduction,
we
could owe additional taxes totaling $1.6 million on this matter. We believe
that
we have properly accrued for this matter on our consolidated condensed balance
sheet at June 30, 2006.
Deferred
income taxes represent a substantial liability on our consolidated condensed
balance sheet and are determined in accordance with SFAS No. 109. Deferred
tax
assets and liabilities (tax benefits and liabilities expected to be realized
in
the future) are recognized for the expected future tax consequences attributable
to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases, and operating loss and
tax credit carry forwards.
The
carrying value of our deferred tax assets assumes that we will be able to
generate, based on certain estimates and assumptions, sufficient future taxable
income in certain tax jurisdictions to utilize these deferred tax benefits.
If
these estimates and related assumptions change in the future, we may be required
to establish a valuation allowance against the carrying value of the deferred
tax assets, which would result in additional income tax expense. On a periodic
basis we assess the need for adjustment of the valuation allowance. No valuation
reserve has been established at June 30, 2006, because, based on forecasted
income, we believe that it is more likely than not that the future benefit
of
the deferred tax assets will be realized. However, there can be no assurance
that we will meet our forecasts of future income.
We
believe that we have adequately provided for our future tax consequences based
upon current facts and circumstances and current tax law. During the first
six
months of 2006, we made no material changes in our assumptions regarding the
determination of income tax liabilities. However, should our tax positions
be
challenged, different outcomes could result and have a significant impact on
the
amounts reported through our consolidated condensed statement of
operations.
INFLATION,
NEW EMISSIONS CONTROL REGULATIONS, AND FUEL COSTS
Most
of
our operating expenses are inflation-sensitive, with inflation generally
producing increased costs of operations. During the past three years, the most
significant effects of inflation have been on revenue equipment prices and
the
compensation paid to the drivers. New emissions control regulations and
increases in commodity prices, wages of manufacturing workers, and other items
have resulted in higher tractor prices, and there has been an industry-wide
increase in wages paid to attract and retain qualified drivers. The cost of
fuel
also has risen substantially over the past three years. We believe this increase
primarily reflects world events rather than underlying inflationary pressure.
We
attempt to limit the effects of inflation through increases in freight rates,
certain cost control efforts, and to limit the effects of fuel prices through
fuel surcharges.
The
engines used in our tractors are subject to emissions control regulations,
which
have substantially increased our operating expenses
.
As of
June 30, 2006, our entire tractor fleet has such emissions compliant engines
and
is experiencing approximately 2% to 4% reduced fuel economy compared with
pre-2002 equipment. In 2007, stricter regulations will become effective.
Compliance with such regulations is expected to increase the cost of new
tractors and could impair equipment productivity, lower fuel mileage, and
increase our operating expenses. These adverse effects combined with the
uncertainty as to the reliability of the vehicles equipped with the newly
designed diesel engines and the residual values that will be realized from
the
disposition of these vehicles could increase our costs or otherwise adversely
affect our business or operations once the regulations become effective.
Fluctuations
in the price or availability of fuel, as well as hedging activities, surcharge
collection, and the volume and terms of diesel fuel purchase commitments may
increase our costs of operation, which could materially and adversely affect
our
profitability.
We
impose
fuel surcharges on substantially all accounts. These arrangements may not fully
protect us from fuel price increases and also may result in us not receiving
the
full benefit of any fuel price decreases. We currently do not have any fuel
hedging contracts in place. If we do hedge, we may be forced to make cash
payments under the hedging arrangements. A small portion of our fuel
requirements for 2006 are covered by volume purchase commitments. Based on
current market conditions, we have decided to limit our hedging and purchase
commitments, but we continue to evaluate such measures. The absence of
meaningful fuel price protection through these measures could adversely affect
our profitability.
SEASONALITY
In
the
trucking industry, revenue generally decreases as customers reduce shipments
during the winter holiday season and as inclement weather impedes operations.
At
the same time, operating expenses generally increase, with fuel efficiency
declining because of engine idling and weather, creating more equipment repairs.
For the reasons stated, first quarter net income historically has been lower
than net income in each of the other three quarters of the year. Our equipment
utilization typically improves substantially between May and October of each
year because of the trucking industry's seasonal shortage of equipment on
traffic originating in California and because of general increases in shipping
demand during those months. The seasonal shortage typically occurs between
May
and August because California produce carriers' equipment is fully utilized
for
produce during those months and does not compete for shipments hauled by our
dry
van operation. During September and October, business increases as a result
of
increased retail merchandise shipped in anticipation of the
holidays.